UNIFORM COMMERCIAL CODE

2010-2011 Edition
Issued in December 2010

The American Law Institute National Conference of Commissioners on Uniform State Laws

OFFICIAL TEXT AND COMMENTS

INCLUDING Article 1 (General Provisions) Article 2 (Sales) Article 2A (Leases) Article 3 (Negotiable Instruments) Article 4 (Bank Deposits and Collections) Article 4A (Funds Transfers) Article 5 (Letters of Credit) Article 6 (Bulk Sales) Article 7 (Documents of Title) Article 8 (Investment Securities) Article 9 (Secured Transactions) Article 10 (Eective Date and Repealer) Article 11 (Eective Date and Transition Provisions) APPENDICES INDEX
The Executive Oce The American Law Institute 4025 Chestnut Street Philadelphia, Pennsylvania 19104 National Conference of Commissioners on Uniform State Laws 111 N. Wabash Ave., Suite 1010 Chicago, Illinois 60602

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TEXT AND NOTES COPYRIGHT 1948-1950, 1952, 1958, 1959, 1963, 1972, 1978, 1987-1991, 1994-1996, 1999-2005, 2007-2010 THE AMERICAN LAW INSTITUTE and NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS

COPYRIGHT 2010 By THE AMERICAN LAW INSTITUTE and NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS

INDEX COPYRIGHT 2010 By Thomson Reuters

TEXT OF UNIFORM COMMERCIAL CODE AND OFFICIAL COMMENTS REPRINTED WITH PERMISSION OF THE AMERICAN LAW INSTITUTE AND THE NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS.

This publication was created to provide you with accurate and authoritative information concerning the subject matter covered; however, this publication was not necessarily prepared by persons licensed to practice law in a particular jurisdiction. The publisher is not engaged in rendering legal or other professional advice and this publication is not a substitute for the advice of an attorney. If you require legal or other expert advice, you should seek the services of a competent attorney or other professional.

PREFACE
This Pamphlet contains the text of the Uniform Commercial Code prepared under the joint sponsorship of The American Law Institute and the National Conference of Commissioners on Uniform State Laws, current through December, 2010. The Code is a comprehensive modernization of various statutes relating to commercial transactions including sales, leases, negotiable instruments, bank deposits and collections, funds transfers, letters of credit, bulk sales, documents of title, investment securities and secured transactions. It replaces the former Uniform Laws relating to sales, conditional sales, negotiable instruments, warehouse receipts, bills of lading, stock transfers and trust receipts. The Code was originally approved by its sponsors and the American Bar Association in 1952, and it has been amended a number of times in succeeding years. An eort to modernize and update the Code was begun in 1987 when new Article 2A was approved. New Article 4A (Funds Transfers) was approved in 1989, and Article 6 (formerly Bulk Transfers, now Bulk Sales) was revised that same year. In 1990, substantial amendments were made to Article 2A (Leases). Article 3 (formerly Commercial Paper, now Negotiable Instruments) was also revised in 1990. Article 8 (Investment Securities) was revised in 1994, and Article 5 (Letters of Credit) was revised in 1995. Revised Article 9 (Secured Transactions) was promulgated in 1998 with subsequent amendments and modications in 1999, 2000, and 2001. Article 1 (General Provisions) was revised in 2001. Article 7 (renamed Documents of Title) was revised in 2003. Article 2 (Sales) and Article 2A (Leases) were amended in 2003 and 2005. This 2009 edition of the Pamphlet contains Permanent Editorial Board Commentary No. 16 (2009) regarding sections 4A-502(d) and 4A-503. The Commentary indicates that neither the originator nor the beneciary of a funds transfer has any property claim to the value held by an intermediary bank in a funds transfer. OFFICIAL COMMENTS One of the indispensable features herein consists of the Ocial Comments, prepared by the National Conference of Commissioners on Uniform State Laws and The American Law Institute, which appear under each section. These Comments explain the purpose and intent of the sections and the changes in the prior law that were eected by the Code. APPENDIX CONTAINING PERMANENT EDITORIAL BOARD (PEB) COMMENTARY The Permanent Editorial Board for the Uniform Commercial Code will issue supplementary commentary on the Code from time to time. The nal draft of Commentaries 1 to 15 may be found in Appendix A. (PEB Comiii

Uniform Commercial Code Reporting Series

mentaries 8 and 11 have been amended to comport with Revised Article 9.) These commentaries normally identify an issue, discuss the issue and come to a conclusion as to how the issue should be resolved. Often, the conclusion will result in a change in the Ocial Comment of one or more sections of the Code. The Ocial Comment, when so changed, will generally refer to the PEB Commentary which brought about the change. All changes in the Ocial Comments as a result of Commentaries 1 to 15 have been incorporated into this Pamphlet. APPENDICES RELATING TO 1972, 1977, AND 1987 CHANGES Appendices are included containing material relating to the 1972 revision of Article 9, the 1977 revision of Article 8 and the 1987 adoption of Article 2A. Appendix B shows the changes in Article 9, and related sections. Included under each section are statements as to the reasons for change. Appendix C shows the changes in Article 8, and related sections. Included under each section are statements as to the reason for change. Appendix D contains amendments to Article 1 and Article 9 conforming to new Article 2A. APPENDICES CONTAINING TEXT AND OFFICIAL COMMENTS OF PRE-REVISION ARTICLES 1, 3, 5, 6, 7, 8, AND 9 Article 6 was revised in 1989, Article 3 was revised in 1990, Article 8 was further revised in 1994, Article 5 was revised in 1995, Article 9 was revised in 1998, Article 1 was revised in 2001, and Article 7 was revised in 2003. The pre-revision versions of the Text and Ocial Comments of these articles may be found variously in Appendix E (Pre-Revision Article 6), Appendix G (Pre-Revision Article 3), Appendix L (Pre-Revision Article 8), Appendix N (Pre-Revision Article 5), Appendix O (Pre-Revision Article 9), Appendix P (Pre-Revision Article 1), and Appendix R (Pre-Revision Article 7). APPENDIX CONTAINING 1990 ARTICLE 1 AMENDMENTS CONFORMING TO REVISED ARTICLE 3 In conjunction with the revision of Article 3 in 1990, conforming amendments to Article 1 were approved. These amendments may be found in Appendix H. APPENDICES CONTAINING 1990 AMENDMENTS TO ARTICLE 2A In 1990, 24 text amendments were made to Article 2A. In addition, the Ocial Comments of three sections, which were not amended textually, were changed to conform to the various text amendments. All of these may be found in Appendix F. TO ARTICLE 4 In 1990, a substantial number of amendments were made to Article 4. Many of these were made to conform to Revised Article 3. Others were miscellaneous amendments. These amendments, together with the reasons for the 1990 changes, may all be found in Appendix I.
iv

Preface

APPENDIX CONTAINING VARIOUS 1994 AMENDMENTS Various amendments were made in 1994 not relating to the revision of Article 8. These amendments may be found in Appendix J. APPENDIX CONTAINING 1994 AND 1995 AMENDMENTS TO ARTICLES 1, 3, 4, 5, 9, AND 10 CONFORMING TO 1994 REVISION OF ARTICLE 8 In 1994 and 1995, amendments to Articles 1, 3, 4, 5, 9, and 10 were made to conform to the 1994 revision of Article 8. These amendments may be found in Appendix K. APPENDIX CONTAINING 1995 AMENDMENTS TO ARTICLES 1, 2, AND 9 CONFORMING TO REVISED ARTICLE 5 In 1995, amendments to Articles 1, 2, and 9 were made to conform to the revision of Article 5. These amendments may be found in Appendix M. APPENDIX CONTAINING 2002 AMENDMENTS TO ARTICLES 3 AND 4 Articles 3 and 4 were amended in 2002. The amendments may be found in Appendix Q. APPENDICES CONTAINING 2003 AMENDMENTS TO ARTICLES 2 AND 2A Articles 2 and 2A were amended in 2003. The amendments may be found in Appendices T and U, respectively. APPENDIX CONTAINING 2005 AMENDMENTS A number of amendments and Ocial Comment corrections were approved in 2005 aecting Articles 1, 2, 2A, 3, and 9. These changes may be found in Appendix V. APPENDIX CONTAINING 2006 OFFICIAL COMMENT CORRECTIONS Ocial Comment corrections aecting Articles 2A and 9 were approved in 2006. The corrections may be found in Appendix W. APPENDIX CONTAINING 2008 AMENDMENT Amendment of Article 1-301 was approved in May, 2008. The amendment may be found in Appendix X. APPENDIX CONTAINING PRE-REVISION ARTICLE 2 Article 2 was amended in 2003 and has not yet been adopted. Prerevision Article 2 can be found in Appendix Y. SPECIAL FEATURES The various materials in the preliminary part of this Pamphlet all contribute to a better understanding of the Code and aid in its interpretation.
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Uniform Commercial Code Reporting Series

The Foreword, written by the Chair of the Permanent Editorial Board, provides an up-to-date overview of the recent modernization of the Code. The Article, Part and Section analysis, beginning on page 1, provides an easy means of nding particular provisions of the Code. INDEX This edition includes an up-to-date index prepared by the publishers Editorial Sta. The Publisher December 2010

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PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE

CHAIR John A. Sebert, Chicago, Illinois Executive Director, NCCUSL
MEMBERS ALI Designees E. Carolan Berkley, Philadelphia, PA Amelia H. Boss, Philadelphia, PA Stephanie Heller, Brooklyn, NY Lance Liebman, New York, NY Linda J. Rusch, Spokane, WA Steven O. Weise, Los Angeles, CA EMERITUS MEMBERS Marion W. Benfield, Jr., New Braunfels, TX William H. Henning, Tuscaloosa, AL Fred H. Miller, Norman, OK EX OFFICIO Roberta Cooper Ramo, Albuquerque, NM President, ALI Robert A. Stein, Minneapolis, MN President, NCCUSL NCCUSL Designees Boris Auerbach, Indianapolis, IN Patricia Brumfield Fry, Edgewood, NM Carlyle C. Ring, Jr., Washington, DC Edwin E. Smith, Boston, MA James J. White, Ann Arbor, MI DIRECTOR OF RESEARCH Neil B. Cohen, Brooklyn, NY LIAISONS Carter H. Klein, Chicago, IL ABA Business Law Section Teresa W. Harmon, Chicago, IL ABA Advisor ALI STAFF Deanne Dissinger, Philadelphia, PA Stephanie Middleton, Philadelphia, PA NCCUSL STAFF Michael R. Kerr, Chicago, IL Katie Robinson, Chicago, IL

vii

FOREWORD TO OFFICIAL TEXT AND COMMENTS

The Permanent Editorial Board and its constituent organizations, the American Law Institute and the National Conference of Commissioners on Uniform State Laws, have worked for more than two decades to update the Uniform Commercial Code. The eort has been greatly assisted by the American Bar Association, which has provided advisers at each step along the way. This eort began with two new articles: Article 2A, rst promulgated in 1987 and revised in 1990, provides a legal structure for leases of goods, and Article 4A (1989) governs commercial funds transfers. The PEB then directed its attention to the original articles of the Code. The primary goal was not to create new law but rather to bring the articles up to date in terms of modern business practices and technology. Articles 3 and 4, covering negotiable instruments and bank deposits and collections, were thoroughly revised in 1990 (and amendments to a limited number of particular provisions in those articles were recommended in 2002). The PEB then recommended repeal of Article 6 (dealing with bulk sales) as no longer necessary in light of modern commercial realities; as an alternative for jurisdictions that chose not to repeal the article, the PEB drafted a revised version of Article 6. Article 8, dealing with investment securities, was revised in 1994, primarily to provide a full set of rules for the indirect holding system that had developed in the securities markets in order to facilitate trades. Article 5, which governs letters of credit, was revised in 1995 to coordinate better with developments in domestic and international letter of credit practice. The modernization of the law of secured credit codied in Article 9, a large undertaking with great commercial signicance, was a major achievement. The state legislatures quickly enacted these revised articles. In the case of Article 9, nationwide enactment was accomplished in just three years, a remarkable achievement. The next step in the modernization process was the promulgation in 2001 of a revised text of Article 1 which, in addition to denitions, contains a limited number of basic substantive rules generally applicable throughout the UCC. Most recently, a set of amendments to sections in Articles 2 and 2A and a revised version of Article 7 were promulgated in 2003. Much of this work, along with the 2002 amendments to Articles 3 and 4, remains on the agenda for enactment in the states. Throughout the modernization project, the PEB and the sponsoring organizations have been cognizant of the need to amend and revise the articles in a manner that comports with modern commercial practices, including the now-prevalent use of electronic methods of doing business. At the same time, the amendments and revisions have exhibited sensitivity to the unique issues that sometimes come
ix

Uniform Commercial Code

into play when transactions involve consumers. The Conference and the Institute are proud of the modernization of the UCC and grateful to the Reporters and the members of Drafting Committees who devoted long hours to this work, as well as to the many others who participated in the process, especially those who oered constructive criticism and who patiently worked to improve laws so crucial to the economy of the United States. John A. Sebert Chair Permanent Editorial Board for the Uniform Commercial Code December 2010

REPORT NO. 1
OF THE PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE October 31, 1962 To the American Law Institute and the National Conference of Commissioners on Uniform State Laws: As this is the rst report made by this Board, it may be worthwhile briey to outline the history which led to the Boards establishment. The Uniform Commercial Code was promulgated by the Conference and the Institute, with the endorsement of the American Bar Association, in the fall of 1951. It had been drafted under the supervision of an Editorial Board composed of representatives of the Conference and the Institute. In 1953, Pennsylvania enacted the Code with no variations from the text which the Codes Editorial Board had approved. No further enactments of the original Code ensued. The reason was that the New York Legislature, instead of enacting the Code, referred it to the New York Law Revision Commission and gave that expert body a large appropriation to enable it to make a critical line-by-line examination of the Code. When this occurred, the Codes Editorial Board was re-activated as were the subcommittees of the Board which had worked on the several articles. In February, 1956, the New York Law Revision Commission made its report in which it approved the idea of a code of commercial law but expressed the opinion that the Code as originally drafted was unsuitable for enactment by New York. While the Code was being studied by the New York Law Revision Commissions task forces, they were in communication with the Editorial Boards subcommittees, so that when the 1956 report was issued, its contents were no surprise to the sponsors of the Code. The Editorial Board immediately resumed intensive work. It adopted a large number of the suggestions made by the New York Commission and, late in 1956, issued a revised Code. This revised Code was enacted by Massachusetts in September, 1957, eective on October 1, 1958, and by Kentucky in 1958, eective July 1, 1960. It was published as the 1957 Ocial Text. In 1958 the Codes Editorial Board promulgated certain amendments to Articles 8 and 9 of the Code, and the Code was republished as the 1958 Ocial Text. Successively, Connecticut, New Hampshire, Rhode Island, Wyoming, Arkansas, New Mexico, Ohio, Oregon, Oklahoma, Illinois, New Jersey, Georgia, Alaska, New York and Michigan enacted the 1958 version of the Code. And, in 1959, Pennsylvania re-enacted the Code, substituting for the
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Uniform Commercial Code

original version the 1958 Ocial Text. It became apparent in 1961 that almost every state enacting the Code was making its own amendments, thus very largely imperiling the primary object of the code which is UNIFORMITY in the laws of the various states regulating commercial transactions. In an eort to curb this tendency, the Institute applied to the Maurice and Laura Falk Foundation, (which had contributed upwards of $275,000 to the cost of preparing the original Code) for an additional grant in the amount of $125,000 to endow the work of a Permanent Editorial Board. The Falk Foundation very generously made the grant and the Board was constituted pursuant to a written agreement between the Conference and the Institute dated August 5, 1961. This agreement provides that the Director of the Institute shall be ex ocio chairman of the Board, that the Chairman of the Commercial code Committee of the Conference shall be an ex ocio member, and that the Conference shall select four additional representatives and the Institute ve. Not more than one elected member may come from any state and the agreement makes it clear that it is desirable, generally speaking, to have as members of the Board, lawyers who come from states which have enacted the Code. Immediately upon the selection of the members of the Board by the Conference and the Institute, the late Judge Goodrich, who as Director of the Institute was ex ocio chairman of the Board, appointed three subcommittees as follows: Subcommittee No. 1, to consider Articles 1, 2, 6 & 7: Professor Robert Braucher, Harvard University Law School, Chairman, Bernard D. Broeker, Bethlehem, Pennsylvania, and Professor William D. Hawkland, University of Illinois Law School. Subcommittee No. 2, to consider Articles 3, 4, 5 & 8: Walter D. Malcolm, Boston, Chairman; Robert M. Blair-Smith, Philadelphia; John J. Clarke, New York; Carl W. Funk, Philadelphia; Murdoch K. Goodwin, Philadelphia; Carlos L. Israels, New York; Arthur Littleton, Philadelphia; Soia Mentschiko, University of Chicago Law School; and William C. Pierce, New York. Subcommittee No. 3, to consider Article 9: J. Francis Ireton, Baltimore; Peter F. Coogan, Boston; Anthony G. Felix, Jr., Philadelphia; Grant Gilmore, Yale University Law School; Roy C. Haberkern, Jr., New York; Homer L. Kripke, New Jersey; and Durmont W. McGraw, Chicago. Judge Goodrich also appointed Soia Mentschiko consultant to the Board and Paul A. Wolkin of Philadelphia, as the Boards secretary. The Board held its rst meeting in Washington, D.C. in May, 1962, when there was a preliminary discussion of the manner in which the subcommittees and the Board would function. At this time a meeting was xed for October 12, 13 and 14th in Philadelphia. The subcommittees examined every amendment which had been made to the Code in the 18 Codes enacted thus far. They also examined a large number of amendments proposed in California and a somewhat smaller number proposed in Wisconsin. In both states a Code bill will probably be introduced into the legislature in 1963. At its meeting in Philadelphia on October 12, 13 and 14th, the Board reviewed the work of the subcommittees, and made the recommendations
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Report No. 1

which follow. We deem it appropriate in connection with this rst report of the Board to print as an Appendix the agreement between The American Law Institute and the National Conference of Commissioners on Uniform State Laws dated August 5, 1961, as amended by a supplemental agreement which has just been executed by the ocers of both organizations. Under Article SEVENTH of the agreement, as amended, the jurisdiction of this Board is rather limited. We certainly do not have any authority to undertake a rewriting of the Code or to make amendments merely because someone feels that a particular provision might have been drafted with greater clarity. The only justication for clarifying amendments must be found in clause (d) of Article SEVENTH which was added by the supplementary agreement. Our recommendations are made in three parts.1 Part I consists of recommendations for the amendment of the 1958 Ocial Text of the Code plus amendments of the Ocial Comments which the changes in text render necessary. Part II consists of the amendments to the Ocial Text made in the various states which the Board rejects, together with the reasons for rejection. Part III consists of a few amendments to the 1958 Ocial Comments which are deemed desirable in the light of experience under the Code. We are not publishing our comments on the proposed California and Wisconsin amendments, but we have furnished them to the Commissioners on Uniform State Laws in those states respectively. We understand that West Publishing Company will shortly put out a 1962 Ocial Text with Comments. This will contain the Text as modied by the amendments in Part I, plus the changes in Comments contained in Parts I and III. We shall be very glad to supply copies of this Report on request. Prior to the issuance of this Report, the amendments recommended in Part I were approved by majorities of the Executive Committees of both of the organizations to which the Report is addressed. RESPECTFULLY SUBMITTED, Wm. A. Schnader Pennsylvania, Acting Chairman. John C. Barrett, Arkansas. Francis M. Bird, Georgia. Willoughby A. Colby, New Hampshire. Albert E. Jenner, Jr. Illinois

October 31, 1962

Paul A. Wolking Secretary The American Law Institute 133 South 36th Street Philadelphia 4, Pennsylvania
1

Reference is to Parts I-III of the Boards 1962 Report which, because of space limitations, could not be accomodated in this edition. xiii

Uniform Commercial Code

John W. MacDonald New York. Walter D. Malcolm, Massachusetts. Ross L. Malone, New Mexico. Maurice H. Merrill, Oklahoma. George R. Richter, Jr., California.

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REPORT NO. 2
OF THE PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE October 31, 1964 To the American Law Institute and the National Conference of Commissioners on Uniform State Laws:The rst report of this Board was made on October 31, 1962. At that time 18 states had enacted the Uniform Commercial Code. Of the 18 states, some endeavored to adhere to the Ocial Text of the Code as promulgated by your two organizations which had sponsored it. For example, the Pennsylvania Code in 1962 had only one substantive departure from the Ocial Text and that departure was a carry-over from the 1952 Ocial Text. The 1959 Pennsylvania Act brought its Code in line with the amendments which had been ocially recommended by the Editorial Board with the approval of the Executive Committees of both of your organizations. Illinois was another state which enacted the Code almost precisely as promulgated. However, other states made a large number of amendments and thus weakened their Codes pro tanto as uniform legislation governing in the same way the same commercial transaction wherever it occurred. In our Report No. 1 dated October 31, 1962, we examined every unocial amendment which had been made by any one of the 18 states and either recommended it for uniform adoption by all American jurisdictions or rejected it and gave the reasons for our action. The rejected amendments appeared at pages 65 to 135, inclusive, of our Report No. 1.1 Subsequent to October 31, 1962, 12 jurisdictions have enacted the Code. With the exception of Nebraska, each of these states used the 1962 Ocial Text of the Code as the basis for its Code bill. And the 1962 Ocial Text was the 1958 Ocial Text, plus the 1962 amendments promulgated by this Board in its Report No. 1 with the approval of the Executive Committees of both of your organizations. We had hoped that our Report No. 1 would serve to minimize amendments to the Code by jurisdictions which would enact it subsequent to our report. While our report may have had some eect in this direction, we are sorry to say that again far too many unocial amendments were enacted. In this report we have repeated our objections to the amendments made to Codes enacted prior to October 31, 1962, and, in addition, have examined all new, unocial amendments made in the 30 jurisdictions which have enacted the Code to date. None of the unocial variations is such an improvement over the 1962 Ocial Text of the Code as to lead the Board to recommend it at this time. Therefore, for the 1965 session of legislatures
1

These amendments have been omitted because of space limitations. xv

Uniform Commercial Code

the 1962 Text of the Code will continue to be the Ocial Text. In the following pages we are dealing with every nonocial amendment to the Code.2 We are quoting the text, showing in what state or states the unocial modication has been made and stating our objection. We do hope that this report will serve to promote uniformity of statutory law governing commercial transactions by preventing states which have not yet enacted the Code from marring the eciency and purpose of their Codes by making unocial amendments, and by encouraging the jurisdictions whose Codes are not really uniform to clean them up by repealing the non-uniform amendments. Lest the position of the Board be misunderstood, it may be worthwhile to say that the Board does not take the position that the 1962 Ocial Text is the last word and that the Code may not be improved as experience under its provisions develops. In due time, the Board intends to make a comprehensive examination of the Code from beginning to end. But experience has taught those interested in the uniformity of our statutory law that it has been much easier to get uniform laws on the books in the rst instance than it has been to interest legislatures in bringing them up to date by amendment. Uniformity of commercial law was the impelling goal of those who worked hard and long for the preparation of the Code and any future revision must, before its promulgation, be appraised from the standpoint of the likelihood of its prompt acceptance by all of the jurisdictions then operating under the Code. Amendments should be the result of experience rather than of theory. It is an interesting fact that in Pennsylvania, which stands high in commercial importance among the states, the Code has been in eect for more than ten years, with never more than one unocial substantive amendment at any one time, and that the Permanent Editorial Board never heard of any request from any segment of business, nance or industry in Pennsylvania to amend any section of the Code. October 31, 1964 Paul A. Wolkin, Secretary 101 North 33rd Street Philadelphia, Pa. 19104. Respectfully submitted, Wm. A. Schnader, Pennsylvania, Chairman Joe C. Barrett, Arkansas Francis M. Bird, Georgia Willoughby A. Colby, New Hampshire Albert E. Jenner, Jr., Illinois John W. MacDonald, New York Walter D. Malcolm, Massachusetts Ross L. Maloney New Mexico

This materials has been omitted because of space limitations.

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Report No. 2

Maurice H. Merrill, Oklahoma George R. Richter, Jr., California Herbert Wechsler, Pennsylvania

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REPORT NO. 3
OF THE PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE December 15, 1966 To the American Law Institute and the National Conference of Commissioners on Uniform State Laws: The last report of this Board [Report No. 2] was made on October 31,1964, at which time 29 states and one jurisdiction (the District of Columbia) had enacted the Uniform Commercial Code. Since that time up to the date of this report, additional states and jurisdictions have enacted the Code to bring the total enactments up to 49. Only three statesArizona, Idaho and Louisianahave not as yet enacted the Code, and two other American jurisdictionsGuam and Puerto Ricohave its enactment under consideration. Since 1964 our Board has had two meetings, both in Philadelphia. The rst was on January 14 and 15, 1966 and the second on November 11 and 12, 1966. At both 1966 meetings the Board received reports from Subcommittees Nos. 1, 2 and 3 to which had been assigned the task of studying and making recommendations on the many, many non-uniform amendments which had been made to the Code as it was enacted jurisdiction by jurisdiction. Three amendments were approvedamendments to Sections 2702, 3501 and 7209. The rst of these amendments has been adopted by California, Connecticut, Illinois, Maine, New Jersey, New Mexico and New York, the second by Iowa and the third by California. They are published herein with the amendment of the 1962 Ocial Comments which changes in the text require. We also considered an amendment added as a new Section 1209 to the New York Uniform Commercial Code. It was the feeling of the Board that this amendment is not necessary, but that it was completely harmless and that if any states other than New York desired to add it to their Codes, they should have the blessing of the Permanent Editorial Board in doing so. Therefore, it is promulgated as a new optional section with appropriate Ocial Comment. The Board also felt that Section 2318, which has been nonuniformly amended in a number of states and entirely omitted in California and Utah, is a section not requiring uniformity throughout all American jurisdictions. Therefore, the Board is designating the present Section 2318 as an Alternative A and is promulgating two alternativesAlternative B and Alternative Cwhich states desiring warranties to have a broader impact may adopt if they choose. Also, the Board is promulgating optional amendments to Sections 9105 and 9106 which will enable states having nautical contacts to amend their Codes to make it clear that a ship charter is not chattel paper
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but that all rights earned or unearned under a charter or other contract involving the use or hire of a vessel are contract rights and neither accounts nor general intangibles. All of these amendments and optional amendments follow in the ensuing text. A number of suggested amendments to Article 9 were discussed at the January meeting without denite decisions. This was due to some extent to the fact that the various people who wanted to see changes in certain sections of the Article were by no means agreed as to how the sections should be changed. By the time the November meeting was held, 337 nonuniform, non ocial amendments had been made to the various sections of Article 9. Some sections had been amended by as many as 30 jurisdictions, each jurisdiction writing its own amendment without regard to the amendments made by other jurisdictions and, of course, without regard to the Ocial Text. 47 of the 54 Sections of Article 9 had been non-uniformly amended. In view of this distressing situation and in view also of the fact that various practicing lawyers and law teachers have written articles or textbooks pointing out certain respects in which Article 9 might be improved, the Board decided that the time had arrived for a restudy in depth of Article 9 on Secured Transactions. It must be remembered that the Code has been in operation since July 1, 1954, so that a really impressive body of experience has been built up under which to make this restudy in depth. A special Article 9 Review Committee was appointed. It consists of Professor Herbert Wechsler, Director of The American Law Institute as Chairman, Joe C. Barrett, a practicing lawyer, of Jonesboro, Arkansas, Carl W. Funk, a practicing lawyer, of Philadelphia, the Honorable John S. Hastings, Chief Judge of the United States Court of Appeals for the Seventh Circuit, Robert Haydock, Jr., a practicing lawyer, of Boston, Ray D. Henson, a practicing lawyer, of Chicago, Professor Harold Marsh, Jr. of the University of California Law School at Los Angeles, William Curtis Pierce, a practicing lawyer, of New York, Professor Millard H. Ruud of the University of Texas Law School and the Honorable Sterry R. Waterman, Judge of the United States Court of Appeals for the Second Circuit. The Research and Reportorial Sta for the Committee will be Professor Robert Braucher of the Harvard University Law School, Reporter; Professor Homer Kripke of the New York University Law School, Associate Reporter; and Professor Soia Mentschiko of the University of Chicago Law School, Associate Reporter ex ocio. To raise the additional funds which will be required for this work, Mr. Howard C. Petersen of Philadelphia has been appointed Chairman of a Ways and Means Committee. In,view of the appointment of the Article 9 Review Committee, two of the Subcommittees of the Board were relieved of their duties for the presentSubcommittee No. 3 and the Reportorial Committee. For their past services the Board expresses to them its gratitude and appreciation.
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Report No. 3

A large part of this volume [Report No. 3] is devoted to the publication of new, nonuniform amendments1 adopted subsequent to our Report No. 2. In cases where another state has simply copied a non-uniform amendment which the Board has previously rejected, we merely refer to the page of Report No. 2 where the Boards reasons for rejection will be found. However, in cases where new, non-uniform amendments have been inserted in the Code, we are quoting the non-uniform amendment and giving our reasons for rejection. Finally, the Board received from certain individuals and organizations suggestions for amendment of certain sections of the Code. Its Subcommittees considered these suggestions and did not nd any basis for uniform amendment in any of the proposals relating to the rst eight Articles of the Code. The Board approved the Subcommittees recommendations. As to suggestions coming to the Board for the amendment of provisions of Article 9 of the Code, all of these recommendations were referred to the special Article 9 Review Committee for study and report. December 15, 1966 Paul A. Wolkin, Respectfully submitted, Secretary Wm. A. Schnader, 101 North 33rd Street Pennsylvania, Philadelphia, Pa. 19104 Chairman Consultant Joe C. Barrett, Soia Mentschiko Arkansas Illinois F. M. Bird, Georgia James C. Dezendorf, Oregon Albert E. Jenner, Jr., Illinois John W. MacDonald, New York Walter D. Malcolm, Massachusetts Maurice H. Merrill, Oklahoma Alfred M. Pence, Wyoming George R. Richter, Jr., California Herbert Wechsler, New York Alternates J. Francis Ireton, Maryland William J. Pierce, Michigan
1

This portion of Report No. 3 has been omitted because of space limitations. xxi

ACKNOWLEDGMENT UNIFORM COMMERCIAL CODE OFFICIAL TEXT AND COMMENTS

Acknowledgment is gratefully made to The American Law Institute and to the National Conference of Commissioners on Uniform State Laws for permission to reproduce the Ocial Text and Comments for the Uniform Commercial Code. The Publisher December 2010

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Summary of Contents
ARTICLE 1 GENERAL PROVISIONS ................................ ARTICLE 2 SALES ......................................................... ARTICLE 2A LEASES .................................................... ARTICLE 3 NEGOTIABLE INSTRUMENTS ....................... ARTICLE 4 BANK DEPOSITS AND COLLECTIONS ........... ARTICLE 4A FUNDS TRANSFERS ................................... ARTICLE 5 LETTERS OF CREDIT ...................................
9 50 200 312 432 484 552

REPEALER OF ARTICLE 6 BULK TRANSFERS AND [REVISED] ARTICLE 6 BULK SALES(STATES TO SELECT ONE ALTERNATIVE).............................................................. 590 ARTICLE 7 DOCUMENTS OF TITLE ................................ ARTICLE 8 INVESTMENT SECURITIES ........................... ARTICLE 9 SECURED TRANSACTIONS ........................... ARTICLE 10 EFFECTIVE DATE AND REPEALER ............. ARTICLE 11 EFFECTIVE DATE AND TRANSITION PROVISIONS ................................................................. APPENDIX A PEB COMMENTARIES ON THE UNIFORM COMMERCIAL CODE .....................................................
621 707 819 1139

1141

1144

APPENDIX B 1972 OFFICIAL TEXT SHOWING CHANGES MADE IN FORMER TEXT OF ARTICLE 9, SECURED TRANSACTIONS, AND OF RELATED SECTIONS AND REASONS FOR CHANGES ...................................................................... 1249 APPENDIX C 1977 OFFICIAL TEXT SHOWING CHANGES MADE IN FORMER TEXT OF ARTICLE 8, INVESTMENT SECURITIES, AND OF RELATED SECTIONS AND REASONS FOR CHANGES ...................................................................... 1338 APPENDIX D ARTICLE 1 AND ARTICLE 9: 1987 CONFORMING AMENDMENTS [CONFORMING TO ARTICLE 2A] ............. 1398
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APPENDIX E PRE-REVISION ARTICLE 6 ........................ APPENDIX F 1990 AMENDMENTS TO ARTICLE 2A .......... APPENDIX G PRE-REVISION ARTICLE 3 ........................

1403 1414 1475

APPENDIX H 1990 ARTICLE 1 AMENDMENTS CONFORMING TO REVISED ARTICLE 3 ...................................................... 1571 APPENDIX I 1990 CONFORMING [TO REVISED ARTICLE 3] AND MISCELLANEOUS AMENDMENTS TO ARTICLE 4 ............ 1574 APPENDIX J 1994 AMENDMENTS TO UNIFORM COMMERCIAL 1604 CODE ............................................................................ APPENDIX K 1994 AND 1995 AMENDMENTS TO ARTICLES 1, 3, 4, 5, 9, AND 10 CONFORMING TO 1994 REVISION OF ARTICLE 8 ................................................................................... 1616 APPENDIX L PRE-REVISION ARTICLE 8.........................
1641

APPENDIX M 1995 AMENDMENTS TO ARTICLES 1, 2, AND 9 CONFORMING TO REVISED ARTICLE 5 .......................... 1714 APPENDIX N PRE-REVISION ARTICLE 5 ........................ APPENDIX O PRE-REVISION ARTICLE 9 ........................ APPENDIX P PRE-REVISION ARTICLE 1 ........................ APPENDIX Q 2002 AMENDMENTS TO ARTICLES 3 AND 4 ................................................................................... APPENDIX R PRE-REVISION ARTICLE 7 ........................ APPENDIX S [RESERVED] ............................................. APPENDIX T 2003 AMENDMENTS TO ARTICLE 2 ............ APPENDIX U 2003 AMENDMENTS TO ARTICLE 2A ..........
1718 1739 1864

1889 1924 1966 1967 2049

APPENDIX V 2005 AMENDMENTS TO UNIFORM COMMERCIAL CODE AS APPROVED BY THE NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS AND THE AMERICAN LAW INSTITUTE .......................................... 2102 APPENDIX W 2006 OFFICIAL COMMENT CORRECTIONS TO UNIFORM COMMERCIAL CODE AS APPROVED BY THE NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS AND THE AMERICAN LAW INSTITUTE ....... 2110

xxvi

Summary of Contents

APPENDIX X 2008 AMENDMENT TO UNIFORM COMMERCIAL CODE REVISED ARTICLE 1 AS APPROVED BY THE NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS AND THE AMERICAN LAW INSTITUTE .................. 2112 APPENDIX Y ARTICLE 2 SALES [1995] ............................ Index
2119

xxvii

Table of Contents
UNIFORM COMMERCIAL CODE GENERAL COMMENT OF NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS AND THE AMERICAN LAW INSTITUTE .......................................... ARTICLE 1 GENERAL PROVISIONS ................................

2 9

DRAFTING COMMITTEE TO REVISE UNIFORM COMMERCIAL 10 CODE ARTICLE 1GENERAL PROVISIONS ..................... PART 1. GENERAL PROVISIONS ....................................
1-101 1-102 1-103 1-104 1-105 1-106 1-107 1-108 Short Titles. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Scope of Article. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Construction of [Uniform Commercial Code] to Promote Its Purposes and Policies; Applicability of Supplemental Principles of Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Construction Against Implied Repeal. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Severability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Use of Singular and Plural; Gender.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Section Captions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Relation to Electronic Signatures in Global and National Commerce Act. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 10 11 11 13 13 13 14 14

PART 2. GENERAL DEFINITIONS AND PRINCIPLES OF INTERPRETATION .........................................................

1-201 1-202 1-203 1-204 1-205 1-206 General Denitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notice; Knowledge.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lease Distinguished From Security Interest. . . . . . . . . . . . . . . . . . . . . . . Value.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reasonable Time; Seasonableness.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Presumptions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

14 14 22 23 26 27 27

PART 3. TERRITORIAL APPLICABILITY AND GENERAL RULES ..........................................................................

1-301 1-302 1-303 1-304 1-305 1-306 1-307 1-308 Territorial Applicability; Parties' Power to Choose Applicable Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Variation by Agreement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Course of Performance, Course of Dealing, and Usage of Trade. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligation of Good Faith. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Remedies to Be Liberally Administered. . . . . . . . . . . . . . . . . . . . . . . . . . . . Waiver or Renunciation of Claim or Right After Breach. . . . . . . . . Prima Facie Evidence by Third-Party Documents.. . . . . . . . . . . . . . . . Performance or Acceptance Under Reservation of Rights. . . . . . . .

28 28 29 30 32 33 33 34 34
xxix

 1-309 1-310

Option to Accelerate at Will.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Subordinated Obligations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

35 35 36 50 53 53 53 54 58 59 61 62 63

APPENDIX I. CONFORMING AMENDMENTS TO OTHER ARTICLES ..................................................................... ARTICLE 2 SALES ......................................................... PART 1. SHORT TITLE, GENERAL CONSTRUCTION AND SUBJECT MATTER ........................................................
2-101 2-102 2-103 2-104 2-105 2-106 2-107 2-108 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Scope; Certain Security and Other Transactions Excluded from this Article. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions: Merchant; Between Merchants; Financing Agency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions: Transferability; Future Goods; Lot; Commercial Unit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions: Contract; Agreement; Contract for Sale; Sale; Present Sale; Conforming to Contract; Termination; Cancellation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goods to Be Severed from Realty: Recording. . . . . . . . . . . . . . . . . . . . . . Transactions Subject to Other Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 2. FORM, FORMATION, TERMS AND READJUSTMENT OF CONTRACT; ELECTRONIC CONTRACTING...................... 65

2-201 2-202 2-203 2-204 2-205 2-206 2-207 2-208 2-209 2-210 2-211 Formal Requirements; Statute of Frauds.. . . . . . . . . . . . . . . . . . . . . . . . . . Final Expression in a Record: Parol or Extrinsic Evidence.. . . . . . Seals Inoperative. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Formation in General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Firm Oers.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Oer and Acceptance in Formation of Contract. . . . . . . . . . . . . . . . . . . Terms of Contract; Eect of Conrmation.. . . . . . . . . . . . . . . . . . . . . . . . . Reserved.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Modication; Rescission and Waiver. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Delegation of Performance; Assignment of Rights.. . . . . . . . . . . . . . . . Legal Recognition of Electronic Contracts, Records, and Signatures.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Attribution. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Electronic Communication. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 68 69 70 71 73 74 75 75 77 79 80 81

2-212 2-213

PART 3. GENERAL OBLIGATION AND CONSTRUCTION OF CONTRACT....................................................................

2-301 2-302 2-303 2-304 2-305 2-306 General Obligations of Parties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unconscionable Contract or Term. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allocation or Division of Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Price Payable in Money, Goods, Realty, or Otherwise. . . . . . . . . . . . . Open Price Term. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Output, Requirements and Exclusive Dealings.. . . . . . . . . . . . . . . . . . . .

82 82 82 83 83 84 86

xxx

Table of Contents Delivery in Single Lot or Several Lots. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Absence of Specied Place for Delivery.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Absence of Specic Time Provisions; Notice of Termination. . . . . . Open Time for Payment or Running of Credit; Authority to Ship under Reservation.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-311 Options and Cooperation Respecting Performance.. . . . . . . . . . . . . . . . 2-312 Warranty of Title and Against Infringement; Buyer's Obligation Against Infringement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-313 Express Warranties by Armation, Promise, Description, Sample; Remedial Promise. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-313A Obligation to Remote Purchaser Created by Record Packaged with or Accompanying Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-313B Obligation to Remote Purchaser Created by Communication to the Public. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-314 Implied Warranty: Merchantability; Usage of Trade. . . . . . . . . . . . . . 2-315 Implied Warranty: Fitness for Particular Purpose. . . . . . . . . . . . . . . . . 2-316 Exclusion or Modication of Warranties. . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-317 Cumulation and Conict of Warranties Express or Implied. . . . . . 2-318 Third-Party Beneciaries of Warranties and Obligations. . . . . . . . . 2-319 Reserved. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-320 Reserved. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-321 Reserved. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-322 Reserved. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-323 Reserved. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-324 Reserved. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-325 Failure to Pay by Agreed Letter of Credit. . . . . . . . . . . . . . . . . . . . . . . . . . 2-326 Sale on Approval and Sale or Return.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-327 Special Incidents of Sale on Approval and Sale or Return. . . . . . . . 2-328 Sale by Auction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-307 2-308 2-309 2-310 87 88 89 91 92 94 96 99 102 104 107 108 111 112 113 114 114 114 114 114 114 114 116 117

PART 4. TITLE, CREDITORS, AND GOOD-FAITH PURCHASERS................................................................

2-401 2-402 2-403 Passing of Title; Reservation for Security; Limited Application of this Section.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights of Seller's Creditors Against Sold Goods. . . . . . . . . . . . . . . . . . . Power to Transfer; Good Faith Purchase of Goods; Entrusting.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

118 118 120 121 123 123 125 126 128 130 131 133 134 136

PART 5. PERFORMANCE ...............................................

2-501 2-502 2-503 2-504 2-505 2-506 2-507 2-508 2-509 Insurable Interest in Goods; Manner of Identication of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buyer's Right to Goods on Seller's Insolvency, Repudiation, or Failure to Deliver. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Manner of Seller's Tender of Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shipment by Seller. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Shipment under Reservation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights of Financing Agency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Seller's Tender; Delivery on Condition. . . . . . . . . . . . . . . . . . . Cure by Seller of Improper Tender or Delivery; Replacement. . . Risk of Loss in the Absence of Breach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

xxxi

2-510 2-511 2-512 2-513 2-514

2-515

Eect of Breach on Risk of Loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tender of Payment by Buyer; Payment by Check. . . . . . . . . . . . . . . . . Payment by Buyer Before Inspection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buyer's Right to Inspection of Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . When Documents Deliverable on Acceptance; When on Payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Preserving Evidence of Goods in Dispute.. . . . . . . . . . . . . . . . . . . . . . . . . .

137 138 139 140 143 143 144 144 145 146 148 148 150 151 154 156 159 160 161 163 164 165 168 169 169 169 170 172 172 174 177 178 180 181 182 183 185 186 187 188 190 190 192

PART 6. BREACH, REPUDIATION, AND EXCUSE .............

2-601 2-602 2-603 2-604 2-605 2-606 2-607 2-608 2-609 2-610 2-611 2-612 2-613 2-614 2-615 2-616 Buyer's Rights on Improper Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Manner and Eect of Rejection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Merchant Buyer's Duties as to Rejected Goods. . . . . . . . . . . . . . . . . . . . Buyer's Options as to Salvage of Rejected Goods. . . . . . . . . . . . . . . . . . Waiver of Buyer's Objections by Failure to Particularize.. . . . . . . . What Constitutes Acceptance of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Acceptance; Notice of Breach; Burden of Establishing Breach after Acceptance; Notice of Claim or Litigation to Person Answerable Over. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Revocation of Acceptance in Whole or in Part. . . . . . . . . . . . . . . . . . . . . Right to Adequate Assurance of Performance.. . . . . . . . . . . . . . . . . . . . . Anticipatory Repudiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retraction of Anticipatory Repudiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment Contract; Breach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Casualty to Identied Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Substituted Performance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excuse by Failure of Presupposed Conditions. . . . . . . . . . . . . . . . . . . . . Procedure on Notice Claiming Excuse. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 7. REMEDIES .......................................................

2-701 2-702 2-703 2-704 2-705 2-706 2-707 2-708 2-709 2-710 2-711 2-712 2-713 2-714 2-715 2-716 2-717 2-718 2-719 2-720 Remedies for Breach of Collateral Contracts Not Impaired. . . . . . Seller's Remedies on Discovery of Buyer's Insolvency.. . . . . . . . . . . . Seller's Remedies in General.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Right to Identify Goods to the Contract Notwithstanding Breach or to Salvage Unnished Goods. . . . . . . . Seller's Stoppage of Delivery in Transit or Otherwise. . . . . . . . . . . . Seller's Resale Including Contract for Resale. . . . . . . . . . . . . . . . . . . . . . Person in the Position of a Seller.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Damages for Nonacceptance or Repudiation. . . . . . . . . . . . . . Action for the Price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Incidental and Consequential Damages. . . . . . . . . . . . . . . . . . . Buyer's Remedies in General; Buyer's Security Interest in Rejected Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cover; Buyer's Procurement of Substitute Goods.. . . . . . . . . . . . . . . Buyer's Damages for Nondelivery or Repudiation. . . . . . . . . . . . . . . . . Buyer's Damages For Breach in Regard to Accepted Goods.. . . . . Buyer's Incidental and Consequential Damages. . . . . . . . . . . . . . . . . . . Specic Performance; Buyer's Right to Replevin. . . . . . . . . . . . . . . . . . Deduction of Damages from the Price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liquidation or Limitation of Damages; Deposits. . . . . . . . . . . . . . . . . . Contractual Modication or Limitation of Remedy. . . . . . . . . . . . . . . . Eect of Cancellation or Rescission on Claims for

xxxii

Table of Contents Antecedent Breach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Remedies for Fraud. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Who May Sue Third Parties for Injury to Goods. . . . . . . . . . . . . . . . . . Proof of Market: Time and Place. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Admissibility of Market Quotations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statute of Limitations in Contracts for Sale. . . . . . . . . . . . . . . . . . . . . . . 193 193 194 194 195 196 199 199 199 199 199 200 202 202 206 207 215 217 218 219 219 220

2-721 2-722 2-723 2-724 2-725

PART 8. TRANSITIONAL PROVISIONS ...........................

2-801 2-802 2-803 2-804 Eective Date. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amendment of Existing Article 2.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Application to Existing Relations.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Savings Clause. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ARTICLE 2A LEASES .................................................... PART 1. GENERAL PROVISIONS ....................................

2A-101 2A-102 2A-103 2A-104 2A-105 Short Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Scope. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leases Subject to Other Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Territorial Application of Article to Goods Covered by Certicate of Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Limitation on Power of Parties to Consumer Lease to Choose Applicable Law and Judicial Forum.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Waiver or Renunciation of Claim or Right after Default. . . . . . . . . . Unconscionability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Option to Accelerate at Will. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2A-106 2A-107 2A-108 2A-109

PART 2. FORMATION AND CONSTRUCTION OF LEASE CONTRACT; ELECTRONIC CONTRACTING......................

2A-201 2A-202 2A-203 2A-204 2A-205 2A-206 2A-207 2A-208 2A-209 2A-210 2A-211 2A-212 2A-213 2A-214 2A-215 2A-216 2A-217 2A-218 Statute of Frauds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Final Expression in a Record: Parol or Extrinsic Evidence. . . . . . . Seals Inoperative.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Formation in General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Firm Oers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Oer and Acceptance in Formation of Lease Contract. . . . . . . . . . . . [Reserved.] [Course of Performance or Practical Construction] . . Modication, Rescission and Waiver.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lessee under Finance Lease as Beneciary of Supply Contract. . Express Warranties.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranties Against Interference and Against Infringement; Lessee's Obligation Against Infringement. . . . . . . . . . . . . . . . . . . . . . . . Implied Warranty of Merchantability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Implied Warranty of Fitness for Particular Purpose.. . . . . . . . . . . . . . Exclusion or Modication of Warranties. . . . . . . . . . . . . . . . . . . . . . . . . . . . Cumulation and Conict of Warranties Express or Implied. . . . . . Third-party Beneciaries of Express and Implied Warranties.. . . Identication. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Insurance and Proceeds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

221 221 223 223 224 225 225 225 226 227 229 229 231 233 234 236 236 238 238

xxxiii

Risk of Loss.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Default on Risk of Loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Casualty to Identied Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Legal Recognition of Electronic Contracts, Records and Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-223 Attribution. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-224 Electronic Communication. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2A-219 2A-220 2A-221 2A-222

239 240 241 241 242 244 244 244 247 247 251 253 254 255 256 257 260 262

PART 3. EFFECT OF LEASE CONTRACT .........................

2A-301 Enforceability Of Lease Contract. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-302 Title to and Possession of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-303 Alienability of Party's Interest under Lease Contract or of Lessor's Residual Interest in Goods; Delegation of Performance; Transfer of Rights. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-304 Subsequent Lease of Goods by Lessor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-305 Sale or Sublease of Goods by Lessee.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-306 Priority of Certain Liens Arising by Operation of Law. . . . . . . . . . . . 2A-307 Priority of Liens Arising by Attachment or Levy On, Security Interests In, and Other Claims to Goods. . . . . . . . . . . . . . . . . . . . . . . . . 2A-308 Special Rights of Creditors.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-309 Lessor's and Lessee's Rights When Goods Become Fixtures. . . . . . 2A-310 Lessor's and Lessee's Rights When Goods Become Accessions. . . 2A-311 Priority Subject to Subordination. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 4. PERFORMANCE OF LEASE CONTRACT: REPUDIATED, SUBSTITUTED AND EXCUSED........................................ 263

2A-401 2A-402 2A-403 2A-404 2A-405 2A-406 2A-407 Insecurity: Adequate Assurance of Performance. . . . . . . . . . . . . . . . . . . Anticipatory Repudiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retraction of Anticipatory Repudiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Substituted Performance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excused Performance.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Procedure on Excused Performance.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Irrevocable Promises: Finance Leases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263 263 264 265 265 266 267 269 269 269 270 271 272 274 274 275 276

PART 5. DEFAULT......................................................... A IN GENERAL ..............................................................

Default: Procedure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notice after Default.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Modication or Impairment of Rights and Remedies. . . . . . . . . . . . Liquidation of Damages. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cancellation and Termination and Eect of Cancellation, Termination, Rescission, or Fraud on Rights and Remedies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-506 Statute of Limitations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-507 Proof of Market Rent: Time and Place.. . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-507A Right to Specic Performance or Replevin or the Like. . . . . . . . . . 2A-501 2A-502 2A-503 2A-504 2A-505

B DEFAULT BY LESSOR .................................................

xxxiv

Table of Contents 277 277 280 281 282 283 283 284 285 286 288 290 292 293 294 294 295 295 299 300 301 302 305 306 309 310 310 311 311 311 311 311

2A-508 Lessee's Remedies.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-509 Lessee's Rights on Improper Delivery; Manner and Eect of Rejection.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-510 Installment Lease Contracts: Rejection and Default.. . . . . . . . . . . . . . 2A-511 Merchant Lessee's Duties as to Rejected Goods. . . . . . . . . . . . . . . . . . . . 2A-512 Lessee's Duties as to Rejected Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-513 Cure by Lessor of Improper Tender or Delivery; Replacement. . . 2A-514 Waiver of Lessee's Objections. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-515 Acceptance of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-516 Eect of Acceptance of Goods; Notice of Default; Burden of Establishing Default after Acceptance; Notice of Claim or Litigation to Person Answerable Over. . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-517 Revocation of Acceptance of Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-518 Cover; Substitute Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-519 Lessee's Damages for Non-delivery, Repudiation, Default, and Breach of Warranty in Regard to Accepted Goods.. . . . . . . . . . . . . . 2A-520 Lessee's Incidental and Consequential Damages.. . . . . . . . . . . . . . . . . . 2A-521 Reserved. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-522 Lessee's Right to Goods on Lessor's Insolvency. . . . . . . . . . . . . . . . . . . .

C DEFAULT BY LESSEE .................................................

2A-523 2A-524 2A-525 2A-526 2A-527 2A-528 2A-529 2A-530 2A-531 2A-532 Lessor's Remedies.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lessor's Right to Identify Goods to Lease Contract. . . . . . . . . . . . . . . . Lessor's Right to Possession of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lessor's Stoppage of Delivery in Transit or Otherwise. . . . . . . . . . . . Lessor's Rights to Dispose of Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lessor's Damages for Non-acceptance, Failure to Pay, Repudiation, or Other Default. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lessor's Action for the Rent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lessor's Incidental and Consequential Damages. . . . . . . . . . . . . . . . . . . Standing to Sue Third Parties for Injury to Goods.. . . . . . . . . . . . . . . . Lessor's Rights to Residual Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 6. TRANSITIONAL PROVISIONS ...........................

2A-601 2A-602 2A-603 2A-604 Eective Date. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amendment of Existing Article 2A.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applicability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Savings Clause. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

APPENDIX I. CONFORMING AMENDMENT TO ARTICLE 1 ................................................................................... ARTICLE 3 NEGOTIABLE INSTRUMENTS .......................

311 312

NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS ................................................................. 314 TABLE OF DISPOSITION OF SECTIONS IN FORMER ARTICLE 3 ................................................................................... 319 PART 1. GENERAL PROVISIONS AND DEFINITIONS .......

xxxv

325 3-101 3-102 3-103 3-104 3-105 3-106 3-107 3-108 3-109 3-110 3-111 3-112 3-113 3-114 3-115 3-116 3-117 3-118 3-119 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Subject Matter. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Negotiable Instrument.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issue of Instrument. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unconditional Promise or Order.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Instrument Payable in Foreign Money. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payable on Demand or at Denite Time.. . . . . . . . . . . . . . . . . . . . . . . . . . . Payable to Bearer or to Order. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Identication of Person to Whom Instrument Is Payable.. . . . . . . . Place of Payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Date of Instrument.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Contradictory Terms of Instrument. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Incomplete Instrument. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Joint and Several Liability; Contribution. . . . . . . . . . . . . . . . . . . . . . . . . . Other Agreements Aecting Instrument. . . . . . . . . . . . . . . . . . . . . . . . . . . Statute of Limitations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notice of Right to Defend Action. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 325 325 327 331 334 334 336 337 337 338 341 341 341 342 342 343 343 344 346

PART 2. NEGOTIATION, TRANSFER, AND INDORSEMENT .............................................................

3-201 3-202 3-203 3-204 3-205 Negotiation.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Negotiation Subject to Rescission. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer of Instrument; Rights Acquired by Transfer. . . . . . . . . . . . Indorsement.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Special Indorsement; Blank Indorsement; Anomalous Indorsement.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restrictive Indorsement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reacquisition.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

347 347 347 348 350 352 353 355 356 356 356 360 362 363 368 368 370 372 373 375 379 383 383

3-206 3-207

PART 3. ENFORCEMENT OF INSTRUMENTS ..................

3-301 3-302 3-303 3-304 3-305 3-306 3-307 3-308 3-309 3-310 3-311 3-312 Person Entitled to Enforce Instrument. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Holder in Due Course.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Value and Consideration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Overdue Instrument. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Defenses and Claims in Recoupment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Claims to an Instrument. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notice of Breach of Fiduciary Duty. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proof of Signatures and Status as Holder in Due Course. . . . . . . . Enforcement of Lost, Destroyed, or Stolen Instrument. . . . . . . . . . . Eect of Instrument on Obligation for Which Taken.. . . . . . . . . . . . . Accord and Satisfaction by Use of Instrument. . . . . . . . . . . . . . . . . . . . . Lost, Destroyed, or Stolen Cashier's Check, Teller's Check, or Certied Check. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 4. LIABILITY OF PARTIES ....................................

3-401 Signature. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

xxxvi

Table of Contents 3-402 3-403 3-404 3-405 Signature by Representative. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unauthorized Signature. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Impostors; Fictitious Payees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Employer's Responsibility for Fraudulent Indorsement by Employee. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Negligence Contributing to Forged Signature or Alteration of Instrument. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Alteration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Drawee Not Liable on Unaccepted Draft. . . . . . . . . . . . . . . . . . . . . . . . . . . Acceptance of Draft; Certied Check.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Acceptance Varying Draft. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Refusal to Pay Cashier's Checks, Teller's Checks, and Certied Checks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligation of Issuer of Note or Cashier's Check. . . . . . . . . . . . . . . . . . . Obligation of Acceptor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligation of Drawer.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligation of Indorser. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer Warranties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Presentment Warranties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payment or Acceptance by Mistake. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Instruments Signed for Accommodation. . . . . . . . . . . . . . . . . . . . . . . . . . . . Conversion of Instrument. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 383 385 386 390 393 395 396 396 397 397 398 399 400 401 402 404 407 409 411 414 414 415 418 418 419 420 420 420 422 422 423 432 433 433 434 435 438 441 442 443 444

3-406 3-407 3-408 3-409 3-410 3-411 3-412 3-413 3-414 3-415 3-416 3-417 3-418 3-419 3-420

PART 5. DISHONOR ......................................................

3-501 3-502 3-503 3-504 3-505 Presentment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dishonor.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notice of Dishonor.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excused Presentment and Notice of Dishonor. . . . . . . . . . . . . . . . . . . . . Evidence of Dishonor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 6. DISCHARGE AND PAYMENT .............................

3-601 3-602 3-603 3-604 3-605 Discharge and Eect of Discharge.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tender of Payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Discharge by Cancellation or Renunciation. . . . . . . . . . . . . . . . . . . . . . . . Discharge of Secondary Obligors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ARTICLE 4 BANK DEPOSITS AND COLLECTIONS ........... PART 1. GENERAL PROVISIONS AND DEFINITIONS .......
4-101 4-102 4-103 4-104 4-105 4-106 4-107 4-108 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applicability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Variation by Agreement; Measure of Damages; Action Constituting Ordinary Care. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions of Types of Banks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payable Through or Payable at Bank: Collecting Bank.. . . . . . . . . . Separate Oce of Bank.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time of Receipt of Items.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

xxxvii

 4-109 4-110 4-111

Delays. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Electronic Presentment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statute of Limitations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

445 445 446

PART 2. COLLECTION OF ITEMS: DEPOSITARY AND COLLECTING BANKS .....................................................

4-201 4-202 4-203 4-204 4-205 4-206 4-207 4-208 4-209 4-210 Status of Collecting Bank as Agent and Provisional Status of Credits; Applicability of Article; Item Indorsed Pay Any Bank. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Responsibility for Collection or Return; When Action Timely. . . . Eect of Instructions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Methods of Sending and Presenting; Sending Directly to Payor Bank. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depositary Bank Holder of Unindorsed Item. . . . . . . . . . . . . . . . . . . . . . Transfer Between Banks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer Warranties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Presentment Warranties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Encoding and Retention Warranties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Security Interest of Collecting Bank in Items, Accompanying Documents and Proceeds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . When Bank Gives Value for Purposes of Holder in Due Course. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Presentment by Notice of Item Not Payable by, Through, or at Bank; Liability of Drawer or Indorser. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Medium and Time of Settlement by Bank.. . . . . . . . . . . . . . . . . . . . . . . . . Right of Charge-Back or Refund; Liability of Collecting Bank: Return of Item. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Final Payment of Item by Payor Bank; When Provisional Debits and Credits Become Final; When Certain Credits Become Available for Withdrawal. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Insolvency and Preference.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

447

447 449 450 451 452 452 453 454 455 456 457 457 458 459 461 465 466 466 468 469

4-211 4-212 4-213 4-214 4-215 4-216

PART 3. COLLECTION OF ITEMS: PAYOR BANKS ...........

4-301 4-302 4-303 Deferred Posting; Recovery of Payment by Return of Items; Time of Dishonor; Return of Items by Payor Bank. . . . . . . . . . . . . . . . Payor Bank's Responsibility for Late Return of Item. . . . . . . . . . . . . When Items Subject to Notice, Stop-Payment Order, Legal Process, or Seto; Order in Which Items May Be Charged or Certied. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 4. RELATIONSHIP BETWEEN PAYOR BANK AND ITS CUSTOMER ...................................................................

4-401 4-402 4-403 4-404 4-405 4-406 When Bank May Charge Customer's Account. . . . . . . . . . . . . . . . . . . . . Bank's Liability to Customer for Wrongful Dishonor; Time of Determining Insuciency of Account. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Customer's Right to Stop Payment; Burden of Proof of Loss.. . . . Bank Not Obliged to Pay Check More Than Six Months Old. . . . Death or Incompetence of Customer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Customer's Duty to Discover and Report Unauthorized

471 471 472 473 475 475

xxxviii

Table of Contents Signature or Alteration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payor Bank's Right to Subrogation on Improper Payment. . . . . . . 476 480 481 481 481 482 482 484

4-407

PART 5. COLLECTION OF DOCUMENTARY DRAFTS .......

4-501 4-502 4-503 4-504 Handling of Documentary Drafts; Duty to Send for Presentment and to Notify Customer of Dishonor.. . . . . . . . . . . . . . . . Presentment of On Arrival Drafts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Responsibility of Presenting Bank for Documents and Goods; Report of Reasons for Dishonor; Referee in Case of Need. . . . . . . . Privilege of Presenting Bank to Deal With Goods; Security Interest for Expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ARTICLE 4A FUNDS TRANSFERS ...................................

NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS ................................................................ 486 PART 1. SUBJECT MATTER AND DEFINITIONS ..............
4A-101 4A-102 4A-103 4A-104 4A-105 4A-106 4A-107 4A-108 Short Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Subject Matter. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payment OrderDenitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Funds TransferDenitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time Payment Order Is Received. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Federal Reserve Regulations and Operating Circulars. . . . . . . . . . . . Exclusion of Consumer Transactions Governed by Federal Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 492 492 492 493 493 497 499 500 501

PART 2. ISSUE AND ACCEPTANCE OF PAYMENT ORDER ..........................................................................

4A-201 4A-202 4A-203 4A-204 Security Procedure.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Authorized and Veried Payment Orders. . . . . . . . . . . . . . . . . . . . . . . . . . . Unenforceability of Certain Veried Payment Orders. . . . . . . . . . . . . Refund of Payment and Duty of Customer to Report With Respect to Unauthorized Payment Order.. . . . . . . . . . . . . . . . . . . . . . . . Erroneous Payment Orders. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transmission of Payment Order Through Funds-Transfer or Other Communication System. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Misdescription of Beneciary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Misdescription of Intermediary Bank or Beneciary's Bank. . . . . . Acceptance of Payment Order. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rejection of Payment Order. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cancellation and Amendment of Payment Order. . . . . . . . . . . . . . . . . . Liability and Duty of Receiving Bank Regarding Unaccepted Payment Order. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

502 502 502 503 507 508 510 511 514 516 520 522 526

4A-205 4A-206 4A-207 4A-208 4A-209 4A-210 4A-211 4A-212

PART 3. EXECUTION OF SENDER'S PAYMENT ORDER BY RECEIVING BANK .........................................................

526

xxxix

Execution and Execution Date. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligations of Receiving Bank in Execution of Payment Order. . Erroneous Execution of Payment Order.. . . . . . . . . . . . . . . . . . . . . . . . . . . . Duty of Sender to Report Erroneously Executed Payment Order.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4A-305 Liability for Late or Improper Execution or Failure to Execute Payment Order. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

4A-301 4A-302 4A-303 4A-304

526 527 530 531 531 534 534 534 536 537 539 541 543 543 544 546 546 547 547 548 552 552 557 559 560 564 566 566 566 568 569 574 577 577 580 581 582 583

PART 4. PAYMENT ........................................................

Payment Date. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligation of Sender to Pay Receiving Bank. . . . . . . . . . . . . . . . . . . . . . . Payment by Sender to Receiving Bank. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligation of Beneciary's Bank to Pay and Give Notice to Beneciary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4A-405 Payment by Beneciary's Bank to Beneciary. . . . . . . . . . . . . . . . . . . . . 4A-406 Payment by Originator to Beneciary; Discharge of Underlying Obligation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4A-401 4A-402 4A-403 4A-404

PART 5. MISCELLANEOUS PROVISIONS ........................

4A-501 Variation by Agreement and Eect of Funds-Transfer System Rule. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4A-502 Creditor Process Served on Receiving Bank; Seto by Beneciary's Bank.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4A-503 Injunction or Restraining Order With Respect to Funds Transfer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4A-504 Order in Which Items and Payment Orders May Be Charged to Account; Order of Withdrawals From Account. . . . . . . . . . . . . . . . . . . 4A-505 Preclusion of Objection to Debit of Customer's Account. . . . . . . . . . . 4A-506 Rate of Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4A-507 Choice of Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ARTICLE 5 LETTERS OF CREDIT ...................................

National Conference of Commissioners on Uniform State Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Table of Disposition of Sections in Former Article 5 . . . . . . . . . . . . Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Scope.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Formal Requirements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consideration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance, Amendment, Cancellation, and Duration. . . . . . . . . . . . . . . Conrmer, Nominated Person, and Adviser.. . . . . . . . . . . . . . . . . . . . . . . Issuer's Rights and Obligations.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fraud and Forgery. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Remedies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer of Letter of Credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer by Operation of Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Assignment of Proceeds.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statute of Limitations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

5-101 5-102 5-103 5-104 5-105 5-106 5-107 5-108 5-109 5-110 5-111 5-112 5-113 5-114 5-115

xl

Table of Contents 5-116 5-117 5-118 Choice of Law and Forum. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Subrogation of Issuer, Applicant, and Nominated Person. . . . . . . . Security Interest of Issuer or Nominated Person. . . . . . . . . . . . . . . . . . 584 585 587 589

TRANSITION PROVISIONS .............................................

REPEALER OF ARTICLE 6 BULK TRANSFERS AND [REVISED] ARTICLE 6 BULK SALES(STATES TO SELECT ONE ALTERNATIVE).............................................................. 590 NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS ................................................................ 591 ALTERNATIVE A ............................................................
[ 1 2 3 4 Repeal. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amendment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amendment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Savings Clause. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applicability of Article. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligations of Buyer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notice to Claimants. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Schedule of Distribution. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liability for Noncompliance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bulk Sales by Auction; Bulk Sales Conducted by Liquidator. . . . What Constitutes Filing; Duties of Filing Ocer; Information From Filing Ocer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Limitation of Actions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 593 593 593 593 593 594 594 595 600 604 605 608 611 616 618 619 621

ALTERNATIVE B............................................................
[ 6-101 6-102 6-103 6-104 6-105 6-106 6-107 6-108 6-109 6-110

ARTICLE 7 DOCUMENTS OF TITLE ................................

DRAFTING COMMITTEE TO REVISE UNIFORM COMMERCIAL CODE ARTICLE 7, DOCUMENTS OF TITLE ...................... 623 PART 1. GENERAL ........................................................
7-101 7-102 7-103 7-104 7-105 7-106 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Relation of Article to Treaty or Statute.. . . . . . . . . . . . . . . . . . . . . . . . . . . . Negotiable and Nonnegotiable Document of Title. . . . . . . . . . . . . . . . . Reissuance in Alternative Medium.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Control of Electronic Document of Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . 624 624 625 627 628 629 630

PART 2. WAREHOUSE RECEIPTS: SPECIAL PROVISIONS .................................................................

7-201 Person That May Issue a Warehouse Receipt; Storage Under Bond. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

632 632

xli

7-202 7-203 7-204 7-205 7-206 7-207 7-208 7-209 7-210

Form of Warehouse Receipt; Eect of Omission. . . . . . . . . . . . . . . . . . . Liability for Nonreceipt or Misdescription.. . . . . . . . . . . . . . . . . . . . . . . . . Duty of Care; Contractual Limitation of Warehouse's Liability.. Title Under Warehouse Receipt Defeated in Certain Cases. . . . . . Termination of Storage at Warehouse's Option. . . . . . . . . . . . . . . . . . . . Goods Must Be Kept Separate; Fungible Goods. . . . . . . . . . . . . . . . . . . Altered Warehouse Receipts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lien of Warehouse. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Enforcement of Warehouse's Lien. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

633 634 635 636 637 638 639 639 643 646 646 647 649 650 651 652 652 653 654

PART 3. BILLS OF LADING: SPECIAL PROVISIONS ........

7-301 7-302 7-303 7-304 7-305 7-306 7-307 7-308 7-309 Liability for Nonreceipt or Misdescription; Said to Contain; Shipper's Weight, Load, and Count; Improper Handling. . . . . . . Through Bills of Lading and Similar Documents of Title.. . . . . . . . Diversion; Reconsignment; Change of Instructions.. . . . . . . . . . . . . . . Tangible Bills of Lading in a Set. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Destination Bills.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Altered Bills of Lading.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lien of Carrier.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Enforcement of Carrier's Lien. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Duty of Care; Contractual Limitation of Carrier's Liability. . . . . .

PART 4. WAREHOUSE RECEIPTS AND BILLS OF LADING: GENERAL OBLIGATIONS ...............................................

7-401 7-402 7-403 7-404 Irregularities in Issue of Receipt or Bill or Conduct of Issuer. . . Duplicate Document of Title; Overissue. . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligation of Bailee to Deliver; Excuse. . . . . . . . . . . . . . . . . . . . . . . . . . . . . No Liability for Good-Faith Delivery Pursuant to Document of Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

656 656 656 657 659

PART 5. WAREHOUSE RECEIPTS AND BILLS OF LADING: NEGOTIATION AND TRANSFER .....................................
7-501 7-502 7-503 7-504 7-505 7-506 7-507 7-508 7-509 Form of Negotiation and Requirements of Due Negotiation.. . . . . Rights Acquired by Due Negotiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Document of Title to Goods Defeated in Certain Cases.. . . . . . . . . . Rights Acquired in Absence of Due Negotiation; Eect of Diversion; Stoppage of Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Indorser not Guarantor for Other Parties. . . . . . . . . . . . . . . . . . . . . . . . . . Delivery Without Indorsement: Right to Compel Indorsement. . Warranties on Negotiation or Delivery of Document of Title. . . . Warranties of Collecting Bank as to Documents of Title. . . . . . . . . Adequate Compliance with Commercial Contract. . . . . . . . . . . . . . . . .

660 660 662 663 665 667 668 669 669 670

PART 6. WAREHOUSE RECEIPTS AND BILLS OF LADING: MISCELLANEOUS PROVISIONS ......................................

7-601 7-602 Lost, Stolen, or Destroyed Documents of Title. . . . . . . . . . . . . . . . . . . . . Judicial Process Against Goods Covered by Negotiable Document of Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

670 670 671

xlii

Table of Contents 7-603 Conicting Claims; Interpleader.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 672 673 673 673 673 673 674

PART 7. MISCELLANEOUS PROVISIONS ........................

7-701 7-702 7-703 7-704 Eective Date. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repeals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applicability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Savings Clause. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

APPENDIX I. CONFORMING AMENDMENTS TO OTHER ARTICLES .....................................................................

AMENDMENTS TO UNIFORM COMMERCIAL CODE ARTICLE 674 1 ................................................................................... ALTERNATIVE A ............................................................ ALTERNATIVE B............................................................
674 678

AMENDMENTS TO UNIFORM COMMERCIAL CODE ARTICLE 2 ................................................................................... 681 AMENDMENTS TO UNIFORM COMMERCIAL CODE ARTICLE 2A ................................................................................. 689 AMENDMENTS TO UNIFORM COMMERCIAL CODE ARTICLE 4 ................................................................................... 690 AMENDMENTS TO UNIFORM COMMERCIAL CODE ARTICLE 5 ................................................................................... 692 AMENDMENTS TO UNIFORM COMMERCIAL CODE ARTICLE 8 ................................................................................... 693 AMENDMENTS TO UNIFORM COMMERCIAL CODE ARTICLE 9 ................................................................................... 694 ARTICLE 8 INVESTMENT SECURITIES ...........................
707

NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS ................................................................. 709 PART 1. SHORT TITLE AND GENERAL MATTERS ...........
8-101 8-102 8-103 8-104 8-105 8-106 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rules for Determining Whether Certain Obligations and Interests are Securities or Financial Assets.. . . . . . . . . . . . . . . . . . . . . . . Acquisition of Security or Financial Asset or Interest Therein. . Notice of Adverse Claim. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Control.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 734 734 734 741 743 744 747

xliii

 8-107 8-108 8-109 8-110 8-111 8-112 8-113 8-114 8-115

8-116

Whether Indorsement, Instruction, or Entitlement Order is Eective. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranties in Direct Holding. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranties in Indirect Holding. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applicability; Choice of Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Clearing Corporation Rules. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Creditor's Legal Process. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statute of Frauds Inapplicable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Evidentiary Rules Concerning Certicated Securities. . . . . . . . . . . . Securities Intermediary and Others Not Liable to Adverse Claimant. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Securities Intermediary as Purchaser For Value. . . . . . . . . . . . . . . . . .

751 754 757 757 761 762 763 763 764 767 768 768 768 771 772 773 774 775 776 777 777

PART 2. ISSUE AND ISSUER ..........................................

8-201 8-202 8-203 8-204 8-205 8-206 8-207 Issuer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuer's Responsibility and Defenses; Notice of Defect or Defense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Staleness as Notice of Defect or Defense. . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Issuer's Restriction on Transfer. . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Unauthorized Signature on Security Certicate. . . . . . . . Completion of Alteration of Security Certicate. . . . . . . . . . . . . . . . . . . Rights and Duties of Issuer with Respect to Registered Owners. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Signature of Authenticating Trustee, Registrar, or Transfer Agent.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuer's Lien. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Overissue.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8-208 8-209 8-210

PART 3. TRANSFER OF CERTIFICATED AND UNCERTIFICATED SECURITIES .....................................

8-301 8-302 8-303 8-304 8-305 8-306 8-307 Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights of Purchaser. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Protected Purchaser.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Indorsement.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Instruction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Guaranteeing Signature, Indorsement, or Instruction.. Purchaser's Right to Requisites for Registration of Transfer.. . . .

778 778 780 781 782 783 784 786 787 787 788 789 791 793 793 794

PART 4. REGISTRATION ...............................................

8-401 8-402 8-403 8-404 8-405 Duty of Issuer to Register Transfer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Assurance that Indorsement or Instruction is Eective. . . . . . . . . . Demand that Issuer Not Register Transfer. . . . . . . . . . . . . . . . . . . . . . . . Wrongful Registration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Replacement of Lost, Destroyed, or Wrongfully Taken Security Certicate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligation to Notify Issuer of Lost, Destroyed, or Wrongfully Taken Security Certicate.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Authenticating Trustee, Transfer Agent, and Registrar. . . . . . . . . .

8-406 8-407

PART 5. SECURITY ENTITLEMENTS ..............................

xliv

Table of Contents 794 8-501 8-502 8-503 8-504 8-505 8-506 8-507 8-508 8-509 Securities Account; Acquisition of Security Entitlement from Securities Intermediary.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Assertion of Adverse Claim Against Entitlement Holder. . . . . . . . . Property Interest of Entitlement Holder in Financial Asset Held By Securities Intermediary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Duty of Securities Intermediary to Maintain Financial Asset. . . Duty of Securities Intermediary with Respect to Payments and Distributions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Duty of Securities Intermediary to Exercise Rights as Directed by Entitlement Holder. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Duty of Securities Intermediary to Comply With Entitlement Order. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Duty of Securities Intermediary to Change Entitlement Holder's Position to Other Form of Security Holding. . . . . . . . . . . . . Specication of Duties of Securities Intermediary by Other Statute or Regulation; Manner of Performance of Duties of Securities Intermediary and Exercise of Rights of Entitlement Holder. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights of Purchaser of Security Entitlement from Entitlement Holder. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Priority Among Security Interests and Entitlement Holders.. . . . 794 798 800 804 807 808 809 811

811 812 815

8-510 8-511

PART 6. TRANSITION PROVISIONS FOR REVISED ARTICLE 8 ................................................................................... 817

8-601 8-602 8-603 Eective Date. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repeals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Savings Clause. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 817 817 817 819

ARTICLE 9 SECURED TRANSACTIONS ...........................

NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS ................................................................. 824 TABLE OF DISPOSITION OF SECTIONS IN FORMER ARTICLE 9 AND OTHER CODE SECTIONS ........................................ 825 TABLE INDICATING SOURCES OR DERIVATIONS OF NEW ARTICLE 9 SECTIONS AND CONFORMING AMENDMENTS .............................................................. PART 1. GENERAL PROVISIONS .................................... [SUBPART 1 SHORT TITLE, DEFINITIONS, AND GENERAL CONCEPTS] ...................................................................
9-101 9-102 9-103 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchase-Money Security Interest; Application of Payments; Burden of Establishing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

827 831

831 831 840 862

xlv

9-104 9-105 9-106 9-107 9-108

Control of Deposit Account. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Control of Electronic Chattel Paper. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Control of Investment Property.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Control of Letter-of-Credit Right. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Suciency of Description. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Scope.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Security Interests Arising Under Article 2 or 2A.. . . . . . . . . . . . . . . . .

865 866 868 868 869 871 871 877

[SUBPART 2 APPLICABILITY OF ARTICLE] ....................

9-109 9-110

PART 2. EFFECTIVENESS OF SECURITY AGREEMENT; ATTACHMENT OF SECURITY INTEREST; RIGHTS OF PARTIES 878 TO SECURITY AGREEMENT ........................................... [SUBPART 1 EFFECTIVENESS AND ATTACHMENT] ........
9-201 9-202 9-203 9-204 9-205 9-206 General Eectiveness of Security Agreement. . . . . . . . . . . . . . . . . . . . . . Title to Collateral Immaterial. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Attachment and Enforceability of Security Interest; Proceeds; Supporting Obligations; Formal Requisites. . . . . . . . . . . . . . . . . . . . . . . . After-Acquired Property; Future Advances.. . . . . . . . . . . . . . . . . . . . . . . . Use or Disposition of Collateral Permissible. . . . . . . . . . . . . . . . . . . . . . . Security Interest Arising in Purchase or Delivery of Financial Asset. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights and Duties of Secured Party Having Possession or Control of Collateral. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additional Duties of Secured Party Having Control of Collateral. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Duties of Secured Party if Account Debtor Has Been Notied of Assignment.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Request for Accounting; Request Regarding List of Collateral or Statement of Account. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 878 878 879 879 883 884 885 886 886 889 891 891 894

[SUBPART 2 RIGHTS AND DUTIES] ................................

9-207 9-208 9-209 9-210

PART 3. PERFECTION AND PRIORITY ........................... [SUBPART 1 LAW GOVERNING PERFECTION AND PRIORITY] ....................................................................
9-301 9-302 9-303 9-304 9-305 9-306 9-307 Law Governing Perfection and Priority of Security Interests. . . . Law Governing Perfection and Priority of Agricultural Liens. . . Law Governing Perfection and Priority of Security Interests in Goods Covered by a Certicate of Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Law Governing Perfection and Priority of Security Interests in Deposit Accounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Law Governing Perfection and Priority of Security Interests in Investment Property. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Law Governing Perfection and Priority of Security Interests in Letter-of-Credit Rights.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Location of Debtor.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

894 894 897 897 899 900 902 903

[SUBPART 2 PERFECTION] ............................................

xlvi

Table of Contents 907 9-308 9-309 9-310 9-311 9-312 When Security Interest or Agricultural Lien Is Perfected; Continuity of Perfection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Security Interest Perfected Upon Attachment. . . . . . . . . . . . . . . . . . . . . When Filing Required to Perfect Security Interest or Agricultural Lien; Security Interests and Agricultural Liens to Which Filing Provisions Do Not Apply.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Perfection of Security Interests in Property Subject to Certain Statutes, Regulations, and Treaties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Perfection of Security Interests in Chattel Paper, Deposit Accounts, Documents, Goods Covered by Documents, Instruments, Investment Property, Letter-of-Credit Rights, and Money; Perfection by Permissive Filing; Temporary Perfection Without Filing or Transfer of Possession. . . . . . . . . . . . . . When Possession by or Delivery to Secured Party Perfects Security Interest Without Filing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Perfection by Control. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Secured Party's Rights on Disposition of Collateral and in Proceeds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Continued Perfection of Security Interest Following Change in Governing Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interests That Take Priority Over or Take Free of Security Interest or Agricultural Lien.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . No Interest Retained in Right to Payment That Is Sold; Rights and Title of Seller of Account or Chattel Paper With Respect to Creditors and Purchasers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights and Title of Consignee With Respect to Creditors and Purchasers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buyer of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Licensee of General Intangible and Lessee of Goods in Ordinary Course of Business.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Priorities Among Conicting Security Interests in and Agricultural Liens on Same Collateral.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Future Advances. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Priority of Purchase-Money Security Interests. . . . . . . . . . . . . . . . . . . . Priority of Security Interests in Transferred Collateral. . . . . . . . . . Priority of Security Interests Created by New Debtor. . . . . . . . . . . . Priority of Security Interests in Deposit Account.. . . . . . . . . . . . . . . . . Priority of Security Interests in Investment Property. . . . . . . . . . . . Priority of Security Interests in Letter-of-Credit Right. . . . . . . . . . . Priority of Purchaser of Chattel Paper or Instrument. . . . . . . . . . . . Priority of Rights of Purchasers of Instruments, Documents, and Securities Under Other Articles; Priority of Interests in Financial Assets and Security Entitlements Under Article 8. . . . Transfer of Money; Transfer of Funds From Deposit Account. . . Priority of Certain Liens Arising by Operation of Law. . . . . . . . . . . Priority of Security Interests in Fixtures and Crops. . . . . . . . . . . . . . Accessions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commingled Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Priority of Security Interests in Goods Covered by Certicate 907 909 911 913

916 919 923 924 927 931 931 934 935 936 939 939 945 948 953 954 956 957 963 964 969 971 972 973 977 979

9-313 9-314 9-315 9-316

[SUBPART 3 PRIORITY] .................................................

9-317 9-318 9-319 9-320 9-321 9-322 9-323 9-324 9-325 9-326 9-327 9-328 9-329 9-330 9-331 9-332 9-333 9-334 9-335 9-336 9-337

xlvii

 9-338 9-339 9-340 9-341 9-342

of Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Priority of Security Interest or Agricultural Lien Perfected by Filed Financing Statement Providing Certain Incorrect Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Priority Subject to Subordination. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eectiveness of Right of Recoupment or Set-O Against Deposit Account. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bank's Rights and Duties With Respect to Deposit Account. . . . . Bank's Right to Refuse to Enter Into or Disclose Existence of Control Agreement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

981 981 982 982 982 983 984 984 984 985 985 987 989

[SUBPART 4 RIGHTS OF BANK] .....................................

PART 4. RIGHTS OF THIRD PARTIES.............................

9-401 9-402 9-403 9-404 Alienability of Debtor's Rights. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Secured Party Not Obligated on Contract of Debtor or in Tort. . Agreement Not to Assert Defenses Against Assignee. . . . . . . . . . . . . Rights Acquired by Assignee; Claims and Defenses Against Assignee. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Modication of Assigned Contract.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Discharge of Account Debtor; Notication of Assignment; Identication and Proof of Assignment; Restrictions on Assignment of Accounts, Chattel Paper, Payment Intangibles, and Promissory Notes Ineective.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restrictions on Creation or Enforcement of Security Interest in Leasehold Interest or in Lessor's Residual Interest. . . . . . . . . . . . . . . Restrictions on Assignment of Promissory Notes, Health-CareInsurance Receivables, and Certain General Intangibles Ineective. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restrictions on Assignment of Letter-of-Credit Rights Ineective. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9-405 9-406

990 994 995 999 1001

9-407 9-408 9-409

PART 5. FILING ............................................................ [SUBPART 1 FILING OFFICE; CONTENTS AND EFFECTIVENESS OF FINANCING STATEMENT] ..............
9-501 9-502 9-503 9-504 9-505 9-506 9-507 9-508 9-509 Filing Oce. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Contents of Financing Statement; Record of Mortgage as Financing Statement; Time of Filing Financing Statement. . . . . . Name of Debtor and Secured Party. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Indication of Collateral. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Filing and Compliance With Other Statutes and Treaties for Consignments, Leases, Other Bailments, and Other Transactions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Errors or Omissions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Certain Events on Eectiveness of Financing Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eectiveness of Financing Statement if New Debtor Becomes Bound by Security Agreement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Persons Entitled to File a Record. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1001 1001 1002 1004 1006 1007 1008 1009 1010 1012

xlviii

Table of Contents 9-510 9-511 9-512 9-513 9-514 9-515 Eectiveness of Filed Record.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Secured Party of Record. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amendment of Financing Statement.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Termination Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Assignment of Powers of Secured Party of Record. . . . . . . . . . . . . . . . Duration and Eectiveness of Financing Statement; Eect of Lapsed Financing Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What Constitutes Filing; Eectiveness of Filing.. . . . . . . . . . . . . . . . . . Eect of Indexing Errors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Claim Concerning Inaccurate or Wrongfully Filed Record. . . . . . . 1014 1015 1016 1017 1019 1020 1022 1025 1025

9-516 9-517 9-518

[SUBPART 2 DUTIES AND OPERATION OF FILING OFFICE] ........................................................................

9-519 9-520 9-521 9-522 9-523 9-524 9-525 9-526 9-527 Numbering, Maintaining, and Indexing Records; Communicating Information Provided in Records. . . . . . . . . . . . . . . . . Acceptance and Refusal to Accept Record. . . . . . . . . . . . . . . . . . . . . . . . . . Uniform Form of Written Financing Statement and Amendment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Maintenance and Destruction of Records.. . . . . . . . . . . . . . . . . . . . . . . . . . Information From Filing Oce; Sale or License of Records. . . . . . Delay by Filing Oce. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Filng-Oce Rules. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Duty to Report. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1026 1026 1029 1030 1035 1036 1038 1038 1040 1041 1041

PART 6. DEFAULT.........................................................

[SUBPART 1 DEFAULT AND ENFORCEMENT OF SECURITY INTEREST] .................................................................... 1041

9-601 9-602 9-603 9-604 9-605 9-606 9-607 9-608 9-609 9-610 9-611 9-612 9-613 Rights After Default; Judicial Enforcement; Consignor or Buyer of Accounts, Chattel Paper, Payment Intangibles, or Promissory Notes.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Waiver and Variance of Rights and Duties.. . . . . . . . . . . . . . . . . . . . . . . . Agreement on Standards Concerning Rights and Duties. . . . . . . . . Procedure if Security Agreement Covers Real Property or Fixtures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unknown Debtor or Secondary Obligor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time of Default for Agricultural Lien.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Collection and Enforcement by Secured Party. . . . . . . . . . . . . . . . . . . . . Application of Proceeds of Collection or Enforcement; Liability for Deciency and Right to Surplus. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Secured Party's Right to Take Possession After Default.. . . . . . . . . Disposition of Collateral After Default.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notication Before Disposition of Collateral. . . . . . . . . . . . . . . . . . . . . . . Timeliness of Notication Before Disposition of Collateral. . . . . . . Contents and Form of Notication Before Disposition of Collateral: General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Contents and Form of Notication Before Disposition of Collateral: Consumer-Goods Transaction. . . . . . . . . . . . . . . . . . . . . . . . . . . Application of Proceeds of Disposition; Liability for Deciency and Right to Surplus.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1041 1043 1045 1045 1046 1047 1047 1050 1052 1053 1056 1058 1059 1060 1062

9-614 9-615

xlix

9-616 9-617 9-618 9-619 9-620 9-621 9-622 9-623 9-624

Explanation of Calculation of Surplus or Deciency. . . . . . . . . . . . . . Rights of Transferee of Collateral. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights and Duties of Certain Secondary Obligors. . . . . . . . . . . . . . . . . Transfer of Record or Legal Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Acceptance of Collateral in Full or Partial Satisfaction of Obligation; Compulsory Disposition of Collateral.. . . . . . . . . . . . . . . . . Notication of Proposal to Accept Collateral. . . . . . . . . . . . . . . . . . . . . . . Eect of Acceptance of Collateral.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Right to Redeem Collateral. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Waiver. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1065 1067 1068 1069 1070 1074 1075 1076 1076 1077 1077 1079 1081 1083 1084 1084 1084 1085 1086 1087 1090 1092 1094 1095

[SUBPART 2 NONCOMPLIANCE WITH ARTICLE] ............

9-625 9-626 9-627 9-628 Remedies for Secured Party's Failure to Comply With Article.. . Action in Which Deciency or Surplus Is in Issue.. . . . . . . . . . . . . . . . Determination of Whether Conduct Was Commercially Reasonable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Nonliability and Limitation on Liability of Secured Party; Liability of Secondary Obligor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 7. TRANSITION ....................................................

9-701 9-702 9-703 9-704 9-705 9-706 Eective Date. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Savings Clause. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Security Interest Perfected Before Eective Date. . . . . . . . . . . . . . . . . Security Interest Unperfected Before Eective Date. . . . . . . . . . . . . . Eectiveness of Action Taken Before Eective Date. . . . . . . . . . . . . . When Initial Financing Statement Suces to Continue Eectiveness of Financing Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amendment of Pre-Eective-Date Financing Statement.. . . . . . . . . Persons Entitled to File Initial Financing Statement or Continuation Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Priority. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9-707 9-708 9-709

APPENDIX I. CONFORMING AMENDMENTS TO OTHER ARTICLES .....................................................................

1097

APPENDIX II. MODEL PROVISIONS FOR PRODUCTION-MONEY PRIORITY ..................................................................... 1121 APPENDIX III. PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE ..................................... 1124 APPENDIX IV. PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE ..................................... 1131 ARTICLE 10 EFFECTIVE DATE AND REPEALER .............
10-101 10-102 10-103 10-104 Eective Date. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Specic Repealer; Provision for Transition. . . . . . . . . . . . . . . . . . . . . . . . . . General Repealer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Laws Not Repealed.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1139 1139 1139 1140 1140

Table of Contents

ARTICLE 11 EFFECTIVE DATE AND TRANSITION PROVISIONS .................................................................

11-101 11-102 11-103 11-104 11-105 11-106 11-107 11-108 Eective Date. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Preservation of Old Transition Provision. . . . . . . . . . . . . . . . . . . . . . . . . . . . Transition to [New Code]General Rule. . . . . . . . . . . . . . . . . . . . . . . . . . . . Transition Provision on Change of Requirement of Filing.. . . . . . . . Transition Provision on Change of Place of Filing.. . . . . . . . . . . . . . . . . Required Relings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transition Provisions as to Priorities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Presumption That Rule of Law Continues Unchanged. . . . . . . . . . . .

1141 1141 1141 1141 1142 1142 1142 1143 1143

APPENDIX A PEB COMMENTARIES ON THE UNIFORM COMMERCIAL CODE ..................................................... COMMENTARIES 17 FINAL DRAFT ................................ PEB RESOLUTION ON PURPOSES, STANDARDS AND PROCEDURES FOR PEB COMMENTARY TO THE UCC ..... PEB COMMENTARY NO. 1 SECTION 2-507(2) .................... PEB COMMENTARY NO. 2 SECTION 9-301(4) .................... PEB COMMENTARY NO. 3 SECTIONS 9-306(2) AND 9-402(7) .......................................................................... PEB COMMENTARY NO. 4 SECTION 8-207(1) .................... PEB COMMENTARY NO. 5 SECTION 9-306(5) .................... PEB COMMENTARY NO. 6 SECTION 9-301(1) .................... PEB COMMENTARY NO. 7 THE RELATIVE PRIORITIES OF SECURITY INTERESTS IN THE CASH PROCEEDS OF ACCOUNTS, CHATTEL PAPER, AND GENERAL INTANGIBLES ............................................................... COMMENTARY NO. 8 FINAL DRAFT ............................... PEB COMMENTARY NO. 8 (AS AMENDED TO APPLY TO REVISED ARTICLE 9) SECTION 9-330 .............................. COMMENTARY NO. 9 FINAL DRAFT ............................... PEB COMMENTARY NO. 9 SECTION 9-306(1) .................... COMMENTARY NO. 10 (SECTION 1-203) FINAL DRAFT ..... PEB COMMENTARY NO. 10 SECTION 1-203 ......................

1144 1146

1147 1149 1152

1154 1158 1163 1168

1171 1174

1176 1181 1183 1187 1189

li

COMMENTARY NO. 11 (SURETYSHIP ISSUES UNDER SECTIONS 3-116, 3-305, 3-415, 3-419, AND 3-605) FINAL DRAFT ........... 1195 PEB COMMENTARY NO. 11 (AS AMENDED TO APPLY TO REVISED ARTICLE 9) SURETYSHIP ISSUES UNDER SECTIONS 3-116, 3-305, 3-415, 3-419, AND 3-605 .................................. 1197 COMMENTARY NO. 12 (SECTION 9-302) FINAL DRAFT ..... PEB COMMENTARY NO. 12 SECTION 9-302 ...................... COMMENTARY NO. 13 (THE PLACE OF ARTICLE 4A IN A WORLD OF ELECTRONIC FUNDS TRANSFERS) FINAL DRAFT ..........................................................................
1212 1214

1220

PEB COMMENTARY NO. 13 THE PLACE OF ARTICLE 4A IN A WORLD OF ELECTRONIC FUNDS TRANSFERS................ 1222 COMMENTARY NO. 14 (SECTION 9-102(1)(B)) FINAL DRAFT .......................................................................... PEB COMMENTARY NO. 14 SECTION 9-102(1)(B) .............. PEB COMMENTARY NO. 15 ELECTRONIC FILING UNDER ARTICLE 9 .................................................................... PEB COMMENTARY NO 16 SECTIONS 4A-502(D) AND 4A-503 ........................................................................... PEB COMMENTARY NO 16 SECTIONS 4A-502(D) AND 4A-503 ...........................................................................
1231 1233

1237

1242

1243

APPENDIX B 1972 OFFICIAL TEXT SHOWING CHANGES MADE IN FORMER TEXT OF ARTICLE 9, SECURED TRANSACTIONS, AND OF RELATED SECTIONS AND REASONS FOR CHANGES ...................................................................... 1249 GENERAL COMMENT ON THE APPROACH OF THE REVIEW COMMITTEE FOR ARTICLE 9 ......................................... 1249 AMENDMENTS TO ARTICLE 1 ........................................ AMENDMENT TO ARTICLE 2 .......................................... AMENDMENT TO ARTICLE 5 ..........................................
1285 1287 1287

ARTICLE 9 SECURED TRANSACTIONS; SALES OF ACCOUNTS [, CONTRACT RIGHTS] AND CHATTEL PAPER ................... 1289

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Table of Contents

PART 1. SHORT TITLE, APPLICABILITY AND DEFINITIONS ................................................................

9-102 Policy and [Scope] Subject Matter of Article. . . . . . . . . . . . . . . . . . . . . . . . [ 9-103 Accounts, Contract Rights, General Intangibles and Equipment Relating to Another Jurisdiction; and Incoming Goods Already Subject to a Security Interest]. . . . . . . . . . . . . . . . . . . . . . . . . . . 9-103 Perfection of Security Interests in Multiple State Transactions. . 9-104 Transactions Excluded From Article. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-105 Denitions and Index of Denitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-106 Denitions: Account; [Contract Right;] General Intangibles. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-114 Consignment.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1289 1289 1290 1291 1294 1295 1297 1298

PART 2. VALIDITY OF SECURITY AGREEMENT AND RIGHTS OF PARTIES THERETO .................................................. 1299
9-203 9-204 9-205 Attachment and Enforceability of Security Interest; Proceeds; Formal Requisites. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . [When Security Interest Attaches;] After-Acquired Property; Future Advances. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Use or Disposition of Collateral Without Accounting Permissible.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1299 1300 1301

PART 3. RIGHTS OF THIRD PARTIES; PERFECTED AND UNPERFECTED SECURITY INTERESTS; RULES OF PRIORITY .....................................................................
9-301 9-302 9-304 Persons Who Take Priority Over Unperfected Security Interests; Right of Lien Creditor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . When Filing Is Required to Perfect Security Interest; Security Interests to Which Filing Provisions of This Article Do Not Apply. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Perfection of Security Interest in Instruments, Documents, and Goods Covered by Documents; Perfection by Permissive Filing; Temporary Perfection Without Filing or Transfer of Possession. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . When Possession by Secured Party Perfects Security Interest Without Filing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds; Secured Party's Rights on Disposition of Collateral. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Protection of Buyers of Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchase of Chattel Paper and [Non-Negotiable] Instruments. . Priorities Among Conicting Security Interests in the Same Collateral. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Priority of Security Interests in Fixtures. . . . . . . . . . . . . . . . . . . . . . . . . . . Defenses Against Assignee; Modication of Contract After Notication of Assignment; Term Prohibiting Assignment Ineective; Identication and Proof of Assignment.. . . . . . . . . . . . . . .

1302 1302 1303

1305 1306 1306 1309 1309 1310 1314 1316 1317

9-305 9-306 9-307 9-308 9-312 9-313 9-318

PART 4. FILING ............................................................

liii

 9-401 9-402 9-403 9-404 9-405 9-406 [[ 9-407 9-408

Place of Filing; Erroneous Filing; Removal of Collateral. . . . . . . . Formal Requisites of Financing Statement; Amendments; Mortgage as Financing Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What Constitutes Filing; Duration of Filing; Eect of Lapsed Filing; Duties of Filing Ocer.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Termination Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Assignment of Security Interest; Duties of Filing Ocer; Fees.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Release of Collateral; Duties of Filing Ocer; Fees. . . . . . . . . . . . . . Information From Filing Ocer]].. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Financing Statements Covering Consigned or Leased Goods. . .

1317 1320 1323 1325 1327 1328 1328 1329 1329 1329 1330 1330 1332

PART 5. DEFAULT.........................................................
9-501 9-502 9-504 9-505 Default; Procedure When Security Agreement Covers Both Real and Personal Property. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Collection Rights of Secured Party. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Secured Party's Right to Dispose of Collateral After Default; Eect of Disposition. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Compulsory Disposition of Collateral; Acceptance of the Collateral as Discharge of Obligation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

ARTICLE 11 EFFECTIVE DATE AND TRANSITION PROVISIONS .................................................................

11-101 11-102 11-103 11-104 11-105 11-106 11-107 11-108 Eective Date. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Preservation of Old Transition Provision. . . . . . . . . . . . . . . . . . . . . . . . . . . . Transition to [New Code]General Rule. . . . . . . . . . . . . . . . . . . . . . . . . . . . Transition Provision on Change of Requirement of Filing.. . . . . . . . Transition Provision on Change of Place of Filing.. . . . . . . . . . . . . . . . . Required Relings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transition Provisions as to Priorities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Presumption that Rule of Law Continues Unchanged. . . . . . . . . . . . .

1334 1334 1334 1334 1335 1335 1336 1337 1337

APPENDIX C 1977 OFFICIAL TEXT SHOWING CHANGES MADE IN FORMER TEXT OF ARTICLE 8, INVESTMENT SECURITIES, AND OF RELATED SECTIONS AND REASONS FOR CHANGES ...................................................................... 1338 REPORTER'S INTRODUCTORY COMMENT ...................... ARTICLE 8 INVESTMENT SECURITIES ........................... PART 1. SHORT TITLE AND GENERAL MATTERS ...........
8-101 8-102 8-103 8-104 8-105 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuer's Lien. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Overissue; Overissue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Certicated Securities Negotiable; Statements and Instructions Not Negotiable; Presumptions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applicability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Securities [Deliverable] Transferable; Action for Price. . . . . . . . . . . 1338 1349 1349 1349 1349 1352 1352 1353 1354 1354

8-106 8-107

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Table of Contents 8-108 Registration of Pledge and Release of Uncerticated Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1355 1355 1355 1356 1358 1358 1359 1359 1360 1361 1362 1362 1363 1363 1364 1364 1365 1367 1367 1369 1369 1370 1370 1372 1375 1376 1377 1377 1379 1379 1380 1381

PART 2. ISSUEISSUER ................................................

8-201 8-202 8-203 8-204 8-205 8-206 8-207 8-208 Issuer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuer's Responsibility and Defenses; Notice of Defect or Defense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Staleness as Notice of Defects or Defenses. . . . . . . . . . . . . . . . . . . . . . . . . Eect of Issuer's Restrictions on Transfer.. . . . . . . . . . . . . . . . . . . . . . . . . Eect of Unauthorized Signature on [Issue] Certicated Security or Initial Transaction Statement.. . . . . . . . . . . . . . . . . . . . . . . . . Completion or Alteration of [Instrument] Certicated Security or Initial Transaction Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights and Duties of Issuer With Respect to Registered Owners and Registered Pledgees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Signature of Authenticating Trustee, Registrar, or Transfer Agent.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 3. [PURCHASE] TRANSFER ..................................

8-301 8-302 8-303 8-304 8-305 8-306 Rights Acquired by Purchaser [; Adverse Claim; Title Acquired by Bona Fide Purchaser]. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bona Fide Purchaser; Adverse Claim; Title Acquired by Bona Fide Purchaser.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Broker. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notice to Purchaser of Adverse Claims. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Staleness as Notice of Adverse Claims. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranties on Presentment and Transfer of Certicated Securities; Warranties of Originators of Instructions. . . . . . . . . . . . . Eect of Delivery Without Indorsement; Right to Compel Indorsement.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . [Indorsement, How Made; Special Indorsement; Indorser Not a Guarantor; Partial Assignment] Indorsements; Instructions.. . . . Eect of Indorsement Without Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . Indorsement of Certicated Security in Bearer Form.. . . . . . . . . . . . Eect of Unauthorized Indorsement or Instruction. . . . . . . . . . . . . . . Eect of Guaranteeing Signature, [or] Indorsement or Instruction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . When [Delivery] Transfer to [the] Purchaser Occurs: [; Purchaser's Broker] Financial Intermediary as [Holder] Bona Fide Purchaser; Financial Intermediary. . . . . . . . . . . . . . . . . . . . . . . . . . Duty to [Deliver] Transfer, When Completed. . . . . . . . . . . . . . . . . . . . . . Action Against [Purchaser] Transferee Based Upon Wrongful Transfer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchaser's Right to Requisites for Registration of Transfer, Pledge, or Release on Books.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . [Attachment or Levy Upon Security] Creditors' Rights. . . . . . . . . . . No Conversion by Good Faith [Delivery] Conduct. . . . . . . . . . . . . . . . . Statute of Frauds.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer or Pledge Within [a] Central Depository System. . . . . . . Enforceability, Attachment, Perfection and Termination of Security Interests. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8-307 8-308 8-309 8-310 8-311 8-312

8-313 8-314 8-315 8-316 8-317 8-318 8-319 8-320 8-321

lv

PART 4. REGISTRATION ...............................................

8-401 8-402 8-403 8-404 8-405 8-406 8-407 8-408 Duty of Issuer to Register Transfer, Pledge, or Release. . . . . . . . . . Assurance that Indorsements and Instructions Are Eective. . . . [Limited Duty of Inquiry] Issuer's Duty as to Adverse Claims. . Liability and Non-Liability for Registration.. . . . . . . . . . . . . . . . . . . . . . . Lost, Destroyed, and Stolen Certicated Securities. . . . . . . . . . . . . . . Duty of Authenticating Trustee, Transfer Agent, or Registrar.. . Exchangeability of Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statements of Uncerticated Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . .

1383 1383 1383 1384 1387 1388 1389 1389 1390 1393 1397

AMENDMENTS TO ARTICLE 9 (1972 OFFICIAL TEXT) ...... CHANGES IN ARTICLES 1 AND 5 ....................................

APPENDIX D ARTICLE 1 AND ARTICLE 9: 1987 CONFORMING AMENDMENTS [CONFORMING TO ARTICLE 2A] ............. 1398
Territorial Application of the Act; Parties' Power to Choose Applicable Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-201(37) General Denitions: Security Interest. . . . . . . . . . . . . . . . . . . . . . . . . 9-113 Security Interests Arising Under Article on Sales or Under Article on Leases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-105 1398 1398 1401 1403 1404 1404 1405 1405 1407 1408 1408 1410 1411 1412 1412 1413 1414 1414 1421 1423 1425 1430

APPENDIX E PRE-REVISION ARTICLE 6 ........................ ARTICLE 6 BULK TRANSFERS .......................................

6-101 6-102 [ Short Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bulk Transfers; Transfers of Equipment; Enterprises Subject to This Article; Bulk Transfers Subject to This Article. . . . . . . . . 6-103 Transfers Excepted From This Article.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-104 Schedule of Property, List of Creditors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-105 Notice to Creditors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-106 Application of the Proceeds]. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-107 The Notice. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-108 Auction Sales; Auctioneer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-109 What Creditors Protected; [Credit for Payment to Particular Creditors]. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-110 Subsequent Transfers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-111 Limitation of Actions and Levies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

APPENDIX F 1990 AMENDMENTS TO ARTICLE 2A .......... AMENDMENT 1 .............................................................. AMENDMENT 2 .............................................................. AMENDMENT 3 .............................................................. AMENDMENT 4 .............................................................. AMENDMENT 5 ..............................................................

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Table of Contents

AMENDMENT 6 .............................................................. AMENDMENT 7 .............................................................. AMENDMENT 8 .............................................................. AMENDMENT 9 .............................................................. AMENDMENT 10 ............................................................ AMENDMENT 11 ............................................................ AMENDMENT 12 ............................................................ AMENDMENT 13 ............................................................ AMENDMENT 14 ............................................................ AMENDMENT 15 ............................................................ AMENDMENT 16 ............................................................ AMENDMENT 17 ............................................................ AMENDMENT 18 ............................................................ AMENDMENT 19 ............................................................ AMENDMENT 20 ............................................................ AMENDMENT 21 ............................................................ AMENDMENT 22 ............................................................ AMENDMENT 23 ............................................................ AMENDMENT 24 ............................................................ APPENDIX TO 1990 ARTICLE 2A AMENDMENTS .............. APPENDIX G PRE-REVISION ARTICLE 3 ........................ ARTICLE 3 COMMERCIAL PAPER .................................. PART 1. SHORT TITLE, FORM AND INTERPRETATION ...
3-101 3-102 3-103 3-104 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Limitations on Scope of Article. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Form of Negotiable Instruments; Draft; Check; Certicate of Deposit; Note.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1432 1435 1438 1438 1440 1441 1442 1443 1446 1448 1449 1451 1453 1457 1458 1459 1462 1464 1467 1468 1475 1476 1478 1478 1478 1480 1481

lvii

3-105 3-106 3-107 3-108 3-109 3-110 3-111 3-112 3-113 3-114 3-115 3-116 3-117 3-118 3-119 3-120 3-121 3-122

When Promise or Order Unconditional. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sum Certain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Money.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payable on Demand. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denite Time. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payable to Order. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payable to Bearer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Terms and Omissions Not Aecting Negotiability.. . . . . . . . . . . . . . . . Seal. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Date, Antedating, Postdating. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Incomplete Instruments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Instruments Payable to Two or More Persons. . . . . . . . . . . . . . . . . . . . . Instruments Payable With Words of Description. . . . . . . . . . . . . . . . . . Ambiguous Terms and Rules of Construction.. . . . . . . . . . . . . . . . . . . . . Other Writings Aecting Instrument. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Instruments Payable Through Bank. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Instruments Payable at Bank.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accrual of Cause of Action. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1482 1484 1485 1486 1487 1488 1489 1490 1492 1492 1493 1494 1495 1496 1497 1498 1499 1500 1501 1501 1502 1504 1504 1505 1505 1507 1508 1509 1509 1509 1511 1512 1515 1517 1518 1520 1520 1521 1521 1523 1524 1525 1527 1529 1529 1530

PART 2. TRANSFER AND NEGOTIATION ........................

3-201 3-202 3-203 3-204 3-205 3-206 3-207 3-208 Transfer: Right to Indorsement.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Negotiation.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Wrong or Misspelled Name. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Special Indorsement; Blank Indorsement. . . . . . . . . . . . . . . . . . . . . . . . . . Restrictive Indorsements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Restrictive Indorsement.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Negotiation Eective Although It May Be Rescinded. . . . . . . . . . . . . Reacquisition.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 3. RIGHTS OF A HOLDER .....................................

3-301 3-302 3-303 3-304 3-305 3-306 3-307 Rights of a Holder. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Holder in Due Course.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taking for Value. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notice to Purchaser. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights of a Holder in Due Course. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights of One Not Holder in Due Course.. . . . . . . . . . . . . . . . . . . . . . . . . . Burden of Establishing Signatures, Defenses and Due Course. .

PART 4. LIABILITY OF PARTIES ....................................

3-401 3-402 3-403 3-404 3-405 3-406 3-407 3-408 3-409 3-410 Signature. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Signature in Ambiguous Capacity.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Signature by Authorized Representative. . . . . . . . . . . . . . . . . . . . . . . . . . . Unauthorized Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Impostors; Signature in Name of Payee. . . . . . . . . . . . . . . . . . . . . . . . . . . . Negligence Contributing to Alteration or Unauthorized Signature. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Alteration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consideration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Draft Not an Assignment.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denition and Operation of Acceptance. . . . . . . . . . . . . . . . . . . . . . . . . . . .

lviii

Table of Contents 3-411 3-412 3-413 3-414 3-415 3-416 3-417 3-418 3-419 Certication of a Check.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Acceptance Varying Draft. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Contract of Maker, Drawer and Acceptor. . . . . . . . . . . . . . . . . . . . . . . . . . Contract of Indorser; Order of Liability. . . . . . . . . . . . . . . . . . . . . . . . . . . . Contract of Accommodation Party.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Contract of Guarantor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranties on Presentment and Transfer.. . . . . . . . . . . . . . . . . . . . . . . . . Finality of Payment or Acceptance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Conversion of Instrument; Innocent Representative. . . . . . . . . . . . . . 1532 1532 1533 1534 1535 1536 1537 1541 1542 1544 1544 1547 1548 1549 1551 1551 1552 1553 1554 1556 1557 1559 1559 1561 1561 1563 1564 1564 1565 1565 1566 1566 1567 1568 1569 1570

PART 5. PRESENTMENT, NOTICE OF DISHONOR AND PROTEST ......................................................................

3-501 3-502 3-503 3-504 3-505 3-506 3-507 3-508 3-509 3-510 3-511 When Presentment, Notice of Dishonor, and Protest Necessary or Permissible.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unexcused Delay; Discharge. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time of Presentment.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . How Presentment Made. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights of Party to Whom Presentment Is Made. . . . . . . . . . . . . . . . . . . Time Allowed for Acceptance or Payment. . . . . . . . . . . . . . . . . . . . . . . . . . Dishonor; Holder's Right of Recourse; Term Allowing Re-presentment.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notice of Dishonor.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Protest; Noting for Protest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Evidence of Dishonor and Notice of Dishonor.. . . . . . . . . . . . . . . . . . . . . Waived or Excused Presentment, Protest or Notice of Dishonor or Delay Therein. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 6. DISCHARGE .....................................................

3-601 3-602 3-603 3-604 3-605 3-606 Discharge of Parties.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Discharge Against Holder in Due Course. . . . . . . . . . . . . . . . Payment or Satisfaction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tender of Payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cancellation and Renunciation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Impairment of Recourse or of Collateral.. . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 7. ADVICE OF INTERNATIONAL SIGHT DRAFT .....

3-701 Letter of Advice of International Sight Draft. . . . . . . . . . . . . . . . . . . . . .

PART 8. MISCELLANEOUS ............................................

3-801 3-802 3-803 3-804 3-805 Drafts in a Set. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Instrument on Obligation for Which It Is Given. . . . . . . . Notice to Third Party. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lost, Destroyed or Stolen Instruments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Instruments Not Payable to Order or to Bearer. . . . . . . . . . . . . . . . . . .

APPENDIX H 1990 ARTICLE 1 AMENDMENTS CONFORMING TO REVISED ARTICLE 3 ...................................................... 1571 ARTICLE 1 GENERAL PROVISIONS ................................

lix

 1-201 1-207

General Denitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Performance or Acceptance Under Reservation of Rights. . . . . . . .

1572 1572 1572

APPENDIX I 1990 CONFORMING [TO REVISED ARTICLE 3] AND MISCELLANEOUS AMENDMENTS TO ARTICLE 4 ............ 1574 ARTICLE 4 BANK DEPOSITS AND COLLECTIONS ...........
4-101 4-102 4-103 4-104 4-105 4-106 4-106 4-107 4-107 4-108 4-108 4-109 4-109 4-110 4-111 4-201 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applicability.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Variation by Agreement; Measure of Damages; Certain Action Constituting Ordinary Care. . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . Bank; Depositary Bank; Payor Bank; Intermediary Bank; Collecting Bank; Presenting Bank; Remitting Bank.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payable Through or Payable at Bank; Collecting Bank.. . . . . Separate Oce of Bank.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time of Receipt of Items.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Delays.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Process of Posting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Electronic Presentment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statute of Limitations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Presumption and Duration of Agency Status of Collecting Banks as Agent and Provisional Status of Credits; Applicability of Article; Item Indorsed Pay Any Bank. . . Responsibility for Collection or Return; When Action Seasonable Timely. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Instructions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Methods of Sending and Presenting; Sending Direct Directly to Payor Bank. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Supplying Missing Indorsement; No Notice from Prior Indorsement Depositary Bank Holder of Unindorsed Item. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer Between Banks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranties of Customer and Collecting Bank on Transfer or Presentment of Items; Time for Claims. . . . . . . . . . . . . . . . . . Transfer Warranties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Presentment Warranties.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Encoding and Retention Warranties. . . . . . . . . . . . . . . . . . . . . . . . . . . Security Interest of Collecting Bank in Items, Accompanying Documents and Proceeds. . . . . . . . . . . . . . . . . . . . When Bank Gives Value for Purposes of Holder in Due Course. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Presentment by Notice of Item Not Payable By, Through, or at Bank; Liability of Secondary Parties Drawer or Indorser. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Media of Remittance; Provisional and Final Settlement in Remittance Cases Medium and Time of Settlement by Bank.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Right of Charge-Back or Refund; Liability of Collecting Bank; Return of Item.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1575 1575 1575 1575 1576 1578 1579 1579 1579 1580 1580 1580 1581 1581 1582 1582 1583 1583 1584 1584 1585 1586 1587 1587 1588 1588 1589 1590

4-202 4-203 4-204 4-205 4-206 4-207 4-207 4-208 4-209 4-208 4-210

4-209 4-211 4-210 4-212 4-211 4-213 4-212 4-214

lx

Table of Contents 4-213 4-215 Final Payment of Item by Payor Bank; When Provisional Debits and Credits Become Final; When Certain Credits Become Available For Withdrawal.. . . . . . . . . . . . . . . . . . . . . . . . . . 4-214 4-216 Insolvency and Preference.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4-301 Deferred Posting; Recovery of Payment by Return of Items; Time of Dishonor; Return of Items by Payor Bank.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4-302 Payor Bank's Responsibility for Late Return of Item. . . . . . . . 4-303 When Items Subject to Notice, Stop Order Stop-Payment Order, Legal Process, or Seto; Order in Which Items May be Charged or Certied.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4-401 When Bank May Charge Customer's Account. . . . . . . . . . . . . . . . 4-402 Bank's Liability to Customer for Wrongful Dishonor; Time of Determining Insuciency of Account. . . . . . . . . . . . . . . . . . . . . 4-403 Customer's Right to Stop Payment; Burden of Proof of Loss.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4-405 Death or Incompetence of Customer. . . . . . . . . . . . . . . . . . . . . . . . . . . 4-406 Customer's Duty to Discover and Report Unauthorized Signature or Alteration.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4-407 Payor Bank's Right to Subrogation on Improper Payment. . 4-501 Handling of Documentary Drafts; Duty to Send for Presentment and to Notify Customer of Dishonor. . . . . . . . . 4-502 Presentment of On Arrival Drafts. . . . . . . . . . . . . . . . . . . . . . . . . . . . 4-503 Responsibility of Presenting Bank for Documents and Goods; Report of Reasons for Dishonor; Referee in Case of Need. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4-504 Privilege of Presenting Bank to Deal with Goods; Security Interest for Expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1591 1593 1594 1594 1595 1596 1597 1598 1599 1599 1602 1602 1602 1602 1603

APPENDIX J 1994 AMENDMENTS TO UNIFORM COMMERCIAL CODE ............................................................................ 1604 AMENDMENT 1 .............................................................. AMENDMENT 2 .............................................................. AMENDMENT 3 .............................................................. AMENDMENT 4 .............................................................. AMENDMENT 5 .............................................................. AMENDMENT 6 .............................................................. AMENDMENT 7 .............................................................. AMENDMENT 8 ..............................................................
1604 1609 1610 1610 1611 1612 1613 1614

APPENDIX K 1994 AND 1995 AMENDMENTS TO ARTICLES 1, 3, 4, 5, 9, AND 10 CONFORMING TO 1994 REVISION OF ARTICLE 8 ...................................................................................

lxi

1616

CONFORMING AMENDMENTS TO ARTICLE 9 ................. CONFORMING AMENDMENTS TO ARTICLES 1, 3, 4, 5, AND 10.................................................................................. APPENDIX L PRE-REVISION ARTICLE 8......................... ARTICLE 8 INVESTMENT SECURITIES ........................... PART 1. SHORT TITLE AND GENERAL MATTERS ...........
8-101 8-102 8-103 8-104 8-105 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuer's Lien. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Overissue; Overissue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Certicated Securities Negotiable; Statements and Instructions Not Negotiable; Presumptions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applicability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Securities Transferable; Action for Price. . . . . . . . . . . . . . . . . . . . . . . . . . . Registration of Pledge and Release of Uncerticated Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1616 1637 1641 1642 1643 1643 1643 1646 1647 1648 1649 1650 1651 1652 1652 1653 1657 1658 1659 1661 1662 1664 1666 1666 1666 1668 1668 1670 1671 1674

8-106 8-107 8-108

PART 2. ISSUEISSUER ................................................

8-201 8-202 8-203 8-204 8-205 8-206 8-207 8-208 Issuer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuer's Responsibility and Defenses; Notice of Defect or Defense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Staleness as Notice of Defects or Defenses. . . . . . . . . . . . . . . . . . . . . . . . . Eect of Issuer's Restrictions on Transfer.. . . . . . . . . . . . . . . . . . . . . . . . . Eect of Unauthorized Signature on Certicated Security or Initial Transaction Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Completion or Alteration of Certicated Security or Initial Transaction Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights and Duties of Issuer With Respect to Registered Owners and Registered Pledgees. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Signature of Authenticating Trustee, Registrar, or Transfer Agent.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 3. TRANSFER ......................................................

8-301 8-302 8-303 8-304 8-305 8-306 Rights Acquired by Purchaser. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bona Fide Purchaser; Adverse Claim; Title Acquired by Bona Fide Purchaser.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Broker. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notice to Purchaser of Adverse Claims. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Staleness as Notice of Adverse Claims. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranties on Presentment and Transfer of Certicated Securities; Warranties of Originators of Instructions. . . . . . . . . . . . . Eect of Delivery Without Indorsement; Right to Compel Indorsement.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

8-307

lxii

Table of Contents 8-308 8-309 8-310 8-311 8-312 8-313 Indorsements; Instructions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Indorsement Without Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . Indorsement of Certicated Security in Bearer Form.. . . . . . . . . . . . Eect of Unauthorized Indorsement or Instruction. . . . . . . . . . . . . . . Eect of Guaranteeing Signature, Indorsement or Instruction. . When Transfer to Purchaser Occurs; Financial Intermediary as Bona Fide Purchaser; Financial Intermediary.. . . . . . . . . . . . . . . Duty to Transfer, When Completed. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Action Against Transferee Based Upon Wrongful Transfer. . . . . . Purchaser's Right to Requisites for Registration of Transfer, Pledge, or Release on Books.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Creditors' Rights. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . No Conversion by Good Faith Conduct. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statute of Frauds.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Transfer or Pledge Within Central Depository System. . . . . . . . . . . Enforceability, Attachment, Perfection and Termination of Security Interests. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1675 1677 1678 1678 1679 1682 1686 1688 1689 1689 1691 1692 1693 1695 1697 1697 1698 1701 1704 1706 1707 1708 1710

8-314 8-315 8-316 8-317 8-318 8-319 8-320 8-321

PART 4. REGISTRATION ...............................................

8-401 8-402 8-403 8-404 8-405 8-406 8-407 8-408 Duty of Issuer to Register Transfer, Pledge, or Release. . . . . . . . . . Assurance That Indorsements and Instructions Are Eective. . . Issuer's Duty as to Adverse Claims. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liability and Non-liability for Registration. . . . . . . . . . . . . . . . . . . . . . . . Lost, Destroyed, and Stolen Certicated Securities. . . . . . . . . . . . . . . Duty of Authenticating Trustee, Transfer Agent, or Registrar.. . Exchangeability of Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statements of Uncerticated Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . .

APPENDIX M 1995 AMENDMENTS TO ARTICLES 1, 2, AND 9 CONFORMING TO REVISED ARTICLE 5 .......................... 1714 CONFORMING AND MISCELLANEOUS AMENDMENTS TO ARTICLE 1 .................................................................... CONFORMING AND MISCELLANEOUS AMENDMENTS TO ARTICLE 2 .................................................................... COMPLEMENTARY AMENDMENTS TO ARTICLE 9 .......... APPENDIX N PRE-REVISION ARTICLE 5 ........................ ARTICLE 5 LETTERS OF CREDIT ...................................
5-101 5-102 5-103 5-104 5-105 5-106 5-107 5-108 5-109 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Scope.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Formal Requirements; Signing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consideration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time and Eect of Establishment of Credit. . . . . . . . . . . . . . . . . . . . . . . . Advice of Credit; Conrmation; Error in Statement of Terms. . . Notation Credit; Exhaustion of Credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuer's Obligation to Its Customer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1714

1714 1714 1718 1719 1719 1719 1721 1723 1723 1724 1725 1726 1727

lxiii

 5-110 5-111 5-112 5-113 5-114 5-115 5-116 5-117

Availability of Credit in Portions; Presenter's Reservation of Lien or Claim. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Warranties on Transfer and Presentment.. . . . . . . . . . . . . . . . . . . . . . . . . Time Allowed for Honor or Rejection; Withholding Honor or Rejection by Consent; Presenter. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Indemnities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuer's Duty and Privilege to Honor; Right to Reimbursement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Remedy for Improper Dishonor or Anticipatory Repudiation. . . . Transfer and Assignment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Insolvency of Bank Holding Funds for Documentary Credit. . . . .

1729 1729 1730 1731 1732 1734 1735 1737 1739

APPENDIX O PRE-REVISION ARTICLE 9 ........................

ARTICLE 9 SECURED TRANSACTIONS; SALES OF ACCOUNTS AND CHATTEL PAPER ................................................... 1740 PART 1. SHORT TITLE, APPLICABILITY AND DEFINITIONS ................................................................
9-101 9-102 9-103 9-104 9-105 9-106 9-107 9-108 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Policy and Subject Matter of Article. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Perfection of Security Interest in Multiple State Transactions. . Transactions Excluded From Article. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions: Account; General Intangibles. . . . . . . . . . . . . . . . . . . . . . Denitions: Purchase Money Security Interest. . . . . . . . . . . . . . . . . . When After-Acquired Collateral Not Security for Antecedent Debt.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Classication of Goods: Consumer Goods; Equipment; Farm Products; Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Suciency of Description.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applicability of Bulk Transfer Laws. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Where Collateral Is Not Owned by Debtor. . . . . . . . . . . . . . . . . . . . . . . . . Security Interests Arising Under Article on Sales or Under Article on Leases. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consignment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment Property. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Security Interest Arising in Purchase or Delivery of Financial Asset. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1741 1741 1743 1749 1758 1760 1765 1767 1767 1768 1770 1770 1771 1772 1773 1774 1786

9-109 9-110 9-111 9-112 9-113

9-114 9-115 9-116

PART 2. VALIDITY OF SECURITY AGREEMENT AND RIGHTS OF PARTIES THERETO .................................................. 1787
9-201 9-202 9-203 9-204 9-205 9-206 General Validity of Security Agreement. . . . . . . . . . . . . . . . . . . . . . . . . . . . Title to Collateral Immaterial. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Attachment and Enforceability of Security Interest; Proceeds; Formal Requisites. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . After-Acquired Property; Future Advances.. . . . . . . . . . . . . . . . . . . . . . . . Use or Disposition of Collateral Without Accounting Permissible.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Agreement Not to Assert Defenses Against Assignee; 1787 1788 1789 1791 1793

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Table of Contents Modication of Sales Warranties Where Security Agreement Exists. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights and Duties When Collateral Is in Secured Party's Possession. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Request for Statement of Account or List of Collateral. . . . . . . . . . .

1794 1795 1797

9-207 9-208

PART 3. RIGHTS OF THIRD PARTIES; PERFECTED AND UNPERFECTED SECURITY INTERESTS; RULES OF PRIORITY .....................................................................
9-301 9-302 9-303 9-304 Persons Who Take Priority Over Unperfected Security Interests; Rights of Lien Creditor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . When Filing Is Required to Perfect Security Interest; Security Interests to Which Filing Provisions of This Article Do Not Apply. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . When Security Interest Is Perfected; Continuity of Perfection.. . Perfection of Security Interest in Instruments, Documents, Proceeds of a Written Letter of Credit, and Goods Covered by Documents; Perfection by Permissive Filing; Temporary Perfection Without Filing or Transfer of Possession. . . . . . . . . . . . . . When Possession by Secured Party Perfects Security Interest Without Filing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds; Secured Party's Rights on Disposition of Collateral. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Protection of Buyers of Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchase of Chattel Paper and Instruments. . . . . . . . . . . . . . . . . . . . . . . Protection of Purchasers of Instruments, Documents, and Securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Priority of Certain Liens Arising by Operation of Law. . . . . . . . . . . Alienability of Debtor's Rights: Judicial Process.. . . . . . . . . . . . . . . . . . Priorities Among Conicting Security Interests in the Same Collateral. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Priority of Security Interests in Fixtures. . . . . . . . . . . . . . . . . . . . . . . . . . . Accessions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Priority When Goods Are Commingled or Processed. . . . . . . . . . . . . . Priority Subject to Subordination. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Secured Party Not Obligated on Contract of Debtor. . . . . . . . . . . . . . Defenses Against Assignee; Modication of Contract After Notication of Assignment; Term Prohibiting Assignment Ineective; Identication and Proof of Assignment.. . . . . . . . . . . . . . .

1798 1798 1801 1804

1805 1808 1810 1814 1815 1817 1818 1818 1819 1824 1830 1831 1832 1832 1832 1835 1835 1839 1844 1846 1848 1849 1850

9-305 9-306 9-307 9-308 9-309 9-310 9-311 9-312 9-313 9-314 9-315 9-316 9-317 9-318

PART 4. FILING ............................................................

9-401 9-402 9-403 9-404 9-405 9-406 9-407 Place of Filing; Erroneous Filing; Removal of Collateral. . . . . . . . . Formal Requisites of Financing Statement; Amendments; Mortgage as Financing Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . What Constitutes Filing; Duration of Filing; Eect of Lapsed Filing; Duties of Filing Ocer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Termination Statement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Assignment of Security Interest; Duties of Filing Ocer; Fees. . Release of Collateral; Duties of Filing Ocer; Fees. . . . . . . . . . . . . . . Information From Filing Ocer. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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 9-408

Financing Statements Covering Consigned or Leased Goods. . . .

1851 1852 1852 1854 1855 1856 1859 1860 1861 1864 1865

PART 5. DEFAULT.........................................................
9-501 9-502 9-503 9-504 9-505 9-506 9-507 Default; Procedure When Security Agreement Covers Both Real and Personal Property. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Collection Rights of Secured Party. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Secured Party's Right to Take Possession After Default.. . . . . . . . . Secured Party's Right to Dispose of Collateral After Default; Eect of Disposition. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Compulsory Disposition of Collateral; Acceptance of the Collateral as Discharge of Obligation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Debtor's Right to Redeem Collateral. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Secured Party's Liability for Failure to Comply With This Part. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

APPENDIX P PRE-REVISION ARTICLE 1 ........................ ARTICLE 1 GENERAL PROVISIONS ................................

PART 1. SHORT TITLE, CONSTRUCTION, APPLICATION AND SUBJECT MATTER OF THE ACT ..................................... 1865
1-101 1-102 1-103 1-104 1-105 1-106 1-107 1-108 1-109 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purposes; Rules of Construction; Variation by Agreement. . . . . . . Supplementary General Principles of Law Applicable. . . . . . . . . . . . Construction Against Implicit Repeal. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Territorial Application of the Act; Parties' Power to Choose Applicable Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Remedies to Be Liberally Administered. . . . . . . . . . . . . . . . . . . . . . . . . . . . Waiver or Renunciation of Claim or Right After Breach. . . . . . . . . Severability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Section Captions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1865 1865 1867 1868 1868 1870 1870 1871 1871

PART 2. GENERAL DEFINITIONS AND PRINCIPLES OF INTERPRETATION .........................................................

1-201 1-202 1-203 1-204 1-205 1-206 General Denitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prima Facie Evidence by Third Party Documents.. . . . . . . . . . . . . . . . Obligation of Good Faith. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Time; Reasonable Time; Seasonably. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Course of Dealing and Usage of Trade.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statute of Frauds for Kinds of Personal Property Not Otherwise Covered. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Performance or Acceptance Under Reservation of Rights. . . . . . . . Option to Accelerate at Will.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Subordinated Obligations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1871 1871 1882 1882 1883 1883 1885 1886 1887 1887

1-207 1-208 1-209

APPENDIX Q 2002 AMENDMENTS TO ARTICLES 3 AND 4 ...................................................................................

1889

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Table of Contents

AMENDMENTS TO ARTICLE 3 NEGOTIABLE INSTRUMENTS .............................................................. AMENDMENTS TO ARTICLE 4 BANK DEPOSITS AND COLLECTIONS .............................................................. APPENDIX R PRE-REVISION ARTICLE 7 ........................

1890

1919 1924

ARTICLE 7 WAREHOUSE RECEIPTS, BILLS OF LADING AND OTHER DOCUMENTS OF TITLE...................................... 1925 PART 1. GENERAL ........................................................
7-101 7-102 7-103 7-104 7-105 Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Relation of Article to Treaty, Statute, Tari, Classication or Regulation.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Negotiable and Non-negotiable Warehouse Receipt, Bill of Lading or Other Document of Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Construction Against Negative Implication. . . . . . . . . . . . . . . . . . . . . . . . 1926 1926 1926 1928 1928 1929

PART 2. WAREHOUSE RECEIPTS: SPECIAL PROVISIONS .................................................................

7-201 7-202 7-203 7-204 7-205 7-206 7-207 7-208 7-209 7-210 Who May Issue a Warehouse Receipt; Storage Under Government Bond. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Form of Warehouse Receipt; Essential Terms; Optional Terms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liability for Non-receipt or Misdescription. . . . . . . . . . . . . . . . . . . . . . . . . Duty of Care; Contractual Limitation of Warehouseman's Liability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Title Under Warehouse Receipt Defeated in Certain Cases. . . . . . Termination of Storage at Warehouseman's Option.. . . . . . . . . . . . . . Goods Must Be Kept Separate; Fungible Goods. . . . . . . . . . . . . . . . . . . Altered Warehouse Receipts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lien of Warehouseman. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Enforcement of Warehouseman's Lien. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1930 1930 1930 1931 1932 1933 1933 1935 1935 1936 1938 1940 1940 1941 1943 1944 1944 1945 1946 1946 1948

PART 3. BILLS OF LADING: SPECIAL PROVISIONS ........

7-301 7-302 7-303 7-304 7-305 7-306 7-307 7-308 7-309 Liability for Non-receipt or Misdescription; Said to Contain; Shipper's Load and Count; Improper Handling. . . . . . . . . . . . . . . . . . Through Bills of Lading and Similar Documents. . . . . . . . . . . . . . . . . . Diversion; Reconsignment; Change of Instructions.. . . . . . . . . . . . . . . Bills of Lading in a Set. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Destination Bills.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Altered Bills of Lading.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lien of Carrier.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Enforcement of Carrier's Lien. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Duty of Care; Contractual Limitation of Carrier's Liability. . . . . .

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PART 4. WAREHOUSE RECEIPTS AND BILLS OF LADING: GENERAL OBLIGATIONS ...............................................

7-401 7-402 7-403 7-404 Irregularities in Issue of Receipt or Bill or Conduct of Issuer. . . Duplicate Receipt or Bill; Overissue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Obligation of Warehouseman or Carrier to Deliver; Excuse.. . . . . No Liability for Good Faith Delivery Pursuant to Receipt or Bill. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1949 1949 1949 1950 1952 1953 1953 1955 1956 1958 1960 1960 1961 1961 1962

PART 5. WAREHOUSE RECEIPTS AND BILLS OF LADING: NEGOTIATION AND TRANSFER .....................................
7-501 7-502 7-503 7-504 7-505 7-506 7-507 7-508 7-509 Form of Negotiation and Requirements of Due Negotiation.. . . Rights Acquired by Due Negotiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Document of Title to Goods Defeated in Certain Cases.. . . . . . . . . . Rights Acquired in the Absence of Due Negotiation; Eect of Diversion; Seller's Stoppage of Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . Indorser Not a Guarantor for Other Parties. . . . . . . . . . . . . . . . . . . . . . . Delivery Without Indorsement: Right to Compel Indorsement. . Warranties on Negotiation or Transfer of Receipt or Bill. . . . . . . . Warranties of Collecting Bank as to Documents. . . . . . . . . . . . . . . . . . Receipt or Bill: When Adequate Compliance With Commercial Contract. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 6. WAREHOUSE RECEIPTS AND BILLS OF LADING: MISCELLANEOUS PROVISIONS ......................................

7-601 7-602 7-603 Lost and Missing Documents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Attachment of Goods Covered by a Negotiable Document.. . . . . . . Conicting Claims; Interpleader.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1962 1962 1964 1964 1966 1967 1972

APPENDIX S [RESERVED] ............................................. APPENDIX T 2003 AMENDMENTS TO ARTICLE 2 ............ AMENDMENTS TO ARTICLE 2SALES ........................... PART 1. SHORT TITLE, GENERAL CONSTRUCTION AND SUBJECT MATTER ........................................................
2-103 2-104 2-105 Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions: Merchant; Between Merchants; Financing Agency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions: Transferability; Goods; Future Goods; Lot; Commercial Unit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1972 1972 1975 1975

PART 2. FORM, FORMATION, TERMS AND READJUSTMENT OF CONTRACT; ELECTRONIC CONTRACTING...................... 1976
2-201 2-202 Formal Requirements; Statute of Frauds.. . . . . . . . . . . . . . . . . . . . . . . . . . Final Written Expression in a Record: Parol or Extrinsic Evidence. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1976 1978

lxviii

Table of Contents 2-203 2-204 2-205 2-206 2-207 Seals Inoperative. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Formation in General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Firm Oers.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Oer and Acceptance in Formation of Contract. . . . . . . . . . . . . . . . . . . Additional Terms in Acceptance or Terms of Contract; Eect of Conrmation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Course of Performance on Practical Construction Reserved.. . . . . Modication; Rescission and Waiver. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Delegation of Performance; Assignment of Rights.. . . . . . . . . . . . . . . . 1978 1979 1980 1980 1981 1983 1983 1983

2-208 2-209 2-210

PART 3. GENERAL OBLIGATION AND CONSTRUCTION OF 1986 CONTRACT....................................................................

2-302 2-304 2-305 2-308 2-309 2-310 Unconscionable Contract or Clause Term. . . . . . . . . . . . . . . . . . . . . . . . . . Price Payable in Money, Goods, Realty, or Otherwise. . . . . . . . . . . . Open Price Term. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Absence of Specied Place for Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Absence of Specic Time Provisions; Notice of Termination. . . . . Open Time for Payment or Running of Credit; Authority to Ship under Reservation.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options and Cooperation Respecting Performance. . . . . . . . . . . . . . . . Warranty of Title and Against Infringement; Buyer's Obligation Against Infringement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Express Warranties by Armation, Promise, Description, Sample; Remedial Promise. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Implied Warranty: Merchantability; Usage of Trade.. . . . . . . . . . . . . Exclusion or Modication of Warranties.. . . . . . . . . . . . . . . . . . . . . . . . . . . Third Party Third-party Beneciaries of Warranties Express or Implied and Obligations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F.O.B. and F.A.S. Terms Reserved. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C.I.F. AND C. & F. Terms Reserved. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C.I.F. OR C. & F.: Net Landed Weights; Payment on Arrival; Warranty of Condition on Arrival Reserved. . . . . . . . . . . . . Delivery Ex-ship Reserved. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Form of Bill of Lading Required in Overseas Shipment; Overseas Reserved. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . No Arrival, No Sale Term Reserved.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Letter of Credit Term; Conrmed Credit Failure to Pay by Agreed Letter of Credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sale on Approval and Sale or Return; Consignment Sales and Rights of Creditors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Sale by Auction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1986 1987 1987 1988 1988 1989 1990 1990 1992 1994 1996 1998 1999 2000 2001 2001 2002 2002 2002 2003 2004

2-311 2-312 2-313 2-314 2-316 2-318 2-319 2-320 2-321 2-322 2-323 2-324 2-325 2-326 2-328

PART 4. TITLE, CREDITORS, AND GOOD-FAITH PURCHASERS................................................................

2-401 2-402 2-403 Passing of Title; Reservation for Security; Limited Application of this Section.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights of Seller's Creditors Against Sold Goods. . . . . . . . . . . . . . . . . . . Power to Transfer; Good Faith Purchase of Goods; Entrusting.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2005 2005 2007 2007

PART 5. PERFORMANCE ...............................................

lxix

2009 2-501 2-502 2-503 2-504 2-505 2-506 2-507 2-508 2-509 2-510 2-512 2-513 2-514 Insurable Interest in Goods; Manner of Identication of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buyer's Right to Goods on Seller's Insolvency, Repudiation, or Failure to Deliver. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Manner of Seller's Tender of Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shipment by Seller. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Shipment under Reservation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights of Financing Agency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Seller's Tender; Delivery on Condition. . . . . . . . . . . . . . . . . . . Cure by Seller of Improper Tender or Delivery; Replacement. . . Risk of Loss in the Absence of Breach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Breach on Risk of Loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payment by Buyer Before Inspection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buyer's Right to Inspection of Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . When Documents Deliverable on Acceptance; When on Payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2009 2009 2010 2012 2012 2014 2014 2015 2016 2017 2018 2018 2019 2020 2020 2020 2021 2021 2022 2023 2023 2025 2026 2026 2027 2027 2028 2029 2030 2030 2031 2031 2032 2033 2033 2035 2037 2038 2039 2039

PART 6. BREACH, REPUDIATION, AND EXCUSE .............

2-601 2-602 2-603 2-604 2-605 2-606 2-607 2-608 2-609 2-610 2-611 2-612 2-613 2-614 2-615 2-616 Buyer's Rights on Improper Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Manner and Eect of Rightful Rejection.. . . . . . . . . . . . . . . . . . . . . . . . . . . Merchant Buyer's Duties as to Rightfully Rejected Goods.. . . . . . . Buyer's Options as to Salvage of Rightfully Rejected Goods. . . . . Waiver of Buyer's Objections by Failure to Particularize.. . . . . . . . What Constitutes Acceptance of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Acceptance; Notice of Breach; Burden of Establishing Breach after Acceptance; Notice of Claim or Litigation to Person Answerable Over. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Revocation of Acceptance in Whole or in Part. . . . . . . . . . . . . . . . . . . . . Right to Adequate Assurance of Performance.. . . . . . . . . . . . . . . . . . . . . Anticipatory Repudiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retraction of Anticipatory Repudiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment Contract; Breach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Casualty to Identied Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Substituted Performance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excuse by Failure of Presupposed Conditions. . . . . . . . . . . . . . . . . . . . . Procedure on Notice Claiming Excuse. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

PART 7. REMEDIES .......................................................

2-702 2-703 2-704 2-705 2-706 2-707 2-708 Seller's Remedies on Discovery of Buyer's Insolvency.. . . . . . . . . . . . Seller's Remedies in General.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Right to Identify Goods to the Contract Notwithstanding Breach or to Salvage Unnished Goods. . . . . . . . Seller's Stoppage of Delivery in Transit or Otherwise. . . . . . . . . . . . Seller's Resale Including Contract for Resale. . . . . . . . . . . . . . . . . . . . . . Person in the Position of a Seller.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Damages for Non-acceptance Nonacceptance or Repudiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Action for the Price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Incidental and Consequential Damages. . . . . . . . . . . . . . . . . . .

2-709 2-710

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Table of Contents 2-711 2-712 2-713 2-714 2-716 2-717 2-718 2-722 2-723 2-724 2-725 Buyer's Remedies in General; Buyer's Security Interest in Rejected Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cover; Buyer's Procurement of Substitute Goods.. . . . . . . . . . . . . . . Buyer's Damages for Non-delivery Nondelivery or Repudiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buyer's Damages for Breach in Regard to Accepted Goods.. . . . . . Buyer's Right to Specic Performance Or; Buyer's Right to Replevin. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deduction of Damages from the Price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liquidation or Limitation of Damages; Deposits. . . . . . . . . . . . . . . . . . Who Can May Sue Third Parties for Injury to Goods. . . . . . . . . . . . . Proof of Market: Time and Place. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Admissibility of Market Quotations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statute of Limitations in Contracts for Sale. . . . . . . . . . . . . . . . . . . . . . .

2040 2041 2042 2043 2043 2044 2044 2045 2046 2046 2046 2049 2049 2049 2049 2050 2059 2060 2060 2061 2061 2061

APPENDIX U 2003 AMENDMENTS TO ARTICLE 2A .......... AMENDMENTS TO ARTICLE 2ALEASES ....................... PART 1. GENERAL PROVISIONS ....................................
2A-101 2A-103 2A-104 2A-105 Short Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Leases Subject to Other Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Territorial Application of Article to Goods Covered by Certicate of Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Limitation on Power of Parties to Consumer Lease to Choose Applicable Law and Judicial Forum.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Waiver or Renunciation of Claim or Right after Default. . . . . . . . . . Unconscionability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Option to Accelerate at Will. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2A-106 2A-107 2A-108 2A-109

PART 2. FORMATION AND CONSTRUCTION OF LEASE CONTRACT; ELECTRONIC CONTRACTING......................

2A-201 Statute of Frauds. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-202 Final Written Expression in a Record: Parol or Extrinsic Evidence. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-203 Seals Inoperative.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-204 Formation in General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-205 Firm Oers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-208 Modication, Rescission and Waiver.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-211 Warranties Against Interference and Against Infringement; Lessee's Obligation Against Infringement. . . . . . . . . . . . . . . . . . . . . . . . 2A-212 Implied Warranty of Merchantability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-214 Exclusion or Modication of Warranties. . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-219 Risk of Loss.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-220 Eect of Default on Risk of Loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-221 Casualty to Identied Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2062 2062 2063 2063 2064 2064 2064 2065 2067 2067 2069 2069 2069 2070

PART 3. EFFECT OF LEASE CONTRACT .........................

lxxi

 2A-303 Alienability of Party's Interest under Lease Contract or of Lessor's Residual Interest in Goods; Delegation of Performance; Transfer of Rights. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-304 Subsequent Lease of Goods by Lessor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-305 Sale or Sublease of Goods by Lessee.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-306 Priority of Certain Liens Arising by Operation of Law. . . . . . . . . . . . 2A-307 Priority of Liens Arising by Attachment or Levy On, Security Interests In, and Other Claims to Goods. . . . . . . . . . . . . . . . . . . . . . . . . 2A-309 Lessor's and Lessee's Rights When Goods Become Fixtures. . . . . . 2A-310 Lessor's and Lessee's Rights When Goods Become Accessions. . .

2070 2072 2072 2073 2073 2075 2077

PART 4. PERFORMANCE OF LEASE CONTRACT: REPUDIATED, SUBSTITUTED AND EXCUSED........................................ 2078

2A-401 2A-402 2A-404 2A-405 2A-406 Insecurity: Adequate Assurance of Performance. . . . . . . . . . . . . . . . . . . Anticipatory Repudiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Substituted Performance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excused Performance.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Procedure on Excused Performance.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2078 2078 2079 2079 2080 2080 2080 2080 2082 2082 2082 2085 2086 2086 2087 2088 2088 2089 2090 2091 2092 2093 2093 2097 2097 2098 2099 2100 2100

PART 5. DEFAULT......................................................... A IN GENERAL ..............................................................

2A-504 Liquidation of Damages. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-506 Statute of Limitations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

B DEFAULT BY LESSOR .................................................

2A-508 Lessee's Remedies.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-509 Lessee's Rights on Improper Delivery; Rightful Manner and Eect of Rejection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-510 Installment Lease Contracts: Rejection and Default.. . . . . . . . . . . . . . 2A-511 Merchant Lessee's Duties as to Rightfully Rejected Goods. . . . . . . 2A-512 Lessee's Duties as to Rightfully Rejected Goods.. . . . . . . . . . . . . . . . . . . 2A-513 Cure by Lessor of Improper Tender or Delivery; Replacement. . . 2A-514 Waiver of Lessee's Objections. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-515 Acceptance of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-516 Eect of Acceptance of Goods; Notice of Default; Burden of Establishing Default after Acceptance; Notice of Claim or Litigation to Person Answerable over. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-517 Revocation of Acceptance of Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-522 Lessee's Right to Goods on Lessor's Insolvency. . . . . . . . . . . . . . . . . . . .

C DEFAULT BY LESSEE .................................................

Lessor's Remedies.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lessor's Stoppage of Delivery in Transit or Otherwise. . . . . . . . . . . . Lessor's Rights to Dispose of Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lessor's Damages for Non-acceptance, Failure to Pay, Repudiation, or Other Default. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-529 Lessor's Action for the Rent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-530 Lessor's Incidental and Consequential Damages. . . . . . . . . . . . . . . . . . . 2A-531 Standing to Sue Third Parties for Injury to Goods.. . . . . . . . . . . . . . . . 2A-523 2A-526 2A-527 2A-528

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Table of Contents

APPENDIX V 2005 AMENDMENTS TO UNIFORM COMMERCIAL CODE AS APPROVED BY THE NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS AND THE AMERICAN LAW INSTITUTE .......................................... 2102
General Denitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Remedies in General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buyer's Remedies in General; Buyer's Security Interest in Rejected Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-101 Short Title. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-103 Denitions and Index of Denitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-211 Warranties Against Interference and Against Infringement; Lessee's Obligation Against Infringement. . . . . . . . . . . . . . . . . . . . . . 2A-501 Default: Procedure. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-507A Right to Specic Performance or Replevin or the Like. . . . . . . . . . 2A-508 Lessee's Remedies.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-509 Lessee's Rights on Improper Delivery; Manner and Eect of Rejection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-514 Waiver of Lessee's Objections.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-517 Revocation of Acceptance of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-523 Lessor's Remedies.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-524 Lessor's Right to Identify Goods to Lease Contract. . . . . . . . . . . . . . 2A-525 Lessor's Right to Possession of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3-405 Employer's Responsibility for Fraudulent Indorsement by Employee. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-325 Priority of Security Interests in Transferred Collateral. . . . . . . . . 1-201 2-103 2-703 2-711 2102 2103 2103 2104 2104 2104 2106 2106 2106 2106 2107 2107 2107 2107 2108 2108 2108 2109

APPENDIX W 2006 OFFICIAL COMMENT CORRECTIONS TO UNIFORM COMMERCIAL CODE AS APPROVED BY THE NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS AND THE AMERICAN LAW INSTITUTE ....... 2110
2A-222 Legal Recognition of Electronic Contacts, Records and Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-510 Installment Lease Contracts: Rejection and Default.. . . . . . . . . . . . . . 9-406 Discharge of Account Debtor; Notication of Assignment; Identication and Proof of Assignment; Restrictions on Assignment of Accounts, Chattel Paper, Payment Intangibles, and Promissory Notes Ineective. . . . . . . . . . . . . . . . . . . 2110 2110

2110

APPENDIX X 2008 AMENDMENT TO UNIFORM COMMERCIAL CODE REVISED ARTICLE 1 AS APPROVED BY THE NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS AND THE AMERICAN LAW INSTITUTE .................. 2112
1-301 Territorial Applicability; Parties' Power to Choose Applicable Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2112 2119

APPENDIX Y ARTICLE 2 SALES [1995] ............................ PART 1. SHORT TITLE, GENERAL CONSTRUCTION AND SUBJECT MATTER ........................................................

2122

lxxiii

 2-101 2-102 2-103 2-104 2-105 2-106 2-107

Short Title.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Scope; Certain Security and Other Transactions Excluded From This Article. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions and Index of Denitions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions: Merchant; Between Merchants; Financing Agency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions: Transferability; Goods; Future Goods; Lot; Commercial Unit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Denitions: Contract; Agreement; Contract for Sale; Sale; Present Sale; Conforming to Contract; Termination; Cancellation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goods to Be Severed From Realty: Recording.. . . . . . . . . . . . . . . . . . . . .

2122 2122 2122 2124 2125 2127 2128

PART 2. FORM, FORMATION AND READJUSTMENT OF CONTRACT....................................................................

2-201 2-202 2-203 2-204 2-205 2-206 2-207 2-208 2-209 2-210 Formal Requirements; Statute of Frauds.. . . . . . . . . . . . . . . . . . . . . . . . . . Final Written Expression: Parol or Extrinsic Evidence. . . . . . . . . . . Seals Inoperative. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Formation in General. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Firm Oers.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Oer and Acceptance in Formation of Contract. . . . . . . . . . . . . . . . . . . Additional Terms in Acceptance or Conrmation.. . . . . . . . . . . . . . . . . Course of Performance or Practical Construction.. . . . . . . . . . . . . . . . . Modication, Rescission and Waiver. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Delegation of Performance; Assignment of Rights.. . . . . . . . . . . . . . . .

2129 2129 2131 2132 2132 2133 2134 2135 2137 2138 2139

PART 3. GENERAL OBLIGATION AND CONSTRUCTION OF CONTRACT.................................................................... 2140

2-301 2-302 2-303 2-304 2-305 2-306 2-307 2-308 2-309 2-310 General Obligations of Parties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unconscionable Contract or Clause. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Allocation or Division of Risks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Price Payable in Money, Goods, Realty, or Otherwise. . . . . . . . . . . . Open Price Term. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Output, Requirements and Exclusive Dealings. . . . . . . . . . . . . . . . . . . . Delivery in Single Lot or Several Lots. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Absence of Specied Place for Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Absence of Specic Time Provisions; Notice of Termination. . . . . Open Time for Payment or Running of Credit; Authority to Ship Under Reservation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Options and Cooperation Respecting Performance. . . . . . . . . . . . . . . . Warranty of Title and Against Infringement; Buyer's Obligation Against Infringement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Express Warranties by Armation, Promise, Description, Sample.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Implied Warranty: Merchantability; Usage of Trade.. . . . . . . . . . . . . Implied Warranty: Fitness for Particular Purpose. . . . . . . . . . . . . . . . Exclusion or Modication of Warranties.. . . . . . . . . . . . . . . . . . . . . . . . . . . Cumulation and Conict of Warranties Express or Implied.. . . . . Third Party Beneciaries of Warranties Express or Implied.. . . . F.O.B. and F.A.S. Terms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2140 2141 2142 2142 2143 2144 2146 2147 2148 2149 2150 2151 2153 2155 2157 2158 2160 2161 2162

2-311 2-312 2-313 2-314 2-315 2-316 2-317 2-318 2-319

lxxiv

Table of Contents 2-320 2-321 2-322 2-323 2-324 2-325 2-326 2-327 2-328 C.I.F. and C. & F. Terms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . C.I.F. or C. & F.: Net Landed Weights; Payment on Arrival; Warranty of Condition on Arrival. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Delivery Ex-Ship. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Form of Bill of Lading Required in Overseas Shipment; Overseas.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . No Arrival, No Sale Term. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Letter of Credit Term; Conrmed Credit. . . . . . . . . . . . . . . . . . . . . . . Sale on Approval and Sale or Return; Consignment Sales and Rights of Creditors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Special Incidents of Sale on Approval and Sale or Return. . . . . . . Sale by Auction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2163 2167 2168 2169 2170 2171 2172 2173 2174

PART 4. TITLE, CREDITORS AND GOOD FAITH PURCHASERS................................................................

2-401 2-402 2-403 Passing of Title; Reservation for Security; Limited Application of This Section. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights of Seller's Creditors Against Sold Goods. . . . . . . . . . . . . . . . . . . Power to Transfer; Good Faith Purchase of Goods; Entrusting.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2175 2175 2177 2178 2180 2180 2181 2182 2184 2186 2187 2188 2189 2190 2192 2193 2194 2195 2197 2197 2199 2199 2199 2201 2202 2202 2203

PART 5. PERFORMANCE ...............................................

2-501 2-502 2-503 2-504 2-505 2-506 2-507 2-508 2-509 2-510 2-511 2-512 2-513 2-514 Insurable Interest in Goods; Manner of Identication of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buyer's Right to Goods on Seller's Insolvency. . . . . . . . . . . . . . . . . . . . . Manner of Seller's Tender of Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shipment by Seller. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Shipment Under Reservation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Rights of Financing Agency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Seller's Tender; Delivery on Condition. . . . . . . . . . . . . . . . . . . Cure by Seller of Improper Tender or Delivery; Replacement. . . Risk of Loss in the Absence of Breach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Breach on Risk of Loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tender of Payment by Buyer; Payment by Check. . . . . . . . . . . . . . . . . Payment by Buyer Before Inspection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buyer's Right to Inspection of Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . When Documents Deliverable on Acceptance; When on Payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Preserving Evidence of Goods in Dispute.. . . . . . . . . . . . . . . . . . . . . . . . . .

2-515

PART 6. BREACH, REPUDIATION AND EXCUSE .............

2-601 2-602 2-603 2-604 2-605 2-606 2-607 Buyer's Rights on Improper Delivery. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Manner and Eect of Rightful Rejection.. . . . . . . . . . . . . . . . . . . . . . . . . . . Merchant Buyer's Duties as to Rightfully Rejected Goods.. . . . . . . Buyer's Options as to Salvage of Rightfully Rejected Goods. . . . . Waiver of Buyer's Objections by Failure to Particularize.. . . . . . . . What Constitutes Acceptance of Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Eect of Acceptance; Notice of Breach; Burden of Establishing Breach After Acceptance; Notice of Claim or Litigation to

lxxv

2-608 2-609 2-610 2-611 2-612 2-613 2-614 2-615 2-616

Person Answerable Over. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Revocation of Acceptance in Whole or in Part. . . . . . . . . . . . . . . . . . . . . Right to Adequate Assurance of Performance.. . . . . . . . . . . . . . . . . . . . . Anticipatory Repudiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retraction of Anticipatory Repudiation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Installment Contract; Breach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Casualty to Identied Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Substituted Performance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Excuse by Failure of Presupposed Conditions. . . . . . . . . . . . . . . . . . . . . Procedure on Notice Claiming Excuse. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2204 2206 2208 2210 2211 2212 2214 2215 2216 2218 2219 2219 2219 2220 2221 2222 2223 2226 2227 2228 2229 2229 2230 2231 2232 2233 2234 2235 2235 2236 2237 2238 2238 2239 2239 2240

PART 7. REMEDIES .......................................................

2-701 2-702 2-703 2-704 2-705 2-706 2-707 2-708 2-709 2-710 2-711 2-712 2-713 2-714 2-715 2-716 2-717 2-718 2-719 2-720 2-721 2-722 2-723 2-724 2-725 Remedies for Breach of Collateral Contracts Not Impaired. . . . . . Seller's Remedies on Discovery of Buyer's Insolvency.. . . . . . . . . . . . Seller's Remedies in General.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Right to Identify Goods to the Contract Notwithstanding Breach or to Salvage Unnished Goods. . . . . . . . Seller's Stoppage of Delivery in Transit or Otherwise. . . . . . . . . . . . Seller's Resale Including Contract for Resale. . . . . . . . . . . . . . . . . . . . . . Person in the Position of a Seller.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Damages for Non-acceptance or Repudiation. . . . . . . . . . . . . Action for the Price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Seller's Incidental Damages.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Buyer's Remedies in General; Buyer's Security Interest in Rejected Goods.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cover; Buyer's Procurement of Substitute Goods.. . . . . . . . . . . . . . . Buyer's Damages for Non-delivery or Repudiation. . . . . . . . . . . . . . . . Buyer's Damages for Breach in Regard to Accepted Goods.. . . . . . Buyer's Incidental and Consequential Damages. . . . . . . . . . . . . . . . . . . Buyer's Right to Specic Performance or Replevin. . . . . . . . . . . . . . . . Deduction of Damages From the Price.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liquidation or Limitation of Damages; Deposits. . . . . . . . . . . . . . . . . . Contractual Modication or Limitation of Remedy. . . . . . . . . . . . . . . . Eect of Cancellation or Rescission on Claims for Antecedent Breach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Remedies for Fraud. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Who Can Sue Third Parties for Injury to Goods.. . . . . . . . . . . . . . . . . . Proof of Market Price: Time and Place. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Admissibility of Market Quotations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statute of Limitations in Contracts for Sale. . . . . . . . . . . . . . . . . . . . . . .

Index

lxxvi

UNIFORM COMMERCIAL CODE

TITLE An Act To be known as the Uniform Commercial Code, Relating to Certain Commercial Transactions in or regarding Personal Property and Contracts and other Documents concerning them, including Sales, Commercial Paper, Bank Deposits and Collections, Letters of Credit, Bulk Transfers, Warehouse Receipts, Bills of Lading, other Documents of Title, Investment Securities, and Secured Transactions, including certain Sales of Accounts, Chattel Paper, and Contract Rights; Providing for Public Notice to Third Parties in Certain Circumstances; Regulating Procedure, Evidence and Damages in Certain Court Actions Involving such Transactions, Contracts or Documents; to Make Uniform the Law with Respect Thereto; and Repealing Inconsistent Legislation.

GENERAL COMMENT OF NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS AND THE AMERICAN LAW INSTITUTE
This Comment covers the development of the Code prior to 1962. Its subsequent history leading to the 1962, 1966, 1972, 1977 and 1987 Ocial Text and Comment changes is contained in Reports and Forewords of the Permanent Editorial Board for the Uniform Commercial Code, which are set out, supra, this pamphlet.

Uniformity throughout American jurisdictions is one of the main objectives of this Code; and that objective cannot be obtained without substantial uniformity of construction. To aid in uniform construction of this Comment and those which follow the text of each section set forth the purpose of various provisions of this Act to promote uniformity, to aid in viewing the Act as an integrated whole, and to safeguard against misconstruction. This Act is a revision of the original Uniform Commercial Code promulgated in 1951 and enacted in Pennsylvania in 1953, eective July 1, 1954; and these Comments are a revision of the original comments, which were before the Pennsylvania legislature at the time of its adoption of the Code. Changes from the text enacted in Pennsylvania in 1953 are clearly legitimate legislative history, but without explanation such changes may be misleading, since frequently matters have been omitted as being implicit without statement and language has been changed or added solely for clarity. Accordingly, the changes from the original text were published, under the title 1956 Recommendations of the Editorial Board for the Uniform Commercial Code, early in 1957, with reasons, and revised Comments were then prepared to restate the statutory purpose in the light of the revision of text. The subsequent history leading to the 1962 Ocial Text with Comments is set out in detail in Report No. 1 of the Permanent Editorial Board for the Uniform Commercial Code. * * * [See Report, supra, this pamphlet.] Hitherto most commercial transactions have been regulated by a number of Uniform Laws prepared and promulgated by the National Conference of Commissioners on Uniform State Laws. These acts, with the dates of their promulgation by the Conference, are: Uniform Uniform Uniform Uniform Uniform
2

Negotiable Instruments Law ......................... Warehouse Receipts Act ............................... Sales Act .................................................. Bills of Lading Act ...................................... Stock Transfer Act ......................................

1896 1906 1906 1909 1909

General Comment

Uniform Conditional Sales Act .................................. Uniform Trust Receipts Act ......................................

1918 1933

Two of these acts were adopted in every American State and the remaining acts have had wide acceptance. Each of them has become a segment of the statutory law relating to commercial transactions. It has been recognized for some years that these acts needed substantial revision to keep them in step with modern commercial practices and to integrate each of them with the others. The concept of the present Act is that commercial transactions is a single subject of the law, notwithstanding its many facets. A single transaction may very well involve a contract for sale, followed by a sale, the giving of a check or draft for a part of the purchase price, and the acceptance of some form of security for the balance. The check or draft may be negotiated and will ultimately pass through one or more banks for collection. If the goods are shipped or stored the subject matter of the sale may be covered by a bill of lading or warehouse receipt or both. Or it may be that the entire transaction was made pursuant to a letter of credit either domestic or foreign. Obviously, every phase of commerce involved is but a part of one transaction, namely, the sale of and payment for goods. If, instead of goods in the ordinary sense, the transaction involved stocks or bonds, some of the phases of the transaction would obviously be dierent. Others would be the same. In addition, there are certain additional formalities incident to the transfer of stocks and bonds from one owner to another. This Act purports to deal with all the phases which may ordinarily arise in the handling of a commercial transaction, from start to nish. Because of the close relationship of each phase of a complete transaction to every other phase, it is believed that each Article of this Act is cognate to the single broad subject Commercial Transactions, and that this Act is valid under any constitutional provision requiring an act to deal with only one subject. See, for excellent discussions of the meaning of single subject: House v. Creveling, 147 Tenn. 589, 250 S.W. 357 (1923) and Commonwealth v. Snyder, 279 Pa. 234, 123 A. 792 (1924). The preparation of the Act (which Section 1-101 denominates the Uniform Commercial Code) was begun as a joint project of The American Law Institute and the National Conference of Commissioners on Uniform State Laws in 1942. Various drafts were considered by joint committees of both bodies and debated by the full membership of each organization at annual meetings. In the main, the project was made possible, nancially, through a large grant by The Maurice and Laura Falk Foundation of Pittsburgh,
3

Uniform Commercial Code

Pennsylvania, supplemented by contributions from the Beaumont Foundation of Cleveland, Ohio, and from 98 business and nancial concerns and law rms. Additional funds for nal revisions and study were received from the Falk Foundation and others. The original drafting and editorial work which led to the 1952 edition of the Code was in charge of an Editorial Board of which United States Circuit Judge Herbert F. Goodrich of Philadelphia was Chairman. The other members at various times were Professor Karl N. Llewellyn of the University of Chicago Law School, Walter D. Malcolm, Esquire, of Boston, John C. Pryor, Esquire, of Burlington, Iowa, Wm. A. Schnader, Esquire, of Philadelphia, and Harrison Tweed, Esquire, of New York City. In the nal stages of work on the Code, certain questions of policy were submitted for consideration to an Enlarged Editorial Board consisting at various times of the foregoing members and Howard L. Barkdull, Esquire, of Cleveland, Joe C. Barrett, Esquire, of Jonesboro, Arkansas, Robert K. Bell, Esquire, of Ocean City, N.J., Robert P. Goldman, Esquire, of Cincinnati, Dean Albert J. Harno of the University of Illinois Law School, Ben W. Heineman, Esquire, of Chicago, Carlos Israels, Esquire, of New York City, Albert E. Jenner, Esquire, of Chicago, Arthur Littleton, Esquire, of Philadelphia, Willard B. Luther, Esquire, of Boston, Kurt F. Pantzer, Esquire, of Indianapolis, Indiana, George Richter, Jr., Esquire, of Los Angeles, R. Jasper Smith, Esquire, of Springeld, Missouri, United States Circuit Judge Sterry Waterman of St. Johnsbury, Vermont, and Charles H. Willard, Esquire, of New York City. The Chief Reporter of the Code was Professor Llewellyn, and the Associate Chief Reporter was Professor Soia Mentschiko. Final editorial preparation of the 1952 edition was in the hands of Professor Charles Bunn of the University of Wisconsin Law School. The Coordinators for the revisions leading to this 1962 edition were Professors Robert Braucher and A.E. Sutherland of the Law School of Harvard University, Professor Braucher doing the nal editorial preparation for this edition. The actual drafting was done in some cases by practicing lawyers and in others by teachers of various law schools. The customary procedure required that before a draft was submitted for discussion to the general memberships of The American Law Institute and of the National Conference of Commissioners, it was successively approved by three groups. The rst group were the so-called advisers, consisting of specially selected judges, practicing lawyers and law teachers. The advisers met with the draftsmen on frequent occasions to debate and iron out, not only the substance but the form and phraseology of the proposed draft. After the draft was cleared by the advisers, it was meticulously examined by the next two groupsthe Council of The American Law Institute and either the Commercial Acts Section or the Property Acts Section of the Conference of Commissioners. When these bodies had given their approval to the draft, it came before the general membership both of the Institute and of the Conference for consideration. In addition in the nal stages leading to this 1962 edition each article
4

General Comment

was reviewed and discussed by a special Subcommittee for that article. Recommendations of the Subcommittee were reviewed and acted upon by the Enlarged Editorial Board, pursuant to authority from the sponsoring bodies. The judges, practicing lawyers and law teachers who originally acted either as advisers or as draftsmen were: Judges: John T. Loughran, of the New York Court of Appeals; Thomas W. Swan, United States Circuit Judge for the Second Circuit; and the late John D. Wickhem, of the Supreme Court of Wisconsin. Practicing lawyers: Dana C. Backus, of New York, N.Y.; Howard L. Barkdull, of Cleveland, Ohio; Lawrence G. Bennett, of New York, N.Y.; Harold F. Birnbaum, of Los Angeles, California; William L. Eagleton, of Washington, D.C.; H. Vernon Eney, of Baltimore, Maryland; Fairfax Leary, Jr., of Philadelphia, Pennsylvania; Willard B. Luther, of Boston, Massachusetts; Walter D. Malcolm, of Boston, Massachusetts; Frederic M. Miller, of Des Moines, Iowa; Hiram Thomas, of New York, N.Y.; Sterry R. Waterman, of St. Johnsbury, Vermont; and Cornelius W. Wickersham, of New York, N.Y. The law teachers were: Ralph J. Baker, of the Harvard Law School; William E. Britton, of the University of Illinois Law School; Charles Bunn, of the University of Wisconsin Law School; Arthur L. Corbin, of Yale University Law School; Allison Dunham, of Columbia University Law School; Grant Gilmore, of Yale University Law School; Albert J. Harno, of the University of Illinois Law School; Friedrich Kessler, of the Yale University Law School; Maurice H. Merrill, of the University of Oklahoma Law School; William L. Prosser, of the University of California School of Law; Louis B. Schwartz, of the University of Pennsylvania Law School; and Bruce Townsend, of the University of Indiana Law School. The members of the Council of the Institute during the period when the Commercial Code was under consideration were: Dillon Anderson, of Houston, Texas; Fletcher R. Andrews of Cleveland Heights, Ohio; the late Walter P. Armstrong of Memphis, Tennessee; Francis M. Bird, of Atlanta, Georgia; John G. Buchanan, of Pittsburgh, Pennsylvania; Charles Bunn, of Madison, Wisconsin; Howard F. Burns, of Cleveland, Ohio; Herbert W. Clark, of San Francisco, California; R. Ammi Cutter, of Boston, Massachusetts; Norris Darrell, of New York, N.Y.; the late John W. Davis, of New York, N.Y.; Edwin D. Dickinson, of Berkeley, California; Edward J. Dimock, of New York, N.Y.; Arthur Dixon, of Chicago, Illinois; Robert G. Dodge, of Boston, Massachusetts; the late George Donworth, of Seattle, Washington; Charles E. Dunbar, Jr., of New Orleans, Louisiana; William Dean Embree, of New York, N.Y.; Frederick F. Faville, of Des Moines, Iowa; James Alger Fee, of Portland, Oregon; Gerald F. Flood, of Philadelphia, Pennsylvania; H. Eastman Hackney, of Pittsburgh, Pennsylvania; the late Augustus N. Hand, of New York, N.Y.; Learned Hand, of New York, N.Y.; Albert J. Harno, of Urbana, Illinois; the late Earl G. Harrison, of Philadelphia, Pennsylvania; William V. Hodges, of New York, N.Y.; Joseph C. Hutcheson, Jr., of Houston, Texas; Laurence M. Hyde, of Jefferson City, Missouri; William J. Jameson, of Billings, Montana; Joseph F. Johnston, of Birmingham, Alabama; the late William H. Keller, of Lancas5

Uniform Commercial Code

ter, Pennsylvania; the late Daniel N. Kirby, of St. Louis, Missouri; Monte M. Lemann, of New Orleans, Louisiana; the late William Draper Lewis, of Philadelphia, Pennsylvania; the late Henry T. Lummus, of Swampscott, Massachusetts; William L. Marbury, of Baltimore, Maryland; Robert N. Miller, of Washington, D.C.; the late William D. Mitchell, of New York, N.Y.; John J. Parker, of Charlotte, North Carolina; Thomas I. Parkinson, of New York, N.Y.; George Wharton Pepper, of Philadelphia, Pennsylvania; Timothy N. Pfeier, of New York, N.Y.; Orie L. Phillips, of Denver, Colorado; Frederick D.G. Ribble, of Charlottesville, Virginia; William A. Schnader, of Philadelphia, Pennsylvania; Bernard G. Segal, of Philadelphia, Pennsylvania; Austin W. Scott, of Cambridge, Massachusetts; the late Harry Shulman, of New Haven, Connecticut; Henry Upson Sims, of Birmingham, Alabama; the late Sydney Smith, of Jackson, Mississippi; Eugene B. Strassburger, of Pittsburgh, Pennsylvania; Thomas W. Swan, of Guilford, Connecticut; the late Thomas Day Thacher, of New York, N.Y.; Floyd E. Thompson, of Chicago, Illinois; the late Edgar Bronson Tolman, of Chicago, Illinois; the late Robert B. Tunstall, of Norfolk, Virginia; the late Arthur J. Tuttle, of Detroit, Michigan; Harrison Tweed, of New York, N.Y.; Cornelius W. Wickersham, of New York, N.Y.; the late John D. Wickhem, of Madison, Wisconsin; Raymond S. Wilkins, of Boston, Massachusetts; Charles H. Willard, of New York, N.Y.; Laurens Williams, of Washington, D.C.; Edward L. Wright, of Little Rock, Arkansas, and Charles E. Wyzanski, Jr., of Boston, Massachusetts. The members of the Conference's Commercial Acts Section during the same period were: Howard L. Barkdull, of Cleveland, Ohio; the late William L. Beers, of New Haven, Connecticut; Charles R. Hardin, of Newark, New Jersey; Frank E. Horack, Jr., of Bloomington, Indiana; L. Barrett Jones, of Jackson, Mississippi; Karl N. Llewellyn, now of Chicago, Illinois; Willard B. Luther, of Boston, Massachusetts; William G. McLaren, of Seattle, Washington; Frederic M. Miller, of Des Moines, Iowa; William L. Prosser, of Berkeley, California; Arthur E. Sutherland, Jr., now of Cambridge, Massachusetts; O.H. Thormodsgard, of University, North Dakota; Sterry R. Waterman, of St. Johnsbury, Vermont; and Edward L. Wright, of Little Rock, Arkansas. The members of the Conference's Property Acts Section during the period when it cooperated in the consideration of the Code were: Joe C. Barrett, of Jonesboro, Arkansas; the late William L. Beers, of New Haven, Connecticut; Boyd M. Benson, of Huron, South Dakota; George G. Bogert, now of San Francisco, California; C. Walter Cole, of Towson, Maryland; John A. Daly, of Boston, Massachusetts; William L. Eagleton, of Washington, D.C.; H. Vernon Eney, of Baltimore, Maryland; Spencer A. Gard, of Iola, Kansas; Homer B. Harris, of Lincoln, Illinois; W.J. Jameson, of Billings, Montana; the late Sherman R. Moulton, of Burlington, Vermont; J.C. Pryor, of Burlington, Iowa; the late C.M.A. Rogers, of Mobile, Alabama; Murray M. Shoemaker, of Cincinnati, Ohio; and Greenberry Simmons, of Louisville, Kentucky. The members of the Subcommittees which considered the various articles of the Code in the work leading to the 1958 Edition were: Article 1: Charles H. Willard, Esquire, Chairman, of New York, New
6

General Comment

York; Professor Charles Bunn of the University of Wisconsin Law School, Madison, Wisconsin; Mahlon E. Lewis, Esquire, of Pittsburgh, Pennsylvania. Article 2: Professor Robert Braucher, Chairman, of the Law School of Harvard University, Cambridge, Massachusetts; Professor Karl N. Llewellyn, of the Law School of the University of Chicago, Chicago, Illinois; Bernard D. Broeker, Esquire, of Bethlehem, Pennsylvania; Frank T. Dierson, Esquire, of New York, New York. Article 3: Professor A.E. Sutherland, Chairman, of the Law School of Harvard University, Cambridge, Massachusetts; William R. Emblidge, Esquire, of Bualo, New York; John J. Clarke, Esquire, of the Federal Reserve Bank of New York, New York; James V. Vergari, Esquire, of Federal Reserve Bank of Philadelphia, Philadelphia, Pennsylvania. Article 4: Walter D. Malcolm, Esquire, Chairman, of Boston, Massachusetts; James V. Vergari, Esquire; John J. Clarke, Esquire; Henry J. Bailey, III, Esquire, of the Federal Reserve Bank of New York, New York; Rollin C. Huggins, Esquire, of Chicago, Illinois; Carl W. Funk, Esquire, of Philadelphia, Pennsylvania. Article 5: Arthur Littleton, Esquire, Chairman, Philadelphia, Pennsylvania; Mr. Horace M. Chadsey, Vice-President of the First National Bank of Boston; Arthur F. McCarthy, Esquire, of Philadelphia, Pennsylvania; Professor Soia Mentschiko, of the University of Chicago Law School, Chicago, Illinois. In addition, the following acted as an Advisory Committee to the Article 5 Subcommittee: Ernest A. Carlson, of the Continental Illinois National Bank and Trust Company, Chicago, Illinois; John E. Corrigan, Jr., of the First National Bank of Chicago; Guy A. Crum, of the First National Bank of Chicago; Louis F. Dempsey, of the Northern Trust Company, Chicago, Illinois; Gerard E. Keidel, of the American National Bank and Trust Company of Chicago; Robert W. Maynard, of the Harris Trust and Savings Bank, Chicago, Illinois. Article 6: Professor Charles Bunn, Chairman; Eugene B. Strassburger, Esquire, of Pittsburgh, Pennsylvania. Article 7: Professor Robert Braucher, Chairman; John C. Pryor, Esquire, of Burlington, Iowa. Article 8: Carlos Israels, Esquire, Chairman, of New York, New York; Professor Soia Mentschiko; Eliot B. Thomas, Esquire, of Philadelphia, Pennsylvania; Fred B. Lund, Esquire, of Boston, Massachusetts. Article 9: J. Francis Ireton, Esquire, Chairman, of Baltimore, Maryland; Homer L. Kripke, Esquire, of New York, New York; Anthony G. Felix, Jr., Esquire, of Philadelphia, Pennsylvania; Peter F. Coogan, Esquire, of Boston, Massachusetts; Professor Grant Gilmore, of Yale University Law School, New Haven, Connecticut; Harold F. Birnbaum, Esquire, of Los Angeles, California; Richard R. Winters, Esquire, of Pittsburgh, Pennsylvania; Professor John Hanna, of the Law School of Columbia University, New York, New York. In addition there were informal consultants much too numerous to mention who frequently advised those working on the Code to insure a work7

Uniform Commercial Code

able set of laws. In this latter class were included practicing lawyers, hard-headed businessmen and operating bankers, who contributed generously of their time and knowledge so that, not only current business practice, but foreseeable future developments would be covered. Committees of several Bar Associations, and in particular a committee of the Section of Corporation, Banking and Business Law of the American Bar Association, of which Mr. Walter D. Malcolm of Boston was chairman, considered the various drafts of the Code and made valuable suggestions. After nal approval of the Code by the Institute and the Conference, and in accordance with the practice of the Conference, the completed Code was submitted to the American Bar Association and was approved by the House of Delegates of that Association. * * *

ARTICLE 1. GENERAL PROVISIONS

PART 1. GENERAL PROVISIONS
1-101. Short Titles. 1-102. Scope of Article. 1-103. Construction of [Uniform Commercial Code] to Promote Its Purposes and Policies; Applicability of Supplemental Principles of Law. 1-104. Construction Against Implied Repeal. 1-105. Severability. 1-106. Use of Singular and Plural; Gender. 1-107. Section Captions. 1-108. Relation to Electronic Signatures in Global and National Commerce Act.

PART 2. GENERAL DEFINITIONS AND PRINCIPLES OF INTERPRETATION

1-201. 1-202. 1-203. 1-204. 1-205. 1-206. General Denitions. Notice; Knowledge. Lease Distinguished From Security Interest. Value. Reasonable Time; Seasonableness. Presumptions.

PART 3. TERRITORIAL APPLICABILITY AND GENERAL RULES

1-301. 1-302. 1-303. 1-304. 1-305. 1-306. 1-307. 1-308. 1-309. 1-310. Territorial Applicability; Parties' Power to Choose Applicable Law. Variation by Agreement. Course of Performance, Course of Dealing, and Usage of Trade. Obligation of Good Faith. Remedies to Be Liberally Administered. Waiver or Renunciation of Claim or Right After Breach. Prima Facie Evidence by Third-Party Documents. Performance or Acceptance Under Reservation of Rights. Option to Accelerate at Will. Subordinated Obligations.

APPENDIX I. CONFORMING AMENDMENTS TO OTHER ARTICLES

DRAFTING COMMITTEE TO REVISE UNIFORM COMMERCIAL CODE ARTICLE 1GENERAL PROVISIONS

BORIS AUERBACH, 332 Ardon Lane, Wyoming, OH 45215, Chair MARION W. BENFIELD, JR., 10 Overlook Circle, New Braunfels, TX 78132 AMELIA H. BOSS, Temple University, School of Law, 1719 N. Broad Street, Philadelphia, PA 19122, The American Law Institute Representative JAMES C. McKAY, JR., Oce of Corporation Counsel, 6th Floor South, 441 4th Street, NW, Washington, DC 20001, Committee on Style Liaison H. KATHLEEN PATCHEL, Indiana University-Indianapolis, School of Law, 530 W. New York Street, Indianapolis, IN 46202-5194, National Conference Associate Reporter CURTIS R. REITZ, University of Pennsylvania, School of Law, 3400 Chestnut Street, Philadelphia, PA 19104 CARLYLE C. RING, JR., 1401 H Street NW, Suite 500, Washington, DC 20005, Enactment Plan Coordinator JAMES J. WHITE, University of Michigan Law School, Hutchins Hall, Room 300, 625 S. State Street, Ann Arbor, MI 48109-1215 NEIL B. COHEN, Brooklyn Law School, Room 904A, 250 Joralemon Street, Brooklyn, NY 11201, Reporter EX OFFICIO JOHN L. McCLAUGHERTY, P.O. Box 553, Charleston, WV 25322, President ROBERT J. TENNESSEN, 3400 City Center, 33 S. 6th Street, Minneapolis, MN 554023796, Division Chair AMERICAN BAR ASSOCIATION ADVISORS HARRY C. SIGMAN, 9717 Cashio Street, Los Angeles, CA 90035, Advisor RICHARD R. GOLDBERG, 51st Floor, 1735 Market Street, Philadelphia, PA 19103, Real Property, Probate & Trust Law Section Advisor WILLIAM J. WOODWARD, JR., Temple University School of Law, 1719 N. Broad Street, Philadelphia, PA 19122, Business Law Section Advisor EXECUTIVE DIRECTOR FRED H. MILLER, University of Oklahoma, College of Law, 300 Timberdell Rd., Norman, OK 73019, Executive Director WILLIAM J. PIERCE, 1505 Roxbury Road, Ann Arbor, MI 48104, Executive Director Emeritus [Revised Article 1 was approved in 2001. Pre-revision Article 1 may be found in Appendix P.]

PART 1. GENERAL PROVISIONS

1-101. Short Titles. (a) This [Act] may be cited as the Uniform Commercial Code. (b) This article may be cited as Uniform Commercial Code-General Provisions. Ocial Comment
Source: Former Section 1-101. Changes from former law: Subsection (b) is new. It is added in order to make the structure of Article 1 parallel with that of the other articles of the Uniform Commercial 10

Art. 1

General Provisions

1-103

Code. 1. Each other article of the Uniform Commercial Code (except Articles 10 and 11) may also be cited by its own short title. See Sections 2-101, 2A-101, 3-101, 4-101, 4A-101, 5-101, 6-101, 7-101, 8-101, and 9-101.

1-102. Scope of Article. This article applies to a transaction to the extent that it is governed by another article of [the Uniform Commercial Code]. Ocial Comment
Source: New. 1. This section is intended to resolve confusion that has occasionally arisen as to the applicability of the substantive rules in this article. This section makes clear what has always been the case-the rules in Article 1 apply to transactions to the extent that those transactions are governed by one of the other articles of the Uniform Commercial Code. See also Comment 1 to Section 1-301.

1-103. Construction of [Uniform Commercial Code] to Promote Its Purposes and Policies; Applicability of Supplemental Principles of Law. (a) [The Uniform Commercial Code] must be liberally construed and applied to promote its underlying purposes and policies, which are: (1) to simplify, clarify, and modernize the law governing commercial transactions; (2) to permit the continued expansion of commercial practices through custom, usage, and agreement of the parties; and (3) to make uniform the law among the various jurisdictions. (b) Unless displaced by the particular provisions of [the Uniform Commercial Code], the principles of law and equity, including the law merchant and the law relative to capacity to contract, principal and agent, estoppel, fraud, misrepresentation, duress, coercion, mistake, bankruptcy, and other validating or invalidating cause supplement its provisions. Ocial Comment
Source: Former Section 1-102 (1)(2); Former Section 1-103. Changes from former law: This section is derived from subsections (1) and (2) of former Section 1-102 and from former Section 1-103. Subsection (a) of this section combines subsections (1) and (2) of former Section 1-102. Except for changing the form of reference to the Uniform Commercial Code and minor stylistic changes, its language is the same as subsections (1) and (2) of former Section 1-102. Except for changing the form of reference to the Uniform Commercial Code and minor stylistic changes, subsection (b) of this section is identical to former Section 1-103. The provisions have been combined in this section to reect the interrelationship between them. 1. The Uniform Commercial Code is drawn to provide exibility so that, since it is intended to be a semi-permanent and infrequently-amended piece of legislation, it will provide its own machinery for expansion of commercial practices. It is intended to make it possible for the law embodied in the Uniform Commercial Code to be applied by the courts in the light of unforeseen and new circumstances and practices. The proper construction of the Uniform Commercial Code requires, of course, that its interpretation and application be limited to its reason. Even prior to the enactment of the Uniform Commercial Code, courts were careful to keep broad acts from being hampered in their eects by later acts of limited scope. See Pacic Wool Growers v. Draper & Co., 158 Or. 1, 73 P.2d 1391 (1937), and compare Section 1-104. The courts have often recognized that the policies embodied in an act are applicable in reason to subject-matter that was not expressly included in the language of the act, 11

 1-103

Uniform Commercial Code

Art. 1

Commercial Nat. Bank of New Orleans v. Canal-Louisiana Bank & Trust Co., 239 U.S. 520, 36 S.Ct. 194, 60 L.Ed. 417 (1916) (bona de purchase policy of Uniform Warehouse Receipts Act extended to case not covered but of equivalent nature), and did the same where reason and policy so required, even where the subject-matter had been intentionally excluded from the act in general. Agar v. Orda, 264 N.Y. 248, 190 N.E. 479 (1934) (Uniform Sales Act change in seller's remedies applied to contract for sale of choses in action even though the general coverage of that Act was intentionally limited to goods other than things in action.) They implemented a statutory policy with liberal and useful remedies not provided in the statutory text. They disregarded a statutory limitation of remedy where the reason of the limitation did not apply. Fiterman v. J. N. Johnson & Co., 156 Minn. 201, 194 N.W. 399 (1923) (requirement of return of the goods as a condition to rescission for breach of warranty; also, partial rescission allowed). Nothing in the Uniform Commercial Code stands in the way of the continuance of such action by the courts. The Uniform Commercial Code should be construed in accordance with its underlying purposes and policies. The text of each section should be read in the light of the purpose and policy of the rule or principle in question, as also of the Uniform Commercial Code as a whole, and the application of the language should be construed narrowly or broadly, as the case may be, in conformity with the purposes and policies involved. 2. Applicability of supplemental principles of law. Subsection (b) states the basic relationship of the Uniform Commercial Code to supplemental bodies of law. The Uniform Commercial Code was drafted against the backdrop of existing bodies of law, including the common law and equity, and relies on those bodies of law to supplement it provisions in many important ways. At the same time, the Uniform Commercial Code is the primary source of commercial law rules in areas that it governs, and its rules represent choices made by its drafters and the enacting legislatures about the appropriate policies to be furthered in the transactions it covers. Therefore, while principles of common law and equity may supplement provisions of the Uniform Commercial Code, they may not be used to supplant its provisions, or the purposes and policies those provisions reect, unless a specic provision of the Uniform Commercial Code provides otherwise. In the absence of such a provision, the Uniform Commercial Code preempts principles of common law and equity that are inconsistent with either its provisions or its purposes and policies. The language of subsection (b) is intended to reect both the concept of supplementation and the concept of preemption. Some courts, however, had diculty in applying the identical language of former Section 1-103 to determine when other law appropriately may be applied to supplement the Uniform Commercial Code, and when that law has been displaced by the Code. Some decisions applied other law in situations in which that application, while not inconsistent with the text of any particular provision of the Uniform Commercial Code, clearly was inconsistent with the underlying purposes and policies reected in the relevant provisions of the Code. See, e.g., Sheerbonnet, Ltd. v. American Express Bank, Ltd., 951 F. Supp. 403 (S.D.N.Y. 1995). In part, this diculty arose from Comment 1 to former Section 1-103, which stated that this section indicates the continued applicability to commercial contracts of all supplemental bodies of law except insofar as they are explicitly displaced by this Act. The explicitly displaced language of that Comment did not accurately reect the proper scope of Uniform Commercial Code preemption, which extends to displacement of other law that is inconsistent with the purposes and policies of the Uniform Commercial Code, as well as with its text. 3. Application of subsection (b) to statutes. The primary focus of Section 1-103 is on the relationship between the Uniform Commercial Code and principles of common law and equity as developed by the courts. State law, however, increasingly is statutory. Not only are there a growing number of state statutes addressing specic issues that come within the scope of the Uniform Commercial Code, but in some States many general principles of common law and equity have been codied. When the other law relating to a matter within the scope of the Uniform Commercial Code is a statute, the principles of subsection (b) remain relevant to the court's analysis of the relationship between that statute and the Uniform Commercial Code, but other principles of statutory interpretation that specically address the interrelationship between statutes will be relevant as well. In some situations, the principles of subsection (b) still will be determinative. For example, the mere fact that an equitable principle is stated in statutory form rather than in judicial decisions should not change the court's analysis of whether the principle can be used to supplement the Uniform Commercial Code-under subsection (b), equitable principles may supplement pro12

Art. 1

General Provisions

1-106

visions of the Uniform Commercial Code only if they are consistent with the purposes and policies of the Uniform Commercial Code as well as its text. In other situations, however, other interpretive principles addressing the interrelationship between statutes may lead the court to conclude that the other statute is controlling, even though it conicts with the Uniform Commercial Code. This, for example, would be the result in a situation where the other statute was specically intended to provide additional protection to a class of individuals engaging in transactions covered by the Uniform Commercial Code. 4. Listing not exclusive. The list of sources of supplemental law in subsection (b) is intended to be merely illustrative of the other law that may supplement the Uniform Commercial Code, and is not exclusive. No listing could be exhaustive. Further, the fact that a particular section of the Uniform Commercial Code makes express reference to other law is not intended to suggest the negation of the general application of the principles of subsection (b). Note also that the word bankruptcy in subsection (b), continuing the use of that word from former Section 1-103, should be understood not as a specic reference to federal bankruptcy law but, rather as a reference to general principles of insolvency, whether under federal or state law.

1-104. Construction Against Implied Repeal. [The Uniform Commercial Code] being a general act intended as a unied coverage of its subject matter, no part of it shall be deemed to be impliedly repealed by subsequent legislation if such construction can reasonably be avoided. Ocial Comment
Source: Former Section 1-104. Changes from former law: Except for changing the form of reference to the Uniform Commercial Code, this section is identical to former Section 1-104. 1. This section embodies the policy that an act that bears evidence of carefully considered permanent regulative intention should not lightly be regarded as impliedly repealed by subsequent legislation. The Uniform Commercial Code, carefully integrated and intended as a uniform codication of permanent character covering an entire eld of law, is to be regarded as particularly resistant to implied repeal.

1-105. Severability. If any provision or clause of [the Uniform Commercial Code] or its application to any person or circumstance is held invalid, the invalidity does not aect other provisions or applications of [the Uniform Commercial Code] which can be given eect without the invalid provision or application, and to this end the provisions of [the Uniform Commercial Code] are severable. Ocial Comment
Source: Former Section 1-108. Changes from former law: Except for changing the form of reference to the Uniform Commercial Code, this section is identical to former Section 1-108. 1. This is the model severability section recommended by the National Conference of Commissioners on Uniform State Laws for inclusion in all acts of extensive scope.

1-106. Use of Singular and Plural; Gender. In [the Uniform Commercial Code], unless the statutory context otherwise requires: (1) words in the singular number include the plural, and those in the plural include the singular; and (2) words of any gender also refer to any other gender.
13

 1-106

Uniform Commercial Code

Art. 1

Ocial Comment
Source: Former Section 1-102(5). See also 1 U.S.C. Section 1. Changes from former law: Other than minor stylistic changes, this section is identical to former Section 1-102(5). 1. This section makes it clear that the use of singular or plural in the text of the Uniform Commercial Code is generally only a matter of drafting style-singular words may be applied in the plural, and plural words may be applied in the singular. Only when it is clear from the statutory context that the use of the singular or plural does not include the other is this rule inapplicable. See, e.g., Section 9-322.

1-107. Section Captions. Section captions are part of [the Uniform Commercial Code]. Ocial Comment
Source: Former Section 1-109. Changes from former law: None. 1. Section captions are a part of the text of the Uniform Commercial Code, and not mere surplusage. This is not the case, however, with respect to subsection headings appearing in Article 9. See Comment 3 to Section 9-101 (subsection headings are not a part of the ofcial text itself and have not been approved by the sponsors.).

1-108. Relation to Electronic Signatures in Global and National Commerce Act. This article modies, limits, and supersedes the Federal Electronic Signatures in Global and National Commerce Act, 15 U.S.C. 7001 et seq., except that nothing in this article modies, limits, or supersedes section 7001(c) of that act or authorizes electronic delivery of any of the notices described in section 7003(b) of that Act. Ocial Comment
Source: New 1. The federal Electronic Signatures in Global and National Commerce Act, 15 U.S.C. Section 7001 et seq. became eective in 2000. Section 102(a) of that Act provides that a State statute may modify, limit, or supersede the provisions of section 101 of that Act with respect to state law if such statute, inter alia, species the alternative procedures or requirements for the use or acceptance (or both) of electronic records or electronic signatures to establish the legal eect, validity, or enforceability of contracts or other records, and (i) such alternative procedures or requirements are consistent with Titles I and II of that Act, (ii) such alternative procedures or requirements do not require, or accord greater legal status or eect to, the implementation or application of a specic technology or technical specication for performing the functions of creating, storing, generating, receiving, communicating, or authenticating electronic records or electronic signatures; and (iii) if enacted or adopted after the date of the enactment of that Act, makes specic reference to that Act. Article 1 fullls the rst two of those three criteria; this Section fullls the third criterion listed above. 2. As stated in this section, however, Article 1 does not modify, limit, or supersede Section 101(c) of the Electronic Signatures in Global and National Commerce Act (requiring afrmative consent from a consumer to electronic delivery of transactional disclosures that are required by state law to be in writing); nor does it authorize electronic delivery of any of the notices described in Section 103(b) of that Act.

PART 2. GENERAL DEFINITIONS AND PRINCIPLES OF INTERPRETATION

1-201. General Denitions. (a) Unless the context otherwise requires, words or phrases dened in
14

Art. 1

General Provisions

1-201

this section, or in the additional denitions contained in other articles of [the Uniform Commercial Code] that apply to particular articles or parts thereof, have the meanings stated. (b) Subject to denitions contained in other articles of [the Uniform Commercial Code] that apply to particular articles or parts thereof: (1) Action, in the sense of a judicial proceeding, includes recoupment, counterclaim, set-o, suit in equity, and any other proceeding in which rights are determined. (2) Aggrieved party means a party entitled to pursue a remedy. (3) Agreement, as distinguished from contract, means the bargain of the parties in fact, as found in their language or inferred from other circumstances, including course of performance, course of dealing, or usage of trade as provided in Section 1-303. (4) Bank means a person engaged in the business of banking and includes a savings bank, savings and loan association, credit union, and trust company. (5) Bearer means a person in control of a negotiable electronic document of title or a person in possession of a negotiable instrument, negotiable tangible document of title, or certicated security that is payable to bearer or indorsed in blank. (6) Bill of lading means a document of title evidencing the receipt of goods for shipment issued by a person engaged in the business of directly or indirectly transporting or forwarding goods. The term does not include a warehouse receipt. (7) Branch includes a separately incorporated foreign branch of a bank. (8) Burden of establishing a fact means the burden of persuading the trier of fact that the existence of the fact is more probable than its nonexistence. (9) Buyer in ordinary course of business means a person that buys goods in good faith, without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person, other than a pawnbroker, in the business of selling goods of that kind. A person buys goods in the ordinary course if the sale to the person comports with the usual or customary practices in the kind of business in which the seller is engaged or with the seller's own usual or customary practices. A person that sells oil, gas, or other minerals at the wellhead or minehead is a person in the business of selling goods of that kind. A buyer in ordinary course of business may buy for cash, by exchange of other property, or on secured or unsecured credit, and may acquire goods or documents of title under a preexisting contract for sale. Only a buyer that takes possession of the goods or has a right to recover the goods from the seller under Article 2 may be a buyer in ordinary course of business. Buyer in ordinary course of business does not include a person that acquires goods in a transfer in bulk or as security for or in total or partial satisfaction of a money debt. (10) Conspicuous, with reference to a term, means so written, displayed, or presented that a reasonable person against which it is to
15

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operate ought to have noticed it. Whether a term is conspicuous or not is a decision for the court. Conspicuous terms include the following: (A) a heading in capitals equal to or greater in size than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same or lesser size; and (B) language in the body of a record or display in larger type than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same size, or set o from surrounding text of the same size by symbols or other marks that call attention to the language. (11) Consumer means an individual who enters into a transaction primarily for personal, family, or household purposes. (12) Contract, as distinguished from agreement, means the total legal obligation that results from the parties' agreement as determined by [the Uniform Commercial Code] as supplemented by any other applicable laws. (13) Creditor includes a general creditor, a secured creditor, a lien creditor, and any representative of creditors, including an assignee for the benet of creditors, a trustee in bankruptcy, a receiver in equity, and an executor or administrator of an insolvent debtor's or assignor's estate. (14) Defendant includes a person in the position of defendant in a counterclaim, cross-claim, or third-party claim. (15) Delivery, with respect to an electronic document of title means voluntary transfer of control and with respect to an instrument, a tangible document of title, or chattel paper, means voluntary transfer of possession. (16) Document of title means a record (i) that in the regular course of business or nancing is treated as adequately evidencing that the person in possession or control of the record is entitled to receive, control, hold, and dispose of the record and the goods the record covers and (ii) that purports to be issued by or addressed to a bailee and to cover goods in the bailee's possession which are either identied or are fungible portions of an identied mass. The term includes a bill of lading, transport document, dock warrant, dock receipt, warehouse receipt, and order for delivery of goods. An electronic document of title means a document of title evidenced by a record consisting of information stored in an electronic medium. A tangible document of title means a document of title evidenced by a record consisting of information that is inscribed on a tangible medium. (17) Fault means a default, breach, or wrongful act or omission. (18) Fungible goods means: (A) goods of which any unit, by nature or usage of trade, is the equivalent of any other like unit; or (B) goods that by agreement are treated as equivalent. (19) Genuine means free of forgery or counterfeiting. (20) Good faith, except as otherwise provided in Article 5, means honesty in fact and the observance of reasonable commercial standards of fair dealing.
16

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(21) Holder means: (A) the person in possession of a negotiable instrument that is payable either to bearer or to an identied person that is the person in possession; (B) the person in possession of a negotiable tangible document of title if the goods are deliverable either to bearer or to the order of the person in possession; or (C) the person in control of a negotiable electronic document of title. (22) Insolvency proceeding includes an assignment for the benet of creditors or other proceeding intended to liquidate or rehabilitate the estate of the person involved. (23) Insolvent means: (A) having generally ceased to pay debts in the ordinary course of business other than as a result of bona de dispute; (B) being unable to pay debts as they become due; or (C) being insolvent within the meaning of federal bankruptcy law. (24) Money means a medium of exchange currently authorized or adopted by a domestic or foreign government. The term includes a monetary unit of account established by an intergovernmental organization or by agreement between two or more countries. (25) Organization means a person other than an individual. (26) Party, as distinguished from third party, means a person that has engaged in a transaction or made an agreement subject to [the Uniform Commercial Code]. (27) Person means an individual, corporation, business trust, estate, trust, partnership, limited liability company, association, joint venture, government, governmental subdivision, agency, or instrumentality, public corporation, or any other legal or commercial entity. (28) Present value means the amount as of a date certain of one or more sums payable in the future, discounted to the date certain by use of either an interest rate specied by the parties if that rate is not manifestly unreasonable at the time the transaction is entered into or, if an interest rate is not so specied, a commercially reasonable rate that takes into account the facts and circumstances at the time the transaction is entered into. (29) Purchase means taking by sale, lease, discount, negotiation, mortgage, pledge, lien, security interest, issue or reissue, gift, or any other voluntary transaction creating an interest in property. (30) Purchaser means a person that takes by purchase. (31) Record means information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form. (32) Remedy means any remedial right to which an aggrieved party is entitled with or without resort to a tribunal. (33) Representative means a person empowered to act for another, including an agent, an ocer of a corporation or association, and a trustee, executor, or administrator of an estate.
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(34) Right includes remedy. (35) Security interest means an interest in personal property or xtures which secures payment or performance of an obligation. Security interest includes any interest of a consignor and a buyer of accounts, chattel paper, a payment intangible, or a promissory note in a transaction that is subject to Article 9. Security interest does not include the special property interest of a buyer of goods on identication of those goods to a contract for sale under Section 2-401, but a buyer may also acquire a security interest by complying with Article 9. Except as otherwise provided in Section 2-505, the right of a seller or lessor of goods under Article 2 or 2A to retain or acquire possession of the goods is not a security interest, but a seller or lessor may also acquire a security interest by complying with Article 9. The retention or reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer under Section 2-401 is limited in eect to a reservation of a security interest. Whether a transaction in the form of a lease creates a security interest is determined pursuant to Section 1-203. (36) Send in connection with a writing, record, or notice means: (A) to deposit in the mail or deliver for transmission by any other usual means of communication with postage or cost of transmission provided for and properly addressed and, in the case of an instrument, to an address specied thereon or otherwise agreed, or if there be none to any address reasonable under the circumstances; or (B) in any other way to cause to be received any record or notice within the time it would have arrived if properly sent. (37) Signed includes using any symbol executed or adopted with present intention to adopt or accept a writing. (38) State means a State of the United States, the District of Columbia, Puerto Rico, the United States Virgin Islands, or any territory or insular possession subject to the jurisdiction of the United States. (39) Surety includes a guarantor or other secondary obligor. (40) Term means a portion of an agreement that relates to a particular matter. (41) Unauthorized signature means a signature made without actual, implied, or apparent authority. The term includes a forgery. (42) Warehouse receipt means a document of title issued by a person engaged in the business of storing goods for hire. (43) Writing includes printing, typewriting, or any other intentional reduction to tangible form. Written has a corresponding meaning. As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
Source: Former Section 1-201. Changes from former law: In order to make it clear that all denitions in the Uniform Commercial Code (not just those appearing in Article 1, as stated in former Section 1-201, but also those appearing in other Articles) do not apply if the context otherwise requires, a new subsection (a) to that eect has been added, and the denitions now appear in subsec18

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tion (b). The reference in subsection (a) to the context is intended to refer to the context in which the dened term is used in the Uniform Commercial Code. In other words, the denition applies whenever the dened term is used unless the context in which the dened term is used in the statute indicates that the term was not used in its dened sense. Consider, for example, Sections 3-103(a)(9) (dening promise, in relevant part, as a written undertaking to pay money signed by the person undertaking to pay) and 3-303(a)(1) (indicating that an instrument is issued or transferred for value if the instrument is issued or transferred for a promise of performance, to the extent that the promise has been performed). It is clear from the statutory context of the use of the word promise in Section 3-303(a)(1) that the term was not used in the sense of its denition in Section 3-103(a)(9). Thus, the Section 3-103(a)(9) denition should not be used to give meaning to the word promise in Section 3-303(a). Some denitions in former Section 1-201 have been reformulated as substantive provisions and have been moved to other sections. See Sections 1-202 (explicating concepts of notice and knowledge formerly addressed in Sections 1-201(25)(27)), 1-204 (determining when a person gives value for rights, replacing the denition of value in former Section 1-201(44)), and 1-206 (addressing the meaning of presumptions, replacing the denitions of presumption and presumed in former Section 1-201(31)). Similarly, the portion of the denition of security interest in former Section 1-201(37) which explained the dierence between a security interest and a lease has been relocated to Section 1-203. Two denitions in former Section 1-201 have been deleted. The denition of honor in former Section 1-201(21) has been moved to Section 2-103(1)(b), inasmuch as the denition only applies to the use of the word in Article 2. The denition of telegram in former Section 1-201(41) has been deleted because that word no longer appears in the denition of conspicuous. Other than minor stylistic changes and renumbering, the remaining denitions in this section are as in former Article 1 except as noted below. 1. Action. Unchanged from former Section 1-201, which was derived from similar denitions in Section 191, Uniform Negotiable Instruments Law; Section 76, Uniform Sales Act; Section 58, Uniform Warehouse Receipts Act; Section 53, Uniform Bills of Lading Act. 2. Aggrieved party. Unchanged from former Section 1-201. 3. Agreement. Derived from former Section 1-201. As used in the Uniform Commercial Code the word is intended to include full recognition of usage of trade, course of dealing, course of performance and the surrounding circumstances as eective parts thereof, and of any agreement permitted under the provisions of the Uniform Commercial Code to displace a stated rule of law. Whether an agreement has legal consequences is determined by applicable provisions of the Uniform Commercial Code and, to the extent provided in Section 1-103, by the law of contracts. 4. Bank. Derived from Section 4A-104. 5. Bearer. Unchanged, except in one respect, from former section 1-201, which was derived from Section 191, Uniform Negotiable Instruments Law. The term bearer applies to negotiable documents of title and has been broadened to include a person in control of an electronic negotiable document of title. Control of an electronic document of title is dened in Article 7 (Section 7-106). 6. Bill of Lading. Derived from former Section 1-201. The reference to, and denition of, an airbill has been deleted as no longer necessary. A bill of lading is one type of document of title as dened in subsection (16). This denition should be read in conjunction with the denition of carrier in Article 7 (Section 7-102). 7. Branch. Unchanged from former Section 1-201. 8. Burden of establishing a fact. Unchanged from former Section 1-201. 9. Buyer in ordinary course of business. Except for minor stylistic changes, identical to former Section 1-201 (as amended in conjunction with the 1999 revisions to Article 9). The major signicance of the phrase lies in Section 2-403 and in the Article on Secured Transactions (Article 9). The rst sentence of paragraph (9) makes clear that a buyer from a pawnbroker cannot be a buyer in ordinary course of business. The second sentence explains what it means to buy in the ordinary course. The penultimate sentence prevents a buyer that does not have the right to possession as against the seller from being a buyer in ordinary course of business. Concerning when a buyer obtains possessory rights, see Sections 2-502 and 2-716. 19

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However, the penultimate sentence is not intended to aect a buyer's status as a buyer in ordinary course of business in cases (such as a drop shipment) involving delivery by the seller to a person buying from the buyer or a donee from the buyer. The requirement relates to whether as against the seller the buyer or one taking through the buyer has possessory rights. 10. Conspicuous. Derived from former Section 1-201(10). This denition states the general standard that to be conspicuous a term ought to be noticed by a reasonable person. Whether a term is conspicuous is an issue for the court. Subparagraphs (A) and (B) set out several methods for making a term conspicuous. Requiring that a term be conspicuous blends a notice function (the term ought to be noticed) and a planning function (giving guidance to the party relying on the term regarding how that result can be achieved). Although these paragraphs indicate some of the methods for making a term attention-calling, the test is whether attention can reasonably be expected to be called to it. The statutory language should not be construed to permit a result that is inconsistent with that test. 11. Consumer. Derived from Section 9-102(a)(25). 12. Contract. Except for minor stylistic changes, identical to former Section 1-201. 13. Creditor. Unchanged from former Section 1-201. 14. Defendant. Except for minor stylistic changes, identical to former Section 1-201, which was derived from Section 76, Uniform Sales Act. 15. Delivery. Derived from former Section 1-201. The reference to certicated securities has been deleted in light of the more specic treatment of the matter in Section 8-301. The denition has been revised to accommodate electronic documents of title. Control of an electronic document of title is dened in Article 7 (Section 7-106). 16.Document of title. Derived from former Section 1-201, which was derived from Section 76, Uniform Sales Act. This denition makes explicit that the obligation or designation of a third party as bailee is essential to a document of title and clearly rejects any such result as obtained in Hixson v. Ward, 254 Ill.App. 505 (1929), which treated a conditional sales contract as a document of title. Also the denition is left open so that new types of documents may be included, including documents which gain commercial recognition in the international arena. See UNCITRAL Draft Instrument on the Carriage of Goods By Sea. It is unforeseeable what documents may one day serve the essential purpose now lled by warehouse receipts and bills of lading. The denition is stated in terms of the function of the documents with the intention that any document which gains commercial recognition as accomplishing the desired result shall be included within its scope. Fungible goods are adequately identied within the language of the denition by identication of the mass of which they are a part. Dock warrants were within the Sales Act denition of document of title apparently for the purpose of recognizing a valid tender by means of such paper. In current commercial practice a dock warrant or receipt is a kind of interim certicate issued by shipping companies upon delivery of the goods at the dock, entitling a designated person to be issued a bill of lading. The receipt itself is invariably nonnegotiable in form although it may indicate that a negotiable bill is to be forthcoming. Such a document is not within the general compass of the denition, although trade usage may in some cases entitle such paper to be treated as a document of title. If the dock receipt actually represents a storage obligation undertaken by the shipping company, then it is a warehouse receipt within this Section regardless of the name given to the instrument. The goods must be described, but the description may be by marks or labels and may be qualied in such a way as to disclaim personal knowledge of the issuer regarding contents or condition. However, baggage and parcel checks and similar tokens of storage which identify stored goods only as those received in exchange for the token are not covered by this Article. The denition is broad enough to include an airway bill. A document of title may be either tangible or electronic. Tangible documents of title should be construed to mean traditional paper documents. Electronic documents of title are documents that are stored in an electronic medium instead of in tangible form. The concept of an electronic medium should be construed liberally to include electronic, digital, magnetic, optical, electromagnetic, or any other current or similar emerging technologies. As to reissuing a document of title in an alternative medium, see Article 7, Section 7-105. Control for electronic documents of title is dened in Article 7 (Section 7-106). 17. Fault. Derived from former Section 1-201. Default has been added to the list of 20

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events constituting fault. 18. Fungible goods. Derived from former Section 1-201. References to securities have been deleted because Article 8 no longer uses the term fungible to describe securities. Accordingly, this provision now denes the concept only in the context of goods. 19. Genuine. Unchanged from former Section 1-201. 20. Good faith. Former Section 1-201(19) dened good faith simply as honesty in fact; the denition contained no element of commercial reasonableness. Initially, that denition applied throughout the Code with only one exception. Former Section 2-103(1)(b) provided that, in that Article, good faith in the case of a merchant means honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade. This alternative denition was limited in applicability, though, because it applied only to transactions within the scope of Article 2 and it applied only to merchants. Over time, however, amendments to the Uniform Commercial Code brought the Article 2 merchant concept of good faith (subjective honesty and objective commercial reasonableness) into other Articles. First, Article 2A explicitly incorporated the Article 2 standard. See Section 2A-103(7). Then, other Articles broadened the applicability of that standard by adopting it for all parties rather than just for merchants. See, e.g., Sections 3-103(a)(4), 4A105(a)(6), 7-102(a)(6), 8-102(a)(10), and 9-102(a)(43). Finally, Articles 2 and 2A were amended so as to apply the standard to non-merchants as well as merchants. See Sections 2-103(1)(j), 2A-103(1)(m). All of these denitions are comprised of two elements-honesty in fact and the observance of reasonable commercial standards of fair dealing. Only revised Article 5 denes good faith solely in terms of subjective honesty, and only Article 6 (in the few states that have not chosen to delete the Article) is without a denition of good faith. (It should be noted that, while revised Article 6 did not dene good faith, Comment 2 to revised Section 6-102 states that this Article adopts the denition of good faith in Article 1 in all cases, even when the buyer is a merchant.) Thus, the denition of good faith in this section merely conrms what has been the case for a number of years as Articles of the UCC have been amended or revised-the obligation of good faith, applicable in each Article, is to be interpreted in the context of all Articles except for Article 5 as including both the subjective element of honesty in fact and the objective element of the observance of reasonable commercial standards of fair dealing. As a result, both the subjective and objective elements are part of the standard of good faith, whether that obligation is specically referenced in another Article of the Code (other than Article 5) or is provided by this Article. Of course, as noted in the statutory text, the denition of good faith in this section does not apply when the narrower denition of good faith in revised Article 5 is applicable. As noted above, the denition of good faith in this section requires not only honesty in fact but also observance of reasonable commercial standards of fair dealing. Although fair dealing is a broad term that must be dened in context, it is clear that it is concerned with the fairness of conduct rather than the care with which an act is performed. This is an entirely dierent concept than whether a party exercised ordinary care in conducting a transaction. Both concepts are to be determined in the light of reasonable commercial standards, but those standards in each case are directed to dierent aspects of commercial conduct. See e.g., Sections 3-103(a)(9) and 4-104(c) and Comment 4 to Section 3-103. 21. Holder. Derived from former Section 1-201. The denition has been reorganized for clarity and amended to provide for electronic negotiable documents of title. 22. Insolvency proceedings. Unchanged from former Section 1-201. 23. Insolvent. Derived from former Section 1-201. The three tests of insolvencygenerally ceased to pay debts in the ordinary course of business other than as a result of a bona de dispute as to them, unable to pay debts as they become due, and insolvent within the meaning of the federal bankruptcy law-are expressly set up as alternative tests and must be approached from a commercial standpoint. 24. Money. Substantively identical to former Section 1-201. The test is that of sanction of government, whether by authorization before issue or adoption afterward, which recognizes the circulating medium as a part of the ocial currency of that government. The narrow view that money is limited to legal tender is rejected. 25. Organization. The former denition of this word has been replaced with the standard denition used in acts prepared by the National Conference of Commissioners on Uniform State Laws. 21

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26. Party. Substantively identical to former Section 1-201. Mention of a party includes, of course, a person acting through an agent. However, where an agent comes into opposition or contrast to the principal, particular account is taken of that situation. 27. Person. The former denition of this word has been replaced with the standard definition used in acts prepared by the National Conference of Commissioners on Uniform State Laws. 28. Present value. This denition was formerly contained within the denition of security interest in former Section 1-201(37). 29. Purchase. Derived from former Section 1-201. The form of denition has been changed from includes to means. 30. Purchaser. Unchanged from former Section 1-201. 31. Record. Derived from Section 9-102(a)(69). 32. Remedy. Unchanged from former Section 1-201. The purpose is to make it clear that both remedy and right (as dened) include those remedial rights of self help which are among the most important bodies of rights under the Uniform Commercial Code, remedial rights being those to which an aggrieved party may resort on its own. 33. Representative. Derived from former Section 1-201. Reorganized, and form changed from includes to means. 34. Right. Except for minor stylistic changes, identical to former Section 1-201. 35. Security Interest. The denition is the rst paragraph of the denition of security interest in former Section 1-201, with minor stylistic changes. The remaining portion of that denition has been moved to Section 1-203. Note that, because of the scope of Article 9, the term includes the interest of certain outright buyers of certain kinds of property. 36. Send. Derived from former Section 1-201. Compare noties. 37. Signed. Derived from former Section 1-201. Former Section 1-201 referred to intention to authenticate; because other articles now use the term authenticate, the language has been changed to intention to adopt or accept. The latter formulation is derived from the denition of authenticate in Section 9-102(a)(7). This provision refers only to writings, because the term signed, as used in some articles, refers only to writings. This provision also makes it clear that, as the term signed is used in the Uniform Commercial Code, a complete signature is not necessary. The symbol may be printed, stamped or written; it may be by initials or by thumbprint. It may be on any part of the document and in appropriate cases may be found in a billhead or letterhead. No catalog of possible situations can be complete and the court must use common sense and commercial experience in passing upon these matters. The question always is whether the symbol was executed or adopted by the party with present intention to adopt or accept the writing. 38. State. This is the standard denition of the term used in acts prepared by the National Conference of Commissioners on Uniform State Laws. 39. Surety. This denition makes it clear that surety includes all secondary obligors, not just those whose obligation refers to the person obligated as a surety. As to the nature of secondary obligations generally, see Restatement (Third), Suretyship and Guaranty Section 1 (1996). 40. Term. Unchanged from former Section 1-201. 41. Unauthorized signature. Unchanged from former Section 1-201. 42. Warehouse receipt. Derived from former Section 1-201, which was derived from Section 76(1), Uniform Sales Act; Section 1, Uniform Warehouse Receipts Act. Receipts issued by a eld warehouse are included, provided the warehouseman and the depositor of the goods are dierent persons. The denition makes clear that the receipt must qualify as a document of title under subsection (16). 43. Written or writing. Unchanged from former Section 1-201.

As amended in 2003 and 2005.

See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003. See Appendix V for material relating to changes made in Ocial Comment in 2005.

1-202. Notice; Knowledge. (a) Subject to subsection (f), a person has notice of a fact if the person:
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(1) has actual knowledge of it; (2) has received a notice or notication of it; or (3) from all the facts and circumstances known to the person at the time in question, has reason to know that it exists. (b) Knowledge means actual knowledge. Knows has a corresponding meaning. (c) Discover, learn, or words of similar import refer to knowledge rather than to reason to know. (d) A person noties or gives a notice or notication to another person by taking such steps as may be reasonably required to inform the other person in ordinary course, whether or not the other person actually comes to know of it. (e) Subject to subsection (f), a person receives a notice or notication when: (1) it comes to that person's attention; or (2) it is duly delivered in a form reasonable under the circumstances at the place of business through which the contract was made or at another location held out by that person as the place for receipt of such communications. (f) Notice, knowledge, or a notice or notication received by an organization is eective for a particular transaction from the time it is brought to the attention of the individual conducting that transaction and, in any event, from the time it would have been brought to the individual's attention if the organization had exercised due diligence. An organization exercises due diligence if it maintains reasonable routines for communicating signicant information to the person conducting the transaction and there is reasonable compliance with the routines. Due diligence does not require an individual acting for the organization to communicate information unless the communication is part of the individual's regular duties or the individual has reason to know of the transaction and that the transaction would be materially aected by the information. Ocial Comment
Source: Derived from former Section 1-201(25)-(27). Changes from former law: These provisions are substantive rather than purely denitional. Accordingly, they have been relocated from Section 1-201 to this section. The reference to the forgotten notice doctrine has been deleted. 1. Under subsection (a), a person has notice of a fact when, inter alia, the person has received a notication of the fact in question. 2. As provided in subsection (d), the word noties is used when the essential fact is the proper dispatch of the notice, not its receipt. Compare Send. When the essential fact is the other party's receipt of the notice, that is stated. Subsection (e) states when a notication is received. 3. Subsection (f) makes clear that notice, knowledge, or a notication, although received, for instance, by a clerk in Department A of an organization, is eective for a transaction conducted in Department B only from the time when it was or should have been communicated to the individual conducting that transaction.

1-203. Lease Distinguished From Security Interest. (a) Whether a transaction in the form of a lease creates a lease or security interest is determined by the facts of each case.
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(b) A transaction in the form of a lease creates a security interest if the consideration that the lessee is to pay the lessor for the right to possession and use of the goods is an obligation for the term of the lease and is not subject to termination by the lessee, and: (1) the original term of the lease is equal to or greater than the remaining economic life of the goods; (2) the lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become the owner of the goods; (3) the lessee has an option to renew the lease for the remaining economic life of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease agreement; or (4) the lessee has an option to become the owner of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease agreement. (c) A transaction in the form of a lease does not create a security interest merely because: (1) the present value of the consideration the lessee is obligated to pay the lessor for the right to possession and use of the goods is substantially equal to or is greater than the fair market value of the goods at the time the lease is entered into; (2) the lessee assumes risk of loss of the goods; (3) the lessee agrees to pay, with respect to the goods, taxes, insurance, ling, recording, or registration fees, or service or maintenance costs; (4) the lessee has an option to renew the lease or to become the owner of the goods; (5) the lessee has an option to renew the lease for a xed rent that is equal to or greater than the reasonably predictable fair market rent for the use of the goods for the term of the renewal at the time the option is to be performed; or (6) the lessee has an option to become the owner of the goods for a xed price that is equal to or greater than the reasonably predictable fair market value of the goods at the time the option is to be performed. (d) Additional consideration is nominal if it is less than the lessee's reasonably predictable cost of performing under the lease agreement if the option is not exercised. Additional consideration is not nominal if: (1) when the option to renew the lease is granted to the lessee, the rent is stated to be the fair market rent for the use of the goods for the term of the renewal determined at the time the option is to be performed; or (2) when the option to become the owner of the goods is granted to the lessee, the price is stated to be the fair market value of the goods determined at the time the option is to be performed. (e) The remaining economic life of the goods and reasonably predictable fair market rent, fair market value, or cost of performing under the lease agreement must be determined with reference to the facts and circumstances at the time the transaction is entered into.
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Ocial Comment
Source: Former Section 1-201(37). Changes from former law: This section is substantively identical to those portions of former Section 1-201(37) that distinguished true leases from security interests, except that the denition of present value formerly embedded in Section 1-201(37) has been placed in Section 1-201(28). 1. An interest in personal property or xtures which secures payment or performance of an obligation is a security interest. See Section 1-201(37). Security interests are sometimes created by transactions in the form of leases. Because it can be dicult to distinguish leases that create security interests from those that do not, this section provides rules that govern the determination of whether a transaction in the form of a lease creates a security interest. 2. One of the reasons it was decided to codify the law with respect to leases was to resolve an issue that created considerable confusion in the courts: what is a lease? The confusion existed, in part, due to the last two sentences of the denition of security interest in the 1978 Ocial Text of the Act, Section 1-201(37). The confusion was compounded by the rather considerable change in the federal, state and local tax laws and accounting rules as they relate to leases of goods. The answer is important because the denition of lease determines not only the rights and remedies of the parties to the lease but also those of third parties. If a transaction creates a lease and not a security interest, the lessee's interest in the goods is limited to its leasehold estate; the residual interest in the goods belongs to the lessor. This has signicant implications to the lessee's creditors. On common law theory, the lessor, since he has not parted with title, is entitled to full protection against the lessee's creditors and trustee in bankruptcy . . .. 1 G. Gilmore, Security Interests in Personal Property Section 3.6, at 76 (1965). Under pre-UCC chattel security law there was generally no requirement that the lessor le the lease, a nancing statement, or the like, to enforce the lease agreement against the lessee or any third party; the Article on Secured Transactions (Article 9) did not change the common law in that respect. Coogan, Leasing and the Uniform Commercial Code, in Equipment LeasingLeveraged Leasing 681, 700 n.25, 729 n.80 (2d ed.1980). The Article on Leases (Article 2A) did not change the law in that respect, except for leases of xtures. Section 2A-309. An examination of the common law will not provide an adequate answer to the question of what is a lease. The denition of security interest in Section 1-201(37) of the 1978 Ocial Text of the Act provided that the Article on Secured Transactions (Article 9) governs security interests disguised as leases, i.e., leases intended as security; however, the denition became vague and outmoded. Lease is dened in Article 2A as a transfer of the right to possession and use of goods for a term, in return for consideration. Section 2A-103(1)(j). The denition continues by stating that the retention or creation of a security interest is not a lease. Thus, the task of sharpening the line between true leases and security interests disguised as leases continues to be a function of this Article. This section begins where Section 1-201(35) leaves o. It draws a sharper line between leases and security interests disguised as leases to create greater certainty in commercial transactions. Prior to enactment of the rules now codied in this section, the 1978 Ocial Text of Section 1-201(37) provided that whether a lease was intended as security (i.e., a security interest disguised as a lease) was to be determined from the facts of each case; however, (a) the inclusion of an option to purchase did not itself make the lease one intended for security, and (b) an agreement that upon compliance with the terms of the lease the lessee would become, or had the option to become, the owner of the property for no additional consideration, or for a nominal consideration, did make the lease one intended for security. Reference to the intent of the parties to create a lease or security interest led to unfortunate results. In discovering intent, courts relied upon factors that were thought to be more consistent with sales or loans than leases. Most of these criteria, however, were as applicable to true leases as to security interests. Examples include the typical net lease provisions, a purported lessor's lack of storage facilities or its character as a nancing party rather than a dealer in goods. Accordingly, this section contains no reference to the parties' intent. Subsections (a) and (b) were originally taken from Section 1(2) of the Uniform Conditional 25

 1-203

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Sales Act (act withdrawn 1943), modied to reect current leasing practice. Thus, reference to the case law prior to the incorporation of those concepts in this article will provide a useful source of precedent. Gilmore, Security Law, Formalism and Article 9, 47 Neb.L.Rev. 659, 671 (1968). Whether a transaction creates a lease or a security interest continues to be determined by the facts of each case. Subsection (b) further provides that a transaction creates a security interest if the lessee has an obligation to continue paying consideration for the term of the lease, if the obligation is not terminable by the lessee (thus correcting early statutory gloss, e.g., In re Royer's Bakery, Inc., 1 U.C.C. Rep.Serv. (Callaghan) 342 (Bankr.E.D.Pa.1963)) and if one of four additional tests is met. The rst of these four tests, subparagraph (1), is that the original lease term is equal to or greater than the remaining economic life of the goods. The second of these tests, subparagraph (2), is that the lessee is either bound to renew the lease for the remaining economic life of the goods or to become the owner of the goods. In re Gehrke Enters., 1 Bankr. 647, 65152 (Bankr.W.D.Wis.1979). The third of these tests, subparagraph (3), is whether the lessee has an option to renew the lease for the remaining economic life of the goods for no additional consideration or for nominal additional consideration, which is dened later in this section. In re Celeryvale Transp., 44 Bankr. 1007, 101415 (Bankr.E.D.Tenn.1984). The fourth of these tests, subparagraph (4), is whether the lessee has an option to become the owner of the goods for no additional consideration or for nominal additional consideration. All of these tests focus on economics, not the intent of the parties. In re Berge , 32 Bankr. 370, 37173 (Bankr.W.D.Wis.1983). The focus on economics is reinforced by subsection (c). It states that a transaction does not create a security interest merely because the transaction has certain characteristics listed therein. Subparagraph (1) has no statutory derivative; it states that a full payout lease does not per se create a security interest. Rushton v. Shea, 419 F.Supp. 1349, 1365 (D.Del.1976). Subparagraphs (2) and (3) provide the same regarding the provisions of the typical net lease. Compare All-States Leasing Co. v. Ochs, 42 Or.App. 319, 600 P.2d 899 (Ct.App.1979), with In re Tillery, 571 F.2d 1361 (5th Cir.1978). Subparagraph (4) restates and expands the provisions of the 1978 Ocial Text of Section 1-201(37) to make clear that the option can be to buy or renew. Subparagraphs (5) and (6) treat xed price options and provide that fair market value must be determined at the time the transaction is entered into. Compare Arnold Mach. Co. v. Balls, 624 P.2d 678 (Utah 1981), with Aoki v. Shepherd Mach. Co., 665 F.2d 941 (9th Cir.1982). The relationship of subsection (b) to subsection (c) deserves to be explored. The xed price purchase option provides a useful example. A xed price purchase option in a lease does not of itself create a security interest. This is particularly true if the xed price is equal to or greater than the reasonably predictable fair market value of the goods at the time the option is to be performed. A security interest is created only if the option price is nominal and the conditions stated in the introduction to the second paragraph of this subsection are met. There is a set of purchase options whose xed price is less than fair market value but greater than nominal that must be determined on the facts of each case to ascertain whether the transaction in which the option is included creates a lease or a security interest. It was possible to provide for various other permutations and combinations with respect to options to purchase and renew. For example, this section could have stated a rule to govern the facts of In re Marhoefer Packing Co., 674 F.2d 1139 (7th Cir.1982). This was not done because it would unnecessarily complicate the denition. Further development of this rule is left to the courts. Subsections (d) and (e) provide denitions and rules of construction.

1-204. Value. Except as otherwise provided in Articles 3, 4, [and] 5, [and 6], a person gives value for rights if the person acquires them: (1) in return for a binding commitment to extend credit or for the extension of immediately available credit, whether or not drawn upon and whether or not a charge-back is provided for in the event of diculties in collection; (2) as security for, or in total or partial satisfaction of, a preexisting claim;
26

Art. 1

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(3) by accepting delivery under a preexisting contract for purchase; or (4) in return for any consideration sucient to support a simple contract. Ocial Comment
Source: Former Section 1-201(44). Changes from former law: Unchanged from former Section 1-201, which was derived from Sections 25, 26, 27, 191, Uniform Negotiable Instruments Law; Section 76, Uniform Sales Act; Section 53, Uniform Bills of Lading Act; Section 58, Uniform Warehouse Receipts Act; Section 22(1), Uniform Stock Transfer Act; Section 1, Uniform Trust Receipts Act. These provisions are substantive rather than purely denitional. Accordingly, they have been relocated from former Section 1-201 to this section. 1. All the Uniform Acts in the commercial law eld (except the Uniform Conditional Sales Act) have carried denitions of value. All those denitions provided that value was any consideration sucient to support a simple contract, including the taking of property in satisfaction of or as security for a pre-existing claim. Subsections (1), (2), and (4) in substance continue the denitions of value in the earlier acts. Subsection (3) makes explicit that value is also given in a third situation: where a buyer by taking delivery under a pre-existing contract converts a contingent into a xed obligation. This denition is not applicable to Articles 3 and 4, but the express inclusion of immediately available credit as value follows the separate denitions in those Articles. See Sections 4-208, 4-209, 3-303. A bank or other nancing agency which in good faith makes advances against property held as collateral becomes a bona de purchaser of that property even though provision may be made for charge-back in case of trouble. Checking credit is immediately available within the meaning of this section if the bank would be subject to an action for slander of credit in case checks drawn against the credit were dishonored, and when a charge-back is not discretionary with the bank, but may only be made when difculties in collection arise in connection with the specic transaction involved.

1-205. Reasonable Time; Seasonableness. (a) Whether a time for taking an action required by [the Uniform Commercial Code] is reasonable depends on the nature, purpose, and circumstances of the action. (b) An action is taken seasonably if it is taken at or within the time agreed or, if no time is agreed, at or within a reasonable time. Ocial Comment
Source: Former Section 1-204(2)(3). Changes from former law: This section is derived from subsections (2) and (3) of former Section 1-204. Subsection (1) of that section is now incorporated in Section 1-302(b). 1. Subsection (a) makes it clear that requirements that actions be taken within a reasonable time are to be applied in the transactional context of the particular action. 2. Under subsection (b), the agreement that xes the time need not be part of the main agreement, but may occur separately. Notice also that under the denition of agreement (Section 1-201) the circumstances of the transaction, including course of dealing or usages of trade or course of performance may be material. On the question what is a reasonable time these matters will often be important.

1-206. Presumptions. Whenever [the Uniform Commercial Code] creates a presumption with respect to a fact, or provides that a fact is presumed, the trier of fact must nd the existence of the fact unless and until evidence is introduced that supports a nding of its nonexistence.
Legislative Note: Former Section 1-206, a Statute of Frauds for sales of kinds of personal property not otherwise covered, has been deleted. The other articles of the Uniform Commercial Code make individual determinations as to requirements for memorializing transac27

 1-206

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tions within their scope, so that the primary eect of former Section 1-206 was to impose a writing requirement on sales transactions not otherwise governed by the UCC. Deletion of former Section 1-206 does not constitute a recommendation to legislatures as to whether such sales transactions should be covered by a Statute of Frauds; rather, it reects a determination that there is no need for uniform commercial law to resolve that issue.

Ocial Comment
Source: Former Section 1-201(31). Changes from former law. None, other than stylistic changes. 1. Several sections of the Uniform Commercial Code state that there is a presumption as to a certain fact, or that the fact is presumed. This section, derived from the denition appearing in former Section 1-201(31), indicates the eect of those provisions on the proof process.

PART 3. TERRITORIAL APPLICABILITY AND GENERAL RULES

1-301. Territorial Applicability; Parties' Power to Choose Applicable Law. (a) Except as otherwise provided in this section, when a transaction bears a reasonable relation to this state and also to another state or nation the parties may agree that the law either of this state or of such other state or nation shall govern their rights and duties. (b) In the absence of an agreement eective under subsection (a), and except as provided in subsection (c), [the Uniform Commercial Code] applies to transactions bearing an appropriate relation to this state. (c) If one of the following provisions of [the Uniform Commercial Code] species the applicable law, that provision governs and a contrary agreement is eective only to the extent permitted by the law so specied: (1) Section 2-402; (2) Sections 2A-105 and 2A-106; (3) Section 4-102; (4) Section 4A-507; (5) Section 5-116; [(6) Section 6-103;] (7) Section 8-110; (8) Sections 9-301 through 9-307. Ocial Comment
Source: Former Section 1-105. Changes from former law: This section is substantively identical to former Section 1-105. Changes in language are stylistic only. 1. Subsection (a) states armatively the right of the parties to a multi state transaction or a transaction involving foreign trade to choose their own law. That right is subject to the rm rules stated in the sections listed in subsection (c), and is limited to jurisdictions to which the transaction bears a reasonable relation. In general, the test of reasonable relation is similar to that laid down by the Supreme Court in Seeman v. Philadelphia Warehouse Co., 274 U.S. 403, 47 S.Ct. 626, 71 L.Ed. 1123 (1927). Ordinarily the law chosen must be that of a jurisdiction where a signicant enough portion of the making or performance of the contract is to occur or occurs. But an agreement as to choice of law may sometimes take eect as a shorthand expression of the intent of the parties as to matters governed by their agreement, even though the transaction has no signicant contact with the jurisdiction chosen. 28

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2. Where there is no agreement as to the governing law, the Act is applicable to any transaction having an appropriate relation to any state which enacts it. Of course, the Act applies to any transaction which takes place in its entirety in a state which has enacted the Act. But the mere fact that suit is brought in a state does not make it appropriate to apply the substantive law of that state. Cases where a relation to the enacting state is not appropriate include, for example, those where the parties have clearly contracted on the basis of some other law, as where the law of the place of contracting and the law of the place of contemplated performance are the same and are contrary to the law under the Code. 3. Where a transaction has signicant contacts with a state which has enacted the Act and also with other jurisdictions, the question what relation is appropriate is left to judicial decision. In deciding that question, the court is not strictly bound by precedents established in other contexts. Thus a conict of laws decision refusing to apply a purely local statute or rule of law to a particular multi state transaction may not be valid precedent for refusal to apply the Code in an analogous situation. Application of the Code in such circumstances may be justied by its comprehensiveness, by the policy of uniformity, and by the fact that it is in large part a reformulation and restatement of the law merchant and of the understanding of a business community which transcends state and even national boundaries. Compare Global Commerce Corp. v. Clark Babbitt Industries, Inc., 239 F.2d 716, 719 (2d Cir. 1956). In particular, where a transaction is governed in large part by the Code, application of another law to some detail of performance because of an accident of geography may violate the commercial understanding of the parties. 4. Subsection (c) spells out essential limitations on the parties right to choose the applicable law. Especially in Article 9 parties taking a security interest or asked to extend credit which may be subject to a security interest must have sure ways to nd out whether and where to le and where to look for possible existing lings. 5. Sections 9-301 through 9-307 should be consulted as to the rules for perfection of security interests and agricultural liens and the eect of perfection and nonperfection and priority. 6. This section is subject to Section 1-102, which states the scope of Article 1. As that section indicates, the rules of Article 1, including this section, apply to a transaction to the extent that transaction is governed by one of the other Articles of the Uniform Commercial Code.

1-302. Variation by Agreement. (a) Except as otherwise provided in subsection (b) or elsewhere in [the Uniform Commercial Code], the eect of provisions of [the Uniform Commercial Code] may be varied by agreement. (b) The obligations of good faith, diligence, reasonableness, and care prescribed by [the Uniform Commercial Code] may not be disclaimed by agreement. The parties, by agreement, may determine the standards by which the performance of those obligations is to be measured if those standards are not manifestly unreasonable. Whenever [the Uniform Commercial Code] requires an action to be taken within a reasonable time, a time that is not manifestly unreasonable may be xed by agreement. (c) The presence in certain provisions of [the Uniform Commercial Code] of the phrase unless otherwise agreed, or words of similar import, does not imply that the eect of other provisions may not be varied by agreement under this section. Ocial Comment
Source: Former Sections 1-102(3)-(4) and 1-204(1). Changes: This section combines the rules from subsections (3) and (4) of former Section 1-102 and subsection (1) of former Section 1-204. No substantive changes are made. 1. Subsection (a) states armatively at the outset that freedom of contract is a principle of the Uniform Commercial Code: the eect of its provisions may be varied by agreement. 29

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The meaning of the statute itself must be found in its text, including its denitions, and in appropriate extrinsic aids; it cannot be varied by agreement. But the Uniform Commercial Code seeks to avoid the type of interference with evolutionary growth found in pre-Code cases such as Manhattan Co. v. Morgan, 242 N.Y. 38, 150 N.E. 594 (1926). Thus, private parties cannot make an instrument negotiable within the meaning of Article 3 except as provided in Section 3-104; nor can they change the meaning of such terms as bona de purchaser, holder in due course, or due negotiation, as used in the Uniform Commercial Code. But an agreement can change the legal consequences that would otherwise ow from the provisions of the Uniform Commercial Code. Agreement here includes the eect given to course of dealing, usage of trade and course of performance by Sections 1-201 and 1-303; the eect of an agreement on the rights of third parties is left to specic provisions of the Uniform Commercial Code and to supplementary principles applicable under Section 1-103. The rights of third parties under Section 9-317 when a security interest is unperfected, for example, cannot be destroyed by a clause in the security agreement. This principle of freedom of contract is subject to specic exceptions found elsewhere in the Uniform Commercial Code and to the general exception stated here. The specic exceptions vary in explicitness: the statute of frauds found in Section 2-201, for example, does not explicitly preclude oral waiver of the requirement of a writing, but a fair reading denies enforcement to such a waiver as part of the contract made unenforceable; Section 9-602, on the other hand, is a quite explicit limitation on freedom of contract. Under the exception for the obligations of good faith, diligence, reasonableness and care prescribed by [the Uniform Commercial Code], provisions of the Uniform Commercial Code prescribing such obligations are not to be disclaimed. However, the section also recognizes the prevailing practice of having agreements set forth standards by which due diligence is measured and explicitly provides that, in the absence of a showing that the standards manifestly are unreasonable, the agreement controls. In this connection, Section 1-303 incorporating into the agreement prior course of dealing and usages of trade is of particular importance. Subsection (b) also recognizes that nothing is stronger evidence of a reasonable time than the xing of such time by a fair agreement between the parties. However, provision is made for disregarding a clause which whether by inadvertence or overreaching xes a time so unreasonable that it amounts to eliminating all remedy under the contract. The parties are not required to x the most reasonable time but may x any time which is not obviously unfair as judged by the time of contracting. 2. An agreement that varies the eect of provisions of the Uniform Commercial Code may do so by stating the rules that will govern in lieu of the provisions varied. Alternatively, the parties may vary the eect of such provisions by stating that their relationship will be governed by recognized bodies of rules or principles applicable to commercial transactions. Such bodies of rules or principles may include, for example, those that are promulgated by intergovernmental authorities such as UNCITRAL or Unidroit (see, e.g., Unidroit Principles of International Commercial Contracts), or non-legal codes such as trade codes. 3. Subsection (c) is intended to make it clear that, as a matter of drafting, phrases such as unless otherwise agreed have been used to avoid controversy as to whether the subject matter of a particular section does or does not fall within the exceptions to subsection (b), but absence of such words contains no negative implication since under subsection (b) the general and residual rule is that the eect of all provisions of the Uniform Commercial Code may be varied by agreement.

1-303. Course of Performance, Course of Dealing, and Usage of Trade. (a) A course of performance is a sequence of conduct between the parties to a particular transaction that exists if: (1) the agreement of the parties with respect to the transaction involves repeated occasions for performance by a party; and (2) the other party, with knowledge of the nature of the performance and opportunity for objection to it, accepts the performance or acquiesces in it without objection. (b) A course of dealing is a sequence of conduct concerning previous
30

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transactions between the parties to a particular transaction that is fairly to be regarded as establishing a common basis of understanding for interpreting their expressions and other conduct. (c) A usage of trade is any practice or method of dealing having such regularity of observance in a place, vocation, or trade as to justify an expectation that it will be observed with respect to the transaction in question. The existence and scope of such a usage must be proved as facts. If it is established that such a usage is embodied in a trade code or similar record, the interpretation of the record is a question of law. (d) A course of performance or course of dealing between the parties or usage of trade in the vocation or trade in which they are engaged or of which they are or should be aware is relevant in ascertaining the meaning of the parties' agreement, may give particular meaning to specic terms of the agreement, and may supplement or qualify the terms of the agreement. A usage of trade applicable in the place in which part of the performance under the agreement is to occur may be so utilized as to that part of the performance. (e) Except as otherwise provided in subsection (f), the express terms of an agreement and any applicable course of performance, course of dealing, or usage of trade must be construed whenever reasonable as consistent with each other. If such a construction is unreasonable: (1) express terms prevail over course of performance, course of dealing, and usage of trade; (2) course of performance prevails over course of dealing and usage of trade; and (3) course of dealing prevails over usage of trade. (f) Subject to Section 2-209 and Section 2A-208, a course of performance is relevant to show a waiver or modication of any term inconsistent with the course of performance. (g) Evidence of a relevant usage of trade oered by one party is not admissible unless that party has given the other party notice that the court nds sucient to prevent unfair surprise to the other party. Ocial Comment
Source: Former Sections 1-205, 2-208, and Section 2A-207. Changes from former law: This section integrates the course of performance concept from Articles 2 and 2A into the principles of former Section 1-205, which deals with course of dealing and usage of trade. In so doing, the section slightly modies the articulation of the course of performance rules to t more comfortably with the approach and structure of former Section 1-205. There are also slight modications to be more consistent with the definition of agreement in former Section 1-201(3). It should be noted that a course of performance that might otherwise establish a defense to the obligation of a party to a negotiable instrument is not available as a defense against a holder in due course who took the instrument without notice of that course of performance. 1. The Uniform Commercial Code rejects both the lay-dictionary and the conveyancer's reading of a commercial agreement. Instead the meaning of the agreement of the parties is to be determined by the language used by them and by their action, read and interpreted in the light of commercial practices and other surrounding circumstances. The measure and background for interpretation are set by the commercial context, which may explain and supplement even the language of a formal or nal writing. 2. Course of dealing, as dened in subsection (b), is restricted, literally, to a sequence of conduct between the parties previous to the agreement. A sequence of conduct after or 31

 1-303

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under the agreement, however, is a course of performance. Course of dealing may enter the agreement either by explicit provisions of the agreement or by tacit recognition. 3. The Uniform Commercial Code deals with usage of trade as a factor in reaching the commercial meaning of the agreement that the parties have made. The language used is to be interpreted as meaning what it may fairly be expected to mean to parties involved in the particular commercial transaction in a given locality or in a given vocation or trade. By adopting in this context the term usage of trade, the Uniform Commercial Code expresses its intent to reject those cases which see evidence of custom as representing an eort to displace or negate established rules of law. A distinction is to be drawn between mandatory rules of law such as the Statute of Frauds provisions of Article 2 on Sales whose very oce is to control and restrict the actions of the parties, and which cannot be abrogated by agreement, or by a usage of trade, and those rules of law (such as those in Part 3 of Article 2 on Sales) which ll in points which the parties have not considered and in fact agreed upon. The latter rules hold unless otherwise agreed but yield to the contrary agreement of the parties. Part of the agreement of the parties to which such rules yield is to be sought for in the usages of trade which furnish the background and give particular meaning to the language used, and are the framework of common understanding controlling any general rules of law which hold only when there is no such understanding. 4. A usage of trade under subsection (c) must have the regularity of observance specied. The ancient English tests for custom are abandoned in this connection. Therefore, it is not required that a usage of trade be ancient or immemorial, universal, or the like. Under the requirement of subsection (c) full recognition is thus available for new usages and for usages currently observed by the great majority of decent dealers, even though dissidents ready to cut corners do not agree. There is room also for proper recognition of usage agreed upon by merchants in trade codes. 5. The policies of the Uniform Commercial Code controlling explicit unconscionable contracts and clauses (Sections 1-304, 2-302) apply to implicit clauses that rest on usage of trade and carry forward the policy underlying the ancient requirement that a custom or usage must be reasonable. However, the emphasis is shifted. The very fact of commercial acceptance makes out a prima facie case that the usage is reasonable, and the burden is no longer on the usage to establish itself as being reasonable. But the anciently established policing of usage by the courts is continued to the extent necessary to cope with the situation arising if an unconscionable or dishonest practice should become standard. 6. Subsection (d), giving the prescribed eect to usages of which the parties are or should be aware, reinforces the provision of subsection (c) requiring not universality but only the described regularity of observance of the practice or method. This subsection also reinforces the point of subsection (c) that such usages may be either general to trade or particular to a special branch of trade. 7. Although the denition of agreement in Section 1-201 includes the elements of course of performance, course of dealing, and usage of trade, the fact that express reference is made in some sections to those elements is not to be construed as carrying a contrary intent or implication elsewhere. Compare Section 1-302(c). 8. In cases of a well established line of usage varying from the general rules of the Uniform Commercial Code where the precise amount of the variation has not been worked out into a single standard, the party relying on the usage is entitled, in any event, to the minimum variation demonstrated. The whole is not to be disregarded because no particular line of detail has been established. In case a dominant pattern has been fairly evidenced, the party relying on the usage is entitled under this section to go to the trier of fact on the question of whether such dominant pattern has been incorporated into the agreement. 9. Subsection (g) is intended to insure that this Act's liberal recognition of the needs of commerce in regard to usage of trade shall not be made into an instrument of abuse.

1-304. Obligation of Good Faith. Every contract or duty within [the Uniform Commercial Code] imposes an obligation of good faith in its performance and enforcement. Ocial Comment
Source: Former Section 1-203. Changes from former law: Except for changing the form of reference to the Uniform 32

Art. 1

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1-306

Commercial Code, this section is identical to former Section 1-203. 1. This section sets forth a basic principle running throughout the Uniform Commercial Code. The principle is that in commercial transactions good faith is required in the performance and enforcement of all agreements or duties. While this duty is explicitly stated in some provisions of the Uniform Commercial Code, the applicability of the duty is broader than merely these situations and applies generally, as stated in this section, to the performance or enforcement of every contract or duty within this Act. It is further implemented by Section 1-303 on course of dealing, course of performance, and usage of trade. This section does not support an independent cause of action for failure to perform or enforce in good faith. Rather, this section means that a failure to perform or enforce, in good faith, a specic duty or obligation under the contract, constitutes a breach of that contract or makes unavailable, under the particular circumstances, a remedial right or power. This distinction makes it clear that the doctrine of good faith merely directs a court towards interpreting contracts within the commercial context in which they are created, performed, and enforced, and does not create a separate duty of fairness and reasonableness which can be independently breached. 2. Performance and enforcement of contracts and duties within the Uniform Commercial Code include the exercise of rights created by the Uniform Commercial Code.

1-305. Remedies to Be Liberally Administered. (a) The remedies provided by [the Uniform Commercial Code] must be liberally administered to the end that the aggrieved party may be put in as good a position as if the other party had fully performed but neither consequential or special damages nor penal damages may be had except as specically provided in [the Uniform Commercial Code] or by other rule of law. (b) Any right or obligation declared by [the Uniform Commercial Code] is enforceable by action unless the provision declaring it species a dierent and limited eect. Ocial Comment
Source: Former Section 1-106. Changes from former law: Other than changes in the form of reference to the Uniform Commercial Code, this section is identical to former Section 1-106. 1. Subsection (a) is intended to eect three propositions. The rst is to negate the possibility of unduly narrow or technical interpretation of remedial provisions by providing that the remedies in the Uniform Commercial Code are to be liberally administered to the end stated in this section. The second is to make it clear that compensatory damages are limited to compensation. They do not include consequential or special damages, or penal damages; and the Uniform Commercial Code elsewhere makes it clear that damages must be minimized. Cf. Sections 1-304, 2-706(1), and 2-712(2). The third purpose of subsection (a) is to reject any doctrine that damages must be calculable with mathematical accuracy. Compensatory damages are often at best approximate: they have to be proved with whatever deniteness and accuracy the facts permit, but no more. Cf. Section 2-204(3). 2. Under subsection (b), any right or obligation described in the Uniform Commercial Code is enforceable by action, even though no remedy may be expressly provided, unless a particular provision species a dierent and limited eect. Whether specic performance or other equitable relief is available is determined not by this section but by specic provisions and by supplementary principles. Cf. Sections 1-103, 2-716. 3. Consequential or special damages and penal damages are not dened in the Uniform Commercial Code; rather, these terms are used in the sense in which they are used outside the Uniform Commercial Code.

1-306. Waiver or Renunciation of Claim or Right After Breach. A claim or right arising out of an alleged breach may be discharged in whole or in part without consideration by agreement of the aggrieved party in an authenticated record.
33

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Ocial Comment
Source: Former Section 1-107. Changes from former law: This section changes former law in two respects. First, former Section 1-107, requiring the delivery of a written waiver or renunciation merges the separate concepts of the aggrieved party's agreement to forego rights and the manifestation of that agreement. This section separates those concepts, and explicitly requires agreement of the aggrieved party. Second, the revised section reects developments in electronic commerce by providing for memorialization in an authenticated record. In this context, a party may authenticate a record by (i) signing a record that is a writing or (ii) attaching to or logically associating with a record that is not a writing an electronic sound, symbol or process with the present intent to adopt or accept the record. See Sections 1-201(b)(37) and 9-102(a)(7). 1. This section makes consideration unnecessary to the eective renunciation or waiver of rights or claims arising out of an alleged breach of a commercial contract where the agreement eecting such renunciation is memorialized in a record authenticated by the aggrieved party. Its provisions, however, must be read in conjunction with the section imposing an obligation of good faith. (Section 1-304).

1-307. Prima Facie Evidence by Third-Party Documents. A document in due form purporting to be a bill of lading, policy or certificate of insurance, ocial weigher's or inspector's certicate, consular invoice, or any other document authorized or required by the contract to be issued by a third party is prima facie evidence of its own authenticity and genuineness and of the facts stated in the document by the third party. Ocial Comment
Source: Former Section 1-202. Changes from former law: Except for minor stylistic changes, this Section is identical to former Section 1-202. 1. This section supplies judicial recognition for documents that are relied upon as trustworthy by commercial parties. 2. This section is concerned only with documents that have been given a preferred status by the parties themselves who have required their procurement in the agreement, and for this reason the applicability of the section is limited to actions arising out of the contract that authorized or required the document. The list of documents is intended to be illustrative and not exclusive. 3. The provisions of this section go no further than establishing the documents in question as prima facie evidence and leave to the court the ultimate determination of the facts where the accuracy or authenticity of the documents is questioned. In this connection the section calls for a commercially reasonable interpretation. 4. Documents governed by this section need not be writings if records in another medium are generally relied upon in the context.

1-308. Performance or Acceptance Under Reservation of Rights. (a) A party that with explicit reservation of rights performs or promises performance or assents to performance in a manner demanded or oered by the other party does not thereby prejudice the rights reserved. Such words as without prejudice, under protest, or the like are sucient. (b) Subsection (a) does not apply to an accord and satisfaction. Ocial Comment
Source: Former Section 1-207. Changes from former law: This section is identical to former Section 1-207. 1. This section provides machinery for the continuation of performance along the lines contemplated by the contract despite a pending dispute, by adopting the mercantile device of going ahead with delivery, acceptance, or payment without prejudice, under protest, 34

Art. 1

General Provisions

1-310

under reserve, with reservation of all our rights, and the like. All of these phrases completely reserve all rights within the meaning of this section. The section therefore contemplates that limited as well as general reservations and acceptance by a party may be made subject to satisfaction of our purchaser, subject to acceptance by our customers, or the like. 2. This section does not add any new requirement of language of reservation where not already required by law, but merely provides a specic measure on which a party can rely as that party makes or concurs in any interim adjustment in the course of performance. It does not aect or impair the provisions of this Act such as those under which the buyer's remedies for defect survive acceptance without being expressly claimed if notice of the defects is given within a reasonable time. Nor does it disturb the policy of those cases which restrict the eect of a waiver of a defect to reasonable limits under the circumstances, even though no such reservation is expressed. The section is not addressed to the creation or loss of remedies in the ordinary course of performance but rather to a method of procedure where one party is claiming as of right something which the other believes to be unwarranted. 3. Subsection (b) states that this section does not apply to an accord and satisfaction. Section 3-311 governs if an accord and satisfaction is attempted by tender of a negotiable instrument as stated in that section. If Section 3-311 does not apply, the issue of whether an accord and satisfaction has been eected is determined by the law of contract. Whether or not Section 3-311 applies, this section has no application to an accord and satisfaction.

1-309. Option to Accelerate at Will. A term providing that one party or that party's successor in interest may accelerate payment or performance or require collateral or additional collateral at will or when the party deems itself insecure, or words of similar import, means that the party has power to do so only if that party in good faith believes that the prospect of payment or performance is impaired. The burden of establishing lack of good faith is on the party against which the power has been exercised. Ocial Comment
Source: Former Section 1-208. Changes from former law: Except for minor stylistic changes, this section is identical to former Section 1-208. 1. The common use of acceleration clauses in many transactions governed by the Uniform Commercial Code, including sales of goods on credit, notes payable at a denite time, and secured transactions, raises an issue as to the eect to be given to a clause that seemingly grants the power to accelerate at the whim and caprice of one party. This section is intended to make clear that despite language that might be so construed and which further might be held to make the agreement void as against public policy or to make the contract illusory or too indenite for enforcement, the option is to be exercised only in the good faith belief that the prospect of payment or performance is impaired. Obviously this section has no application to demand instruments or obligations whose very nature permits call at any time with or without reason. This section applies only to an obligation of payment or performance which in the rst instance is due at a future date.

1-310. Subordinated Obligations. An obligation may be issued as subordinated to performance of another obligation of the person obligated, or a creditor may subordinate its right to performance of an obligation by agreement with either the person obligated or another creditor of the person obligated. Subordination does not create a security interest as against either the common debtor or a subordinated creditor. Ocial Comment
Source: Former Section 1-209. Changes from former law: This section is substantively identical to former Section 35

 1-310

Uniform Commercial Code

Art. 1

1-209. The language in that section stating that it shall be construed as declaring the law as it existed prior to the enactment of this section and not as modifying it has been deleted. 1. Billions of dollars of subordinated debt are held by the public and by institutional investors. Commonly, the subordinated debt is subordinated on issue or acquisition and is evidenced by an investment security or by a negotiable or non-negotiable note. Debt is also sometimes subordinated after it arises, either by agreement between the subordinating creditor and the debtor, by agreement between two creditors of the same debtor, or by agreement of all three parties. The subordinated creditor may be a stockholder or other insider interested in the common debtor; the subordinated debt may consist of accounts or other rights to payment not evidenced by any instrument. All such cases are included in the terms subordinated obligation, subordination, and subordinated creditor. 2. Subordination agreements are enforceable between the parties as contracts; and in the bankruptcy of the common debtor dividends otherwise payable to the subordinated creditor are turned over to the superior creditor. This turn-over practice has on occasion been explained in terms of equitable lien, equitable assignment, or constructive trust, but whatever the label the practice is essentially an equitable remedy and does not mean that there is a transaction that creates a security interest in personal property . . . by contract or a sale of accounts, chattel paper, payment intangibles, or promissory notes within the meaning of Section 9-109. On the other hand, nothing in this section prevents one creditor from assigning his rights to another creditor of the same debtor in such a way as to create a security interest within Article 9, where the parties so intend. 3. The enforcement of subordination agreements is largely left to supplementary principles under Section 1-103. If the subordinated debt is evidenced by a certicated security, Section 8-202(a) authorizes enforcement against purchasers on terms stated or referred to on the security certicate. If the fact of subordination is noted on a negotiable instrument, a holder under Sections 3-302 and 3-306 is subject to the term because notice precludes him from taking free of the subordination. Sections 3-302(3)(a), 3-306, and 8-317 severely limit the rights of levying creditors of a subordinated creditor in such cases.

APPENDIX I. CONFORMING AMENDMENTS TO OTHER ARTICLES

36

2-103. Denitions and Index of Denitions. 2-202. Final Written Expression: Parol or Extrinsic Evidence. 2-208. Course of Performance or Practical Construction. 2A-103. Denitions and Index of Denitions. 2A-207. Course of Performance or Practical Construction. 2A-501. Default: Procedure. 2A-518. Cover; Substitute Goods. 2A-519. Lessee's Damages for Non-Delivery, Repudiation, Default, and Breach of Warranty in Regard to Accepted Goods. 2A-527. Lessor's Rights to Dispose of Goods. 2A-528. Lessor's Damages for Non-Acceptance, Failure to Pay, Repudiation, or Other Default. 3-103. Denitions. 4-104. Denitions and Index of Denitions. 4A-105. Other Denitions. 4A-106. Time Payment Order is Received. 4A-204. Refund of Payment and Duty of Customer to Report with Respect to Unauthorized Payment Order. 5-103. Scope. 8-102. Denitions. 9-102. Denitions and Index of Denitions.

Art. 1

General Provisions

App. I
2-208

2-103. Denitions and Index of Denitions. (1) In this Article unless the context otherwise requires (a) Buyer means a person who buys or contracts to buy goods. (b) [Reserved.] Good faith in the case of a merchant means honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade. (c) Receipt of goods means taking physical possession of them. (d) Seller means a person who sells or contracts to sell goods. * * * 2-202. Final Written Expression: Parol or Extrinsic Evidence. Terms with respect to which the conrmatory memoranda of the parties agree or which are otherwise set forth in a writing intended by the parties as a nal expression of their agreement with respect to such terms as are included therein may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be explained or supplemented (a) by course of performance, course of dealing, or usage of trade (Section 1-205 1-303) or by course of performance (Section 2-208); and (b) by evidence of consistent additional terms unless the court nds the writing to have been intended also as a complete and exclusive statement of the terms of the agreement. Ocial Comment * * *
Cross References: Point 3: Sections 1-205 1-303, 2-207, 2-302 and 2-316. Denitional Cross References: Agreed and agreement. Section 1-201. Course of dealing. Section 1-205 1-303. Course of performance. Section 1-303. Partyies. Section 1-201. Term. Section 1-201. Usage of trade. Section 1-205 1-303. Written and writing. Section 1-201.

2-208. Course of Performance or Practical Construction. (1) Where the contract for sale involves repeated occasions for performance by either party with knowledge of the nature of the performance and opportunity for objection to it by the other, any course of performance accepted or acquiesced in without objection shall be relevant to determine the meaning of the agreement. (2) The express terms of the agreement and any such course of performance, as well as any course of dealing and usage of trade, shall be construed whenever reasonable as consistent with each other; but when such construction is unreasonable, express terms shall control course of performance and course of performance shall control both course of dealing and usage of trade (Section 1-205). (3) Subject to the provisions of the next section on modication and waiver, such course of performance shall be relevant to show a waiver or modication of any term inconsistent with such course of performance.
37

App. I
2-208

Uniform Commercial Code

Art. 1

Ocial Comment
Prior Uniform Statutory Provision: No such general provision but concept of this section recognized by terms such as course of dealing, the circumstances of the case, the conduct of the parties, etc., in Uniform Sales Act. Purposes: 1. The parties themselves know best what they have meant by their words of agreement and their action under that agreement is the best indication of what that meaning was. This section thus rounds out the set of factors which determines the meaning of the agreement and therefore also of the unless otherwise agreed qualication to various provisions of this Article. 2. Under this section a course of performance is always relevant to determine the meaning of the agreement. Express mention of course of performance elsewhere in this Article carries no contrary implication when there is a failure to refer to it in other sections. 3. Where it is dicult to determine whether a particular act merely sheds light on the meaning of the agreement or represents a waiver of a term of the agreement, the preference is in favor of waiver whenever such construction, plus the application of the provisions on the reinstatement of rights waived (see Section 2-209), is needed to preserve the exible character of commercial contracts and to prevent surprise or other hardship. 4. A single occasion of conduct does not fall within the language of this section but other sections such as the ones on silence after acceptance and failure to specify particular defects can aect the parties' rights on a single occasion (see Sections 2-605 and 2-607). Cross References: Point 1: Section 1-201. Point 2: Section 2-202. Point 3: Sections 2-209, 2-601 and 2-607. Point 4: Sections 2-605 and 2-607.

2A-103. Denitions and Index of Denitions. * * * (3) The following denitions in other Articles apply to this Article: Account. Section 9-102(a)(2). Between merchants. Section 2-104(3). Buyer. Section 2-103(1)(a). Chattel paper. Section 9-102(a)(11). Consumer goods. Section 9-102(a)(23). Document. Section 9-102(a)(30). Entrusting. Section 2-403(3). General intangible. Section 9-102(a)(42). Good faith. Section 2-103(1)(b). Instrument. Section 9-102(a)(47). Merchant. Section 2-104(1). Mortgage. Section 9-102(a)(55). Pursuant to commitment. Section 9-102(a)(68). Receipt. Section 2-103(1)(c). Sale. Section 2-106(1). Sale on approval. Section 2-326. Sale or return. Section 2-326. Seller. Section 2-103(1)(d). * * *
38

Art. 1

General Provisions

App. I
2A-103

Ocial Comment
(a) Buyer in ordinary course of business. Section 1-201(b)(9).

* * *
(h) Goods. Section 9-105(1)(h) 9-102(a)(44). See Section 2A-103(3) for reference to the denition of Account, Chattel paper, Document, General intangibles and Instrument. See Section 2A-217 for determination of the time and manner of identication.

* * *
(j) Lease. New. There are several reasons to codify the law with respect to leases of goods. An analysis of the case law as it applies to leases of goods suggests at least several signicant issues to be resolved by codication. First and foremost is the denition of a lease. It is necessary to dene lease to determine whether a transaction creates a lease or a security interest disguised as a lease. If the transaction creates a security interest disguised as a lease, the transaction will be governed by the Article on Secured Transactions (Article 9) and the lessor will be required to le a nancing statement or take other action to perfect its interest in the goods against third parties. There is no such requirement with respect to leases under the common law and, except with respect to leases of xtures (Section 2A-309), this Article imposes no such requirement. Yet the distinction between a lease and a security interest disguised as a lease is not clear from the case law at the time of the promulgation of this Article. DeKoven, Leases of Equipment: Puritan Leasing Company v. August, A Dangerous Decision, 12 U.S.F. L.Rev. 257 (1978). At common law a lease of personal property is a bailment for hire. While there are several denitions of bailment for hire, all require a thing to be let and a price for the letting. Thus, in modern terms and as provided in this denition, a lease is created when the lessee agrees to furnish consideration for the right to the possession and use of goods over a specied period of time. Mooney, Personal Property Leasing: A Challenge, 36 Bus.Law. 1605, 1607 (1981). Further, a lease is neither a sale (Section 2-106(1)) nor a retention or creation of a security interest (Sections 1-201(37)(b)(35) and 1-203). Due to extensive litigation to distinguish true leases from security interests, an amendment to former Section 1-201(37) (now codied as Section 1-203) was has been promulgated with this Article to create a sharper distinction. This section as well as Section 1-201(37) 1-203 must be examined to determine whether the transaction in question creates a lease or a security interest. The following hypotheticals indicate the perimeters of the issue. Assume that A has purchased a number of copying machines, new, for $1,000 each; the machines have an estimated useful economic life of three years. A advertises that the machines are available to rent for a minimum of one month and that the monthly rental is $100.00. A intends to enter into leases where A provides all maintenance, without charge to the lessee. Further, the lessee will rent the machine, month to month, with no obligation to renew. At the end of the lease term the lessee will be obligated to return the machine to A's place of business. This transaction qualies as a lease under the rst half of the denition, for the transaction includes a transfer by A to a prospective lessee of possession and use of the machine for a stated term, month to month. The machines are goods (Section 2A-103(1)(h)). The lessee is obligated to pay consideration in return, $100.00 for each month of the term. However, the second half of the denition provides that a sale or a security interest is not a lease. Since there is no passing of title, there is no sale. Sections 2A-103(3) and 2-106(1). Under pre-Act security law this transaction would have created a bailment for hire or a true lease and not a conditional sale. Da Rocha v. Macomber, 330 Mass. 611, 61415, 116 N.E.2d 139, 142 (1953). Under Section 1-201(37) 1-203, as amended with the promulgation of this Article, the same result would follow. While the lessee is obligated to pay rent for the one month term of the lease, one of the other four conditions of the second paragraph of Section 1-201(37) Section 1-203(b) must be met and none is. The term of the lease is one month and the economic life of the machine is 36 months; thus, subparagraph (a) of Section 1-201(37) Section 1-203(b)(1) is not now satised. Considering the amount of the monthly rent, absent economic duress or coercion, the lessee is not bound either to renew the lease for the remaining economic life of the goods or to become the owner. If the lessee did lease the machine for 36 months, the lessee would have paid the lessor $3,600 for a machine that could have been purchased for $1,000; thus, subparagraph (b) of Section 1-201(37) Section 1-203(b)(2) is not satised. Finally, there are no options; thus, subparagraphs (c3) and (d4) of Section 1-201(37) 1-203(b) are not satised. This transaction creates a lease, not a secu39

App. I
2A-103

Uniform Commercial Code

Art. 1

rity interest. However, with each renewal of the lease the facts and circumstances at the time of each renewal must be examined to determine if that conclusion remains accurate, as it is possible that a transaction that rst creates a lease, later creates a security interest. Assume that the facts are changed and that A requires each lessee to lease the goods for 36 months, with no right to terminate. Under pre-Act security law this transaction would have created a conditional sale, and not a bailment for hire or true lease. Hervey v. Rhode Island Locomotive Works, 93 U.S. 664, 67273 (1876). Under this subsection, and Section 1-203 1-201(37), as amended with the inclusion of this Article in the Act, the same result would follow. The lessee's obligation for the term is not subject to termination by the lessee and the term is equal to the economic life of the machine. Between these extremes there are many transactions that can be created. Some of the transactions have were not been properly categorized by the courts in applying the 1978 and earlier Ocial Texts of former Section 1-201(37). This subsection, together with Section 1-203 1-201(37), as amended with the promulgation of this Article, draws a brighter line, which should create a clearer signal to the professional lessor and lessee. (k) Lease agreement. This denition is derived from the rst sentence of Section 1-201(b)(3). Because the denition of lease is broad enough to cover future transfers, lease agreement includes an agreement contemplating a current or subsequent transfer. Thus it was not necessary to make an express reference to an agreement for the future lease of goods (Section 2-106(1)). This concept is also incorporated in the denition of lease contract. Note that the denition of lease does not include transactions in ordinary building materials that are incorporated into an improvement on land. Section 2A-309(2). The provisions of this Article, if applicable, determine whether a lease agreement has legal consequences; otherwise the law of bailments and other applicable law determine the same. Sections 2A-103(4) and 1-103. (l) Lease contract. This denition is derived from the denition of contract in Section 1-201(11)(b)(12). Note that a lease contract may be for the future lease of goods, since this notion is included in the denition of lease.

* * *
(o) Lessee in ordinary course of business. Section 1-201(b)(9).

* * *
(u) Present value. New. Authorities agree that present value should be used to determine fairly the damages payable by the lessor or the lessee on default. E.g., Taylor v. Commercial Credit Equip. Corp., 170 Ga.App. 322, 316 S.E.2d 788 (1984). Present value is dened to mean an amount that represents the discounted value as of a date certain of one or more sums payable in the future. This is a function of the economic principle that a dollar today is more valuable to the holder than a dollar payable in two years. While there is no question as to the principle, reasonable people would dier as to the rate of discount to apply in determining the value of that future dollar today. To minimize litigation, this Article allows the parties to specify the discount or interest rate, if the rate was not manifestly unreasonable at the time the transaction was entered into. In all other cases, the interest rate will be a commercially reasonable rate that takes into account the facts and circumstances of each case, as of the time the transaction was entered into. (v) Purchase. Section 1-201(32)(b)(29). This denition omits the reference to lien contained in the denition of purchase in Article 1 (Section 1-201(32)(b)(29)). This should not be construed to exclude consensual liens from the denition of purchase in this Article; the exclusion was mandated by the scope of the denition of lien in Section 2A-103(1)(r). Further, the denition of purchaser in this Article adds a reference to lease; as purchase is dened in Section 1-201(32)(b)(29) to include any other voluntary transaction creating an interest in property, this addition is not substantive.

* * * 2A-207. Course of Performance or Practical Construction. (1) If a lease contract involves repeated occasions for performance by either party with knowledge of the nature of the performance and opportunity for objection to it by the other, any course of performance accepted or acquiesced in without objection is relevant to determine the meaning of the lease agreement.
40

Art. 1

General Provisions

App. I
2A-501

(2) The express terms of a lease agreement and any course of performance, as well as any course of dealing and usage of trade, must be construed whenever reasonable as consistent with each other; but if that construction is unreasonable, express terms control course of performance, course of performance controls both course of dealing and usage of trade, and course of dealing controls usage of trade. (3) Subject to the provisions of Section 2A-208 on modication and waiver, course of performance is relevant to show a waiver or modication of any term inconsistent with the course of performance. Ocial Comment
Uniform Statutory Source: Sections 2-208 and 1-205(4). Changes: Revised to reect leasing practices and terminology, except that subsection (2) was further revised to make the subsection parallel the provisions of Section 1-205(4) by adding that course of dealing controls usage of trade. Purposes: The section should be read in conjunction with Section 2A-208. In particular, although a specic term may control over course of performance as a matter of lease construction under subsection (2), subsection (3) allows the same course of dealing to show a waiver or modication, if Section 2A-208 is satised. Cross References: Sections 1-205(4), 2-208 and 2A-208. Denitional Cross References: Course of dealing. Section 1-205. Knowledge. Section 1-201(25). Lease agreement. Section 2A-103(1)(k). Lease contract. Section 2A-103(1)(l). Party. Section 1-201(29). Term. Section 1-201(42). Usage of trade. Section 1-205.

2A-501. Default: Procedure. * * * (4) Except as otherwise provided in Section 1-106(1) 1-305(a) or this Article or the lease agreement, the rights and remedies referred to in subsections (2) and (3) are cumulative. * * * Ocial Comment
Uniform Statutory Source: Former Section 9-501 (now codied as Sections 9-601 through 9-604).

* * *
2. Subsection (2) is a version of the rst sentence of Section 9-501(1) 9-601(a), revised to reect leasing terminology. 3. Subsection (3), an expansive version of the second sentence of Section 9-501(1) 9-601(a), lists the procedures that may be followed by the party seeking enforcement; in eect, the scope of the procedures listed in subsection (3) is consistent with the scope of the procedures available to the foreclosing secured party. 4. Subsection (4) establishes that the parties' rights and remedies are cumulative. DeKoven, Leases of Equipment: Puritan Leasing Company v. August, A Dangerous Decision, 12 U.S.F.L.Rev. 257, 27680 (1978). Cumulation, and largely unrestricted selection, of remedies is allowed in furtherance of the general policy of the Commercial Code, stated in Section 1-106 1-305, that remedies be liberally administered to put the aggrieved party in as good a position as if the other party had fully performed. Therefore, cumulation of, or selection among, remedies is available to the extent necessary to put the aggrieved party in as good a position as it would have been in had there been full performance. However, cumula41

App. I
2A-501

Uniform Commercial Code

Art. 1

tion of, or selection among, remedies is not available to the extent that the cumulation or selection would put the aggrieved party in a better position than it would have been in had there been full performance by the other party. 5. Section 9-501(3) 9-602, which, among other things, states that certain rules, to the extent they give rights to the debtor and impose duties on the secured party, may not be waived or varied, was is not incorporated in this Article. Given the signicance of freedom of contract in the development of the common law as it applies to bailments for hire and the lessee's lack of an equity of redemption, there was is no reason to impose that restraint. Cross References: Sections 1-106 1-305, 2A-508, 2A-523, Article 9, especially Sections 9-501(1) 9-601 and 9-501(3) 9-602. Denitional Cross References:

* * *
Party. Section 1-201(29)(b)(26). Remedy. Section 1-201(34)(b)(32). Rights. Section 1-201(36)(b)(34).

2A-518. Cover; Substitute Goods. * * * (2) Except as otherwise provided with respect to damages liquidated in the lease agreement (Section 2A-504) or otherwise determined pursuant to agreement of the parties (Sections 1-102(3) 1-302 and 2A-503), if a lessee's cover is by a lease agreement substantially similar to the original lease agreement and the new lease agreement is made in good faith and in a commercially reasonable manner, the lessee may recover from the lessor as damages (i) the present value, as of the date of the commencement of the term of the new lease agreement, of the rent under the new lease agreement applicable to that period of the new lease term which is comparable to the then remaining term of the original lease agreement minus the present value as of the same date of the total rent for the then remaining lease term of the original lease agreement, and (ii) any incidental or consequential damages, less expenses saved in consequence of the lessor's default. * * * Ocial Comment * * *
1. Subsection (1) allows the lessee to take action to x its damages after default by the lessor. Such action may consist of the lease of goods. The decision to cover is a function of commercial judgment, not a statutory mandate replete with sanctions for failure to comply. Cf. Section 9-507 9-625. Cross References: Sections 2-712(1), 2A-519 and 9-507 9-625. Denitional Cross References: Agreement. Section 1-201(b)(3). Contract. Section 1-201(11)(b)(12). Good faith. Sections 1-201(b)(20) 1-201(19) and 2-103(1)(b). Goods. Section 2A-103(1)(h). Lease. Section 2A-103(1)(j). Lease agreement. Section 2A-103(1)(k). Lease contract. Section 2A-103(1)(l). Lessee. Section 2A-103(1)(n). Lessor. Section 2A-103(1)(p). Party. Section 1-201(29)(b)(26). 42

Art. 1

General Provisions

App. I
2A-527

Present value. Section 2A-103(1)(u) 1-201(b)(28). Purchase. Section 2A-103(1)(v).

2A-519. Lessee's Damages for Non-Delivery, Repudiation, Default, and Breach of Warranty in Regard to Accepted Goods. (1) Except as otherwise provided with respect to damages liquidated in the lease agreement (Section 2A-504) or otherwise determined pursuant to agreement of the parties (Sections 1-102(3) 1-302 and 2A-503), if a lessee elects not to cover or a lessee elects to cover and the cover is by lease agreement that for any reason does not qualify for treatment under Section 2A-518(2), or is by purchase or otherwise, the measure of damages for nondelivery or repudiation by the lessor or for rejection or revocation of acceptance by the lessee is the present value, as of the date of the default, of the then market rent minus the present value as of the same date of the original rent, computed for the remaining lease term of the original lease agreement, together with incidental and consequential damages, less expenses saved in consequence of the lessor's default. * * * Ocial Comment * * *
Denitional Cross References: Conforming. Section 2A-103(1)(d). Delivery. Section 1-201(14)(b)(15). Goods. Section 2A-103(1)(h). Lease. Section 2A-103(1)(j). Lease agreement. Section 2A-103(1)(k). Lessee. Section 2A-103(1)(n). Lessor. Section 2A-103(1)(p). Notication. Section 1-201(26) 1-202. Present value. Section 2A-103(1)(u) 1-201(b)(28). Value. Section 1-201(44) 1-204.

2A-527. Lessor's Rights to Dispose of Goods. * * * (2) Except as otherwise provided with respect to damages liquidated in the lease agreement (Section 2A-504) or otherwise determined pursuant to agreement of the parties (Sections 1-102(3) 1-302 and 2A-503), if the disposition is by lease agreement substantially similar to the original lease agreement and the new lease agreement is made in good faith and in a commercially reasonable manner, the lessor may recover from the lessee as damages (i) accrued and unpaid rent as of the date of the commencement of the term of the new lease agreement, (ii) the present value, as of the same date, of the total rent for the then remaining lease term of the original lease agreement minus the present value, as of the same date, of the rent under the new lease agreement applicable to that period of the new lease term which is comparable to the then remaining term of the original lease agreement, and (iii) any incidental damages allowed under Section 2A-530, less expenses saved in consequence of the lessee's default. * * *
43

App. I
2A-527

Uniform Commercial Code

Art. 1

Ocial Comment * * *
1. Subsection (1), a revised version of the rst sentence of subsection 2-706(1), allows the lessor the right to dispose of goods after a statutory or other material default by the lessee (even if the goods remain in the lessee's possessionSection 2A-525(2)), after the lessor refuses to deliver or takes possession of the goods, or, if agreed, after other contractual default. The lessor's decision to exercise this right is a function of a commercial judgment, not a statutory mandate replete with sanctions for failure to comply. Cf. Section 9-507 9-625. As the owner of the goods, in the case of a lessor, or as the prime lessee of the goods, in the case of a sublessor, compulsory disposition of the goods is inconsistent with the nature of the interest held by the lessor or the sublessor and is not necessary because the interest held by the lessee or the sublessee is not protected by a right of redemption under the common law or this Article. Subsection 2A-527(5). 2. The rule for determining the measure of damages recoverable by the lessor against the lessee is a function of several variables. If the lessor has elected to eect disposition under subsection (1) and such disposition is by lease that qualies under subsection (2), the measure of damages set forth in subsection (2) will apply, absent agreement to the contrary. Sections 2A-504, 2A-103(4) and 1-102(3) 1-302.

* * *
Cross References: Sections 1-102(3) 1-302, 2-706(1), 2-706(5), 2-706(6), 2A-103(4), 2A-304(1), 2A-504, 2A507(2), 2A-523(1)(e), 2A-525(2), 2A-527(5), 2A-528 and 9-507 9-625. Denitional Cross References: Buyer and Buying. Section 2-103(1)(a). Delivery. Section 1-201(14)(b)(15). Good faith. Sections 1-201(b)(20)1-201(19) and 2-103(1)(b). Goods. Section 2A-103(1)(h). Lease. Section 2A-103(1)(j). Lease contract. Section 2A-103(1)(l). Lessee. Section 2A-103(1)(n). Lessor. Section 2A-103(1)(p). Present value. Section 2A-103(1)(u) 1-201(b)(28). Rights. Section 1-201(36)(b)(34). Sale. Section 2-106(1). Security interest. Sections 1-201(37)(b)(35) and 1-203. Value. Section 1-201(44) 1-204.

2A-528. Lessor's Damages for Non-Acceptance, Failure to Pay, Repudiation, or Other Default. (1) Except as otherwise provided with respect to damages liquidated in the lease agreement (Section 2A-504) or otherwise determined pursuant to agreement of the parties (Sections 1-102(3) 1-302 and 2A-503), if a lessor elects to retain the goods or a lessor elects to dispose of the goods and the disposition is by lease agreement that for any reason does not qualify for treatment under Section 2A-527(2), or is by sale or otherwise, the lessor may recover from the lessee as damages for a default of the type described in Section 2A-523(1) or 2A-523(3)(a), or, if agreed, for other default of the lessee, (i) accrued and unpaid rent as of the date of default if the lessee has never taken possession of the goods, or, if the lessee has taken possession of the goods, as of the date the lessor repossesses the goods or an earlier date on which the lessee makes a tender of the goods to the lessor, (ii) the present value as of the date determined under clause (i) of the total rent for the then remaining lease term of the original lease agreement minus the present value as of the same date of the market rent at the
44

Art. 1

General Provisions

App. I
3-103

place where the goods are located computed for the same lease term, and (iii) any incidental damages allowed under Section 2A-530, less expenses saved in consequence of the lessee's default. * * * Ocial Comment * * *
1. Subsection (1), a substantially revised version of Section 2-708(1), states the basic rule governing the measure of lessor's damages for a default described in Section 2A-523(1) or (3)(a), and, if agreed, for a contractual default. This measure will apply if the lessor elects to retain the goods (whether undelivered, returned by the lessee, or repossessed by the lessor after acceptance and default by the lessee) or if the lessor's disposition does not qualify under subsection 2A-527(2). Section 2A-527(3). Note that under some of these conditions, the lessor may recover damages from the lessee pursuant to the rule set forth in Section 2A-529. There is no sanction for disposition that does not qualify under subsection 2A527(2). Application of the rule set forth in this section is subject to agreement to the contrary. Sections 2A-504, 2A-103(4) and 1-102(3) 1-302.

* * *
Cross References: Sections 1-102(3) 1-302, 2-708, 2A-103(1)(u), 2A-402, 2A-504, 2A-507, 2A-527(2) and 2A529. Denitional Cross References: Agreement. Section 1-201(b)(3). Goods. Section 2A-103(1)(h). Lease. Section 2A-103(1)(j). Lease agreement. Section 2A-103(1)(k). Lessee. Section 2A-103(1)(n). Lessor. Section 2A-103(1)(p). Party. Section 1-201(29)(b)(26). Present value. Section 2A-103(1)(u) 1-201(b)(28). Sale. Section 2-106(1).

3-103. Denitions. (a) In this Article: * * * (4) Good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing. [reserved] * * * (10) Prove with respect to a fact means to meet the burden of establishing the fact (Section 1-201(b)(8)). * * * Ocial Comment * * *
4. Subsection (a)(4) introduces a denition of good faith to apply to Articles 3 and 4. Former Articles 3 and 4 used the denition in Section 1-201(19). The denition in subsection (a)(4) is consistent with the denitions of good faith applicable to Articles 2, 2A, 4, and 4A. The denition requires not only honesty in fact but also observance of reasonable commercial standards of fair dealing. Although fair dealing is a broad term that must be dened in context, it is clear that it is concerned with the fairness of conduct rather than the care with which an act is performed. Failure to exercise ordinary care in conducting a transaction is an entirely dierent concept than failure to deal fairly in conducting the transaction. Both fair dealing and ordinary care, which is dened in Section 3-103(a)(7), are to be judged in the light of reasonable commercial standards, but those standards in each case are directed to dierent aspects of commercial conduct. 45

App. I
3-103

Uniform Commercial Code

Art. 1

54. Subsection (a)(7) is a denition of ordinary care which is applicable not only to Article 3 but to Article 4 as well. See Section 4-104(c). The general rule is stated in the rst sentence of subsection (a)(7) and it applies both to banks and to persons engaged in businesses other than banking. Ordinary care means observance of reasonable commercial standards of the relevant businesses prevailing in the area in which the person is located. The second sentence of subsection (a)(7) is a particular rule limited to the duty of a bank to examine an instrument taken by a bank for processing for collection or payment by automated means. This particular rule applies primarily to Section 4-406 and it is discussed in Comment 4 to that section. Nothing in Section 3-103(a)(7) is intended to prevent a customer from proving that the procedures followed by a bank are unreasonable, arbitrary, or unfair. 65. In subsection (c) reference is made to a new denition of bank in amended Article 4.

4-104. Denitions and Index of Denitions. * * * (c) The following denitions in other Articles apply to this Article: * * * Good faith Section 3-103. * * * 4A-105. Other Denitions. (a) In this Article: * * * (6) Good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing. [reserved] (7) Prove with respect to a fact means to meet the burden of establishing the fact (Section 1-201(b)(8)). * * * 4A-106. Time Payment Order is Received. (a) The time of receipt of a payment order or communication cancelling or amending a payment order is determined by the rules applicable to receipt of a notice stated in Section 1-201(27) 1-202. A receiving bank may x a cut-o time or times on a funds-transfer business day for the receipt and processing of payment orders and communications cancelling or amending payment orders. Dierent cut-o times may apply to payment orders, cancellations, or amendments, or to dierent categories of payment orders, cancellations, or amendments. A cut-o time may apply to senders generally or dierent cut-o times may apply to dierent senders or categories of payment orders. If a payment order or communication cancelling or amending a payment order is received after the close of a funds-transfer business day or after the appropriate cut-o time on a funds-transfer business day, the receiving bank may treat the payment order or communication as received at the opening of the next funds-transfer business day. * * * Ocial Comment
The time that a payment order is received by a receiving bank usually denes the payment date or the execution date of a payment order. Section 4A-401 and Section 4A-301. The time of receipt of a payment order, or communication cancelling or amending a payment order is dened in subsection (a) by reference to the rules stated in Section 1-201(27) 1-202. Thus, time of receipt is determined by the same rules that determine when a notice 46

Art. 1

General Provisions

App. I
8-102

is received. Time of receipt, however, may be altered by a cut-o time.

4A-204. Refund of Payment and Duty of Customer to Report with Respect to Unauthorized Payment Order. * * * (b) Reasonable time under subsection (a) may be xed by agreement as stated in Section 1-204(1) 1-302(b), but the obligation of a receiving bank to refund payment as stated in subsection (a) may not otherwise be varied by agreement. 5-103. Scope. * * * (c) With the exception of this subsection, subsections (a) and (d), Sections 5-102(a)(9) and (10), 5-106(d), and 5-114(d), and except to the extent prohibited in Sections 1-102(3) 1-302 and 5-117(d), the eect of this article may be varied by agreement or by a provision stated or incorporated by reference in an undertaking. A term in an agreement or undertaking generally excusing liability or generally limiting remedies for failure to perform obligations is not sucient to vary obligations prescribed by this article. * * * Ocial Comment * * *
2. Like all of the provisions of the Uniform Commercial Code, Article 5 is supplemented by Section 1-103 and, through it, by many rules of statutory and common law. Because this article is quite short and has no rules on many issues that will aect liability with respect to a letter of credit transaction, law beyond Article 5 will often determine rights and liabilities in letter of credit transactions. Even within letter of credit law, the article is far from comprehensive; it deals only with certain rights of the parties. Particularly with respect to the standards of performance that are set out in Section 5-108, it is appropriate for the parties and the courts to turn to customs and practice such as the Uniform Customs and Practice for Documentary Credits, currently published by the International Chamber of Commerce as I.C.C. Pub. No. 500 (hereafter UCP). Many letters of credit specically adopt the UCP as applicable to the particular transaction. Where the UCP are adopted but conict with Article 5 and except where variation is prohibited, the UCP terms are permissible contractual modications under Sections 1-102(3) 1-302 and 5-103(c). See Section 5-116(c). Normally Article 5 should not be considered to conict with practice except when a rule explicitly stated in the UCP or other practice is dierent from a rule explicitly stated in Article 5. [remainder of comment 2 is unchanged]

* * * 8-102. Denitions. (a) In this Article: * * * (10) [reserved] Good faith, for purposes of the obligation of good faith in the performance or enforcement of contracts or duties within this Article, means honesty in fact and the observance of reasonable commercial standards of fair dealing. * * *
47

App. I
8-102

Uniform Commercial Code

Art. 1

Ocial Comment * * *
10. Good faith. Good faith is dened in Article 8 for purposes of the application to Article 8 of Section 1-203, which provides that Every contract or duty within this Act [the Uniform Commercial Code] imposes an obligation of good faith in its performance or enforcement. Section 1-201(b)(20) denes good faith as honesty in fact and the observance of reasonable commercial standards of fair dealing. The sole function of the good faith denition in Revised Article 8 is to give content to the Section 1-203 obligation as it applies to contracts and duties that are governed by Article 8. The standard is one of reasonable commercial standards of fair dealing. The reference to commercial standards makes clear that assessments of conduct are to be made in light of the commercial setting. The substantive rules of Article 8 have been drafted to take account of the commercial circumstances of the securities holding and processing system. For example, Section 8-115 provides that a securities intermediary acting on an eective entitlement order, or a broker or other agent acting as a conduit in a securities transaction, is not liable to an adverse claimant, unless the claimant obtained legal process or the intermediary acted in collusion with the wrongdoer. This, and other similar provisions, see Sections 8-404 and 8-503(e), do not depend on notice of adverse claims, because it would impair rather than advance the interest of investors in having a sound and ecient securities clearance and settlement system to require intermediaries to investigate the propriety of the transactions they are processing. The good faith obligation does not supplant the standards of conduct established in provisions of this kind. In Revised Article 8, the denition of good faith is not germane to the question whether a purchaser takes free from adverse claims. The rules on such questions as whether a purchaser who takes in suspicious circumstances is disqualied from protected purchaser status are treated not as an aspect of good faith but directly in the rules of Section 8-105 on notice of adverse claims.

* * *
Denitional Cross References: Agreement. Section 1-201(b)(3). Bank. Section 1-201(b)(4). Person. Section 1-201(30)(b)(27). Send. Section 1-201(38)(b)(36). Signed. Section 1-201(39)(b)(37). Writing. Section 1-201(46)(b)(43).

9-102. Denitions and Index of Denitions. (a) [Article 9 denitions.] In this article: * * * (43) [reserved] Good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing. * * * Ocial Comment * * *
3. Denitions Relating to Creation of a Security Interest.

* * *
b. Security Agreement. The denition of security agreement is substantially the same as under former Section 9-105-an agreement that creates or provides for a security interest. However, the term frequently was used colloquially in former Article 9 to refer to the document or writing that contained a debtor's security agreement. This Article eliminates that usage, reserving the term for the more precise meaning specied in the denition. Whether an agreement creates a security interest depends not on whether the parties intend that the law characterize the transaction as a security interest but rather on whether the transaction falls within the denition of security interest in Section 1-201. Thus, an 48

Art. 1

General Provisions

App. I
9-102

agreement that the parties characterize as a lease of goods may be a security agreement, notwithstanding the parties' stated intention that the law treat the transaction as a lease and not as a secured transaction. See Section 1-203.

* * *
14. Consignment-Related Denitions: Consignee; Consignment; Consignor. The denition of consignment excludes, in subparagraphs (B) and (C), transactions for which ling would be inappropriate or of insucient benet to justify the costs. A consignment excluded from the application of this Article by one of those subparagraphs may still be a true consignment; however, it is governed by non-Article 9 law. The denition also excludes, in subparagraph (D), what have been called consignments intended for security. These consignments are not bailments but secured transactions. Accordingly, all of Article 9 applies to them. See Sections 1-201(37)(b)(35), 9-109(a)(1). The consignor is the person who delivers goods to the consignee in a consignment. The denition of consignment requires that the goods be delivered to a merchant for the purpose of sale. If the goods are delivered for another purpose as well, such as milling or processing, the transaction is a consignment nonetheless because a purpose of the delivery is sale. On the other hand, if a merchant-processor-bailee will not be selling the goods itself but will be delivering to buyers to which the owner-bailor agreed to sell the goods, the transaction would not be a consignment.

* * *
16. Document. The denition of document is unchanged in substance from the corresponding denitions in former Section 9-105. See Section 1-201(15)(b)(16) and Comment 1516.

* * *
19. Good Faith. This Article expands the denition of good faith to include the observance of reasonable commercial standards of fair dealing. The denition in this section applies when the term is used in this Article, and the same concept applies in the context of this Article for purposes of the obligation of good faith imposed by Section 1-203. See subsection (c).

49

ARTICLE 2. SALES*
PART 1. SHORT TITLE, GENERAL CONSTRUCTION AND SUBJECT MATTER
2-101. Short Title. 2-102. Scope; Certain Security and Other Transactions Excluded from this Article. 2-103. Denitions and Index of Denitions. 2-104. Denitions: Merchant; Between Merchants; Financing Agency. 2-105. Denitions: Transferability; Future Goods; Lot; Commercial Unit. 2-106. Denitions: Contract; Agreement; Contract for Sale; Sale; Present Sale; Conforming to Contract; Termination; Cancellation. 2-107. Goods to Be Severed from Realty: Recording. 2-108. Transactions Subject to Other Law.

PART 2. FORM, FORMATION, TERMS AND READJUSTMENT OF CONTRACT; ELECTRONIC CONTRACTING

2-201. 2-202. 2-203. 2-204. 2-205. 2-206. 2-207. 2-208. 2-209. 2-210. 2-211. 2-212. 2-213. Formal Requirements; Statute of Frauds. Final Expression in a Record: Parol or Extrinsic Evidence. Seals Inoperative. Formation in General. Firm Oers. Oer and Acceptance in Formation of Contract. Terms of Contract; Eect of Conrmation. Reserved. Modication; Rescission and Waiver. Delegation of Performance; Assignment of Rights. Legal Recognition of Electronic Contracts, Records, and Signatures. Attribution. Electronic Communication.

PART 3. GENERAL OBLIGATION AND CONSTRUCTION OF CONTRACT

2-301. 2-302. 2-303. 2-304. 2-305. 2-306. General Obligations of Parties. Unconscionable Contract or Term. Allocation or Division of Risks. Price Payable in Money, Goods, Realty, or Otherwise. Open Price Term. Output, Requirements and Exclusive Dealings.
Note and list of drafting committee members, see Appendix T.

*Article 2 was amended in 2003. For the 2003 Amendments, along with Prefatory 50

Art. 2 2-307. 2-308. 2-309. 2-310.

Sales

Delivery in Single Lot or Several Lots. Absence of Specied Place for Delivery. Absence of Specic Time Provisions; Notice of Termination. Open Time for Payment or Running of Credit; Authority to Ship under Reservation. 2-311. Options and Cooperation Respecting Performance. 2-312. Warranty of Title and Against Infringement; Buyer's Obligation Against Infringement. 2-313. Express Warranties by Armation, Promise, Description, Sample; Remedial Promise. 2-313A. Obligation to Remote Purchaser Created by Record Packaged with or Accompanying Goods. 2-313B. Obligation to Remote Purchaser Created by Communication to the Public. 2-314. Implied Warranty: Merchantability; Usage of Trade. 2-315. Implied Warranty: Fitness for Particular Purpose. 2-316. Exclusion or Modication of Warranties. 2-317. Cumulation and Conict of Warranties Express or Implied. 2-318. Third-Party Beneciaries of Warranties and Obligations. 2-319. Reserved. 2-320. Reserved. 2-321. Reserved. 2-322. Reserved. 2-323. Reserved. 2-324. Reserved. 2-325. Failure to Pay by Agreed Letter of Credit. 2-326. Sale on Approval and Sale or Return. 2-327. Special Incidents of Sale on Approval and Sale or Return. 2-328. Sale by Auction.

PART 4. TITLE, CREDITORS, AND GOOD-FAITH PURCHASERS

2-401. Passing of Title; Reservation for Security; Limited Application of this Section. 2-402. Rights of Seller's Creditors Against Sold Goods. 2-403. Power to Transfer; Good Faith Purchase of Goods; Entrusting.

PART 5. PERFORMANCE
2-501. Insurable Interest in Goods; Manner of Identication of Goods. 2-502. Buyer's Right to Goods on Seller's Insolvency, Repudiation, or Failure to Deliver. 2-503. Manner of Seller's Tender of Delivery. 2-504. Shipment by Seller. 2-505. Seller's Shipment under Reservation. 2-506. Rights of Financing Agency. 2-507. Eect of Seller's Tender; Delivery on Condition. 2-508. Cure by Seller of Improper Tender or Delivery; Replacement. 2-509. Risk of Loss in the Absence of Breach. 2-510. Eect of Breach on Risk of Loss. 2-511. Tender of Payment by Buyer; Payment by Check.
51

Uniform Commercial Code 2-512. 2-513. 2-514. 2-515. Payment by Buyer Before Inspection. Buyer's Right to Inspection of Goods. When Documents Deliverable on Acceptance; When on Payment. Preserving Evidence of Goods in Dispute.

Art. 2

PART 6. BREACH, REPUDIATION, AND EXCUSE

2-601. 2-602. 2-603. 2-604. 2-605. 2-606. 2-607. 2-608. 2-609. 2-610. 2-611. 2-612. 2-613. 2-614. 2-615. 2-616. Buyer's Rights on Improper Delivery. Manner and Eect of Rejection. Merchant Buyer's Duties as to Rejected Goods. Buyer's Options as to Salvage of Rejected Goods. Waiver of Buyer's Objections by Failure to Particularize. What Constitutes Acceptance of Goods. Eect of Acceptance; Notice of Breach; Burden of Establishing Breach after Acceptance; Notice of Claim or Litigation to Person Answerable Over. Revocation of Acceptance in Whole or in Part. Right to Adequate Assurance of Performance. Anticipatory Repudiation. Retraction of Anticipatory Repudiation. Installment Contract; Breach. Casualty to Identied Goods. Substituted Performance. Excuse by Failure of Presupposed Conditions. Procedure on Notice Claiming Excuse.

PART 7. REMEDIES
2-701. 2-702. 2-703. 2-704. 2-705. 2-706. 2-707. 2-708. 2-709. 2-710. 2-711. 2-712. 2-713. 2-714. 2-715. 2-716. 2-717. 2-718. 2-719. 2-720. Remedies for Breach of Collateral Contracts Not Impaired. Seller's Remedies on Discovery of Buyer's Insolvency. Seller's Remedies in General. Seller's Right to Identify Goods to the Contract Notwithstanding Breach or to Salvage Unnished Goods. Seller's Stoppage of Delivery in Transit or Otherwise. Seller's Resale Including Contract for Resale. Person in the Position of a Seller. Seller's Damages for Nonacceptance or Repudiation. Action for the Price. Seller's Incidental and Consequential Damages. Buyer's Remedies in General; Buyer's Security Interest in Rejected Goods. Cover; Buyer's Procurement of Substitute Goods. Buyer's Damages for Nondelivery or Repudiation. Buyer's Damages For Breach in Regard to Accepted Goods. Buyer's Incidental and Consequential Damages. Specic Performance; Buyer's Right to Replevin. Deduction of Damages from the Price. Liquidation or Limitation of Damages; Deposits. Contractual Modication or Limitation of Remedy. Eect of Cancellation or Rescission on Claims for Antecedent Breach. Remedies for Fraud.

2-721.
52

Art. 2 2-722. 2-723. 2-724. 2-725.

Sales Who May Sue Third Parties for Injury to Goods. Proof of Market: Time and Place. Admissibility of Market Quotations. Statute of Limitations in Contracts for Sale.

2-102

PART 8. TRANSITIONAL PROVISIONS

2-801. 2-802. 2-803. 2-804. Eective Date. Amendment of Existing Article 2. Application to Existing Relations. Savings Clause.

PART 1. SHORT TITLE, GENERAL CONSTRUCTION AND SUBJECT MATTER

2-101. Short Title. This Article shall be known and may be cited as Uniform Commercial CodeSales. Ocial Comment
This Article is a complete revision and modernization of the Uniform Sales Act which was promulgated by the National Conference of Commissioners on Uniform State Laws in 1906 and has been adopted in 34 states and Alaska, the District of Columbia and Hawaii. The coverage of the present Article is much more extensive than that of the old Sales Act and extends to the various bodies of case law which have been developed both outside of and under the latter. The arrangement of the present Article is in terms of contract for sale and the various steps of its performance. The legal consequences are stated as following directly from the contract and action taken under it without resorting to the idea of when property or title passed or was to pass as being the determining factor. The purpose is to avoid making practical issues between practical men turn upon the location of an intangible something, the passing of which no man can prove by evidence and to substitute for such abstractions proof of words and actions of a tangible character.

2-102. Scope; Certain Security and Other Transactions Excluded from this Article. Unless the context otherwise requires, this Article applies to transactions in goods; it does not apply to any transaction which although in the form of an unconditional contract to sell or present sale is intended to operate only as a security transaction nor does this Article impair or repeal any statute regulating sales to consumers, farmers or other specied classes of buyers. Ocial Comment
Prior Uniform Statutory Provision: Section 75, Uniform Sales Act. Changes: Section 75 has been rephrased. Purposes of Changes and New Matter: To make it clear that: The Article leaves substantially unaected the law relating to purchase money security such as conditional sale or chattel mortgage though it regulates the general sales aspects of such transactions. Security transaction is used in the same sense as in the Article on Secured Transactions (Article 9). Cross Reference: Article 9. 53

 2-102

Uniform Commercial Code

Art. 2

Denitional Cross References: Contract. Section 1-201. Contract for sale. Section 2-106. Goods. Section 2-103. Present sale. Section 2-106. Sale. Section 2-106.

2-103. Denitions and Index of Denitions. (1) In this article unless the context otherwise requires: (a) Buyer means a person that buys or contracts to buy goods. (b) Conspicuous, with reference to a term, means so written, displayed, or presented that a reasonable person against which it is to operate ought to have noticed it. A term in an electronic record intended to evoke a response by an electronic agent is conspicuous if it is presented in a form that would enable a reasonably congured electronic agent to take it into account or react to it without review of the record by an individual. Whether a term is conspicuous or not is a decision for the court. Conspicuous terms include the following: (i) for a person: (A) a heading in capitals equal to or greater in size than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same or lesser size; and (B) language in the body of a record or display in larger type than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same size, or set o from surrounding text of the same size by symbols or other marks that call attention to the language; and (ii) for a person or an electronic agent, a term that is so placed in a record or display that the person or electronic agent may not proceed without taking action with respect to the particular term. (c) Consumer means an individual who buys or contracts to buy goods that, at the time of contracting, are intended by the individual to be used primarily for personal, family, or household purposes. (d) Consumer contract means a contract between a merchant seller and a consumer. (e) Delivery means, with respect to goods, the voluntary transfer of physical possession or control of goods. (f) Electronic means relating to technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities. (g) Electronic agent means a computer program or an electronic or other automated means used independently to initiate an action or respond to electronic records or performances in whole or in part, without review or action by an individual. (h) Electronic record means a record created, generated, sent, communicated, received, or stored by electronic means. (i) Foreign exchange transaction means a transaction in which one party agrees to deliver a quantity of a specied money or unit of account in consideration of the other party's agreement to deliver another quantity of a dierent money or unit of account either currently or at a
54

Art. 2

Sales

2-103

future date, and in which delivery is to be through funds transfer, book entry accounting, or other form of payment order, or other agreed means to transfer a credit balance. The term includes a transaction of this type involving two or more moneys and spot, forward, option, or other products derived from underlying moneys and any combination of these transactions. The term does not include a transaction involving two or more moneys in which one or both of the parties is obligated to make physical delivery, at the time of contracting or in the future, of banknotes, coins, or other form of legal tender or specie. [(j) Reserved] [(j) Good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing.]
Legislative Note: The denition of good faith should not be adopted if the jurisdiction has enacted this denition as part of Article 1.

(k) Goods means all things that are movable at the time of identication to a contract for sale. The term includes future goods, specially manufactured goods, the unborn young of animals, growing crops, and other identied things attached to realty as described in Section 2-107. The term does not include information, the money in which the price is to be paid, investment securities under Article 8, the subject matter of foreign exchange transactions, or choses in action. (l) Receipt of goods means taking physical possession of goods. (m) Record means information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.
Legislative Note: The denition of record should not be adopted if the jurisdiction has enacted revised Article 1.

(n) Remedial promise means a promise by the seller to repair or replace goods or to refund all or part of the price of goods upon the happening of a specied event. (o) Seller means a person that sells or contracts to sell goods. (p) Sign means, with present intent to authenticate or adopt a record: (i) to execute or adopt a tangible symbol; or (ii) to attach to or logically associate with the record an electronic sound, symbol, or process. (2) Other denitions applying to this Article or to specied Parts thereof, and the sections in which they appear are: Acceptance. Section 2-606. Between merchants. Section 2-104. Cancellation. Section 2-106(4). Commercial unit. Section 2-105. Conforming to contract. Section 2-106. Contract for sale. Section 2-106. Cover. Section 2-712. Entrusting. Section 2-403. Financing agency. Section 2-104. Future goods. Section 2-105.
55

 2-103

Uniform Commercial Code

Art. 2

Identication. Section 2-501. Installment contract. Section 2-612. Lot. Section 2-105. Merchant. Section 2-104. Person in position of seller. Section 2-707. Present sale. Section 2-106. Sale. Section 2-106. Sale on approval. Section 2-326. Sale or return. Section 2-326. Termination. Section 2-106. (3) Control as provided in Section 7-106 and the following denitions in other Articles apply to this Article: Check. Section 3-104(f). Consignee. Section 7-102(3) Consignor. Section 7-102(4) Consumer goods. Section 9-102(a)(23). Dishonor. Section 3-502. Draft. Section 3-104(e). Honor. Section 5-102(a)(8). Injunction against honor. Section 5-109(b). Letter of credit. Section 5-102(a)(10). (4) In addition Article 1 contains general denitions and principles of construction and interpretation applicable throughout this Article. As amended in 1994, 1999, 2001, 2003 and 2005.
See Appendix J for material relating to changes made in text in 1994. See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999. See Appendix I contained within revised Article 1 for material relating to changes made in text in 2001. See Appendix T for material relating to changes made in text in 2003. See Appendix V for material relating to changes made in text in 2005.

Ocial Comment
1. The rst sentence of the denition of conspicuous is based on Section 1-201(10) but the concept is expanded to include terms in electronic records. The general standard is, that to be conspicuous, a term ought to be noticed by a reasonable person. The second sentence states a special rule for situations where the sender of an electronic record intends to evoke a response from an electronic agent. In that case, the presentation of the term must be capable of evoking a response from a reasonably congured electronic agent. Whether a term is conspicuous is an issue for the court. Paragraphs (i) and (ii) set out several methods for making a term conspicuous. The requirement that a term be conspicuous functions both as notice (the term ought to be noticed) and as a basis for planning (giving guidance to the party that relies on the term about how that result can be achieved). Paragraph (i), which relates to the general standard for conspicuousness, is based on original Section 1-201(10) but it is intended to give more guidance than was given in the prior version of this denition. Paragraph (ii) is new and it relates to the special standard for electronic records that are intended to evoke a response from an electronic agent. Although these paragraphs indicate some of the methods for calling attention to a term, the 56

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test is whether notice of the term can reasonably be expected. The statutory language should not be construed to permit a result that is inconsistent with that test. 2. A consumer is a natural person (cf. Section 1-201(27)) who enters into a transaction for a purpose typically associated with consumers-i.e., a personal, family or household purpose. The requirement that the buyer intend that the goods be used primarily for personal, family or household purposes is generally consistent with the denition of consumer goods in revised Article 9. See Section 9-102(a)(23). 3. The term consumer contract is limited to a contract for sale between a seller that is a merchant and a buyer that is a consumer. Thus, neither a sale by a consumer to a consumer nor a sale by a merchant to an individual who intends that the goods be used primarily in a home business qualify as a consumer contract. 4. Delivery with respect to documents of title is dened in Section 1-201(15) as the voluntary transfer of possession of the document. This Article denes delivery with respect to goods to mean the voluntary transfer of physical possession or control of the goods. 5. The electronic contracting provisions, including the denitions of electronic, electronic agent, electronic record, and record are based on the provisions of the Uniform Electronic Transactions Act and are consistent with the federal Electronic Signatures in Global and National Commerce Act (15 U.S.C. 7001 et seq.). 6. The term foreign exchange transaction is used in the denition of goods in Section 2-103(1)(k). That denition excludes the subject matter of foreign exchange transactions. 7. The denition of goods in this article has been amended to exclude information not associated with goods. Thus, this article does not directly apply to an electronic transfer of information, such as the transaction involved in Specht v. Netscape, 150 F. Supp. 2d 585 (S.D.N.Y. 2001), a'd, 306 F.3d 17 (2d. Cir. 2002). However, transactions often include both goods and information: some are transactions in goods as that term is used in Section 2-102, and some are not. For example, the sale of smart goods such as an automobile is a transaction in goods fully within this article even though the automobile contains many computer programs. On the other hand, an architect's provision of architectural plans on a computer disk would not be a transaction in goods. When a transaction includes both the sale of goods and the transfer of rights in information, it is up to the courts to determine whether the transaction is entirely within or outside of this article, or whether or to what extent this article should be applied to a portion of the transaction. While this article may apply to a transaction including information, nothing in this Article alters, creates, or diminishes intellectual property rights. The denition has also been amended to exclude the subject matter of foreign exchange transactions. See Section 2-103(1)(i). Although a contract in which currency in the commodity exchanged is a sale of goods, an exchange in which delivery is through funds transfer, book entry accounting, or other form of payment order, or other agreed means to transfer a credit balance is not a sale of goods and is not governed by this article. In the latter case, Article 4A or other law applies. On the other hand, if the parties agree to a forward transaction where dollars are to be physically delivered in exchange for the delivery of another currency, the transaction is not within the foreign exchange exclusion and this article applies. 8. Section 1-202(e) provides rules for determining whether a notice or notication has been received. This Article by contrast denes receipt of goods to mean the taking of physical possession of the goods. 9. A remedial promise is a promise by the seller to take a certain remedial action upon the happening of a specied event. The types of remedies contemplated by this term as used in this Article are specied in the denition-repair or replacement of the goods, or refund of all or part of the price. No other promise by a seller qualies as a remedial promise. Furthermore, the seller is entitled to specify precisely the event that will precipitate the obligation. Typical examples include a commitment to repair any parts of the goods that are defective, or a commitment to refund the purchase price if the goods fail to perform in a certain manner. A post-sale promise to correct a problem with the goods that the seller is not obligated to correct that is made to placate a dissatised customer is not within the denition of remedial promise. Whether the promised remedy is exclusive, and if so whether it has failed its essential purpose, is determined under Section 2-719. The distinction between a remedial promise and a warranty that is made in this Article resolves a statute-of-limitations problem. Under original Section 2-725, a right of action for 57

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breach of an express warranty accrued at the time the goods were tendered unless the warranty explicitly extended to the future performance of the goods. In that case, the statute of limitations began to run at the time of the discovery of the breach. By contrast, a right of action for breach of an ordinary (non-warranty) promise accrued when the promise was breached. A number of courts held that commitments by sellers to take remedial action in the event the goods proved to be defective during a specied period of time constituted a warranty, and in theses cases the courts determined that the statute of limitations began to run at the time that the goods were tendered. Other courts used strained reasoning that allowed them to apply the discovery rule even though the promise referred to the future performance of the seller and not the future performance of the goods. Under this Article, a promise by the seller to take remedial action is not a warranty at all and therefore the statute of limitations for a breach of a remedial promise does not begin to run at either the time the goods are tendered or at the time the breach is discovered. Section 2-725(2)(c) separately addresses the accrual of a right of action for a remedial promise. See Ocial Comment 3 to Section 2-725. 10. The denition of sign is broad enough to cover any record that is signed within the meaning of Article 1 or that contains an electronic signature within the meaning of the Uniform Electronic Transactions Act. It is consistent with the federal Electronic Signatures in Global and National Commerce Act (15 U.S.C. 7001 et seq.).

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-104. Denitions: Merchant; Between Merchants; Financing Agency. (1) Merchant means a person that deals in goods of the kind or otherwise holds itself out by occupation as having knowledge or skill peculiar to the practices or goods involved in the transaction or to which the knowledge or skill may be attributed by the person's employment of an agent or broker or other intermediary that holds itself out by occupation as having the knowledge or skill. (2) Financing agency means a bank, nance company, or other person that in the ordinary course of business makes advances against goods or documents of title or that by arrangement with either the seller or the buyer intervenes in ordinary course to make or collect payment due or claimed under the contract for sale, as by purchasing or paying the seller's draft or making advances against it or by merely taking it for collection whether or not documents of title accompany or are associated with the draft. The term includes also a bank or other person that similarly intervenes between persons that are in the position of seller and buyer in respect to the goods (Section 2-707). (3) Between merchants means in any transaction with respect to which both parties are chargeable with the knowledge or skill of merchants. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None. But see Sections 15(2), (5), 16(c), 45(2) and 71, Uniform Sales Act, and Sections 35 and 37, Uniform Bills of Lading Act for examples of the policy expressly provided for in this Article. Purposes: 1. This Article assumes that transactions between professionals in a given eld require special and clear rules which may not apply to a casual or inexperienced seller or buyer. It thus adopts a policy of expressly stating rules applicable between merchants and as 58

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against a merchant, wherever they are needed instead of making them depend upon the circumstances of each case as in the statutes cited above. This section lays the foundation of this policy by dening those who are to be regarded as professionals or merchants and by stating when a transaction is deemed to be between merchants. 2. The term merchant as dened here roots in the law merchant concept of a professional in business. The professional status under the denition may be based upon specialized knowledge as to the goods, specialized knowledge as to business practices, or specialized knowledge as to both and which kind of specialized knowledge may be sucient to establish the merchant status is indicated by the nature of the provisions. The special provisions as to merchants appear only in this Article and they are of three kinds. Sections 2-201(2), 2-205, 2-207 and 2-209 dealing with the statute of frauds, rm offers, conrmatory memoranda and modication rest on normal business practices which are or ought to be typical of and familiar to any person in business. For purposes of these sections almost every person in business would, therefore, be deemed to be a merchant under the language who . . . by his occupation holds himself out as having knowledge or skill peculiar to the practices . . . involved in the transaction . . . since the practices involved in the transaction are non-specialized business practices such as answering mail. In this type of provision, banks or even universities, for example, well may be merchants. But even these sections only apply to a merchant in his mercantile capacity; a lawyer or bank president buying shing tackle for his own use is not a merchant. On the other hand, in Section 2-314 on the warranty of merchantability, such warranty is implied only if the seller is a merchant with respect to goods of that kind. Obviously this qualication restricts the implied warranty to a much smaller group than everyone who is engaged in business and requires a professional status as to particular kinds of goods. The exception in Section 2-402(2) for retention of possession by a merchant-seller falls in the same class; as does Section 2-403(2) on entrusting of possession to a merchant who deals in goods of that kind. A third group of sections includes 2-103(1)(b), which provides that in the case of a merchant good faith includes observance of reasonable commercial standards of fair dealing in the trade; 2-327(1)(c), 2-603 and 2-605, dealing with responsibilities of merchant buyers to follow seller's instructions, etc.; 2-509 on risk of loss, and 2-609 on adequate assurance of performance. This group of sections applies to persons who are merchants under either the practices or the goods aspect of the denition of merchant. 3. The or to whom such knowledge or skill may be attributed by his employment of an agent or broker . . . clause of the denition of merchant means that even persons such as universities, for example, can come within the denition of merchant if they have regular purchasing departments or business personnel who are familiar with business practices and who are equipped to take any action required. Cross References: Point 1: Sections 1-102 and 1-203. Point 2: Sections 2-314, 2-315, and Article 9. Denitional Cross References: Bank. Section 1-201. Buyer. Section 2-103. Contract for sale. Section 2-106. Document of title. Section 1-201. Draft. Section 3-104(e). Goods. Section 2-103. Person. Section 1-201. Purchase. Section 1-201. Seller. Section 2-103.

2-105. Denitions: Transferability; Future Goods; Lot; Commercial Unit. (1) Goods must be both existing and identied before any interest in them may pass. Goods that are not both existing and identied are future goods. A purported present sale of future goods or of any interest therein operates as a contract to sell.
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(2) There may be a sale of a part interest in existing identied goods. (3) An undivided share in an identied bulk of fungible goods is sufciently identied to be sold although the quantity of the bulk is not determined. Any agreed proportion of the bulk or any quantity thereof agreed upon by number, weight, or other measure may to the extent of the seller's interest in the bulk be sold to the buyer that then becomes an owner in common. (4) Lot means a parcel or a single article which is the subject matter of a separate sale or delivery, whether or not it is sucient to perform the contract. (5) Commercial unit means such a unit of goods as by commercial usage is a single whole for purposes of sale and division of which materially impairs its character or value on the market or in use. A commercial unit may be a single article (as a machine) or a set of articles (as a suite of furniture or an assortment of sizes) or a quantity (as a bale, gross, or carload) or any other unit treated in use or in the relevant market as a single whole. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Subsections (1), (2), (3) and (4)Sections 5, 6 and 76, Uniform Sales Act; Subsections (5) and (6)none. Changes: Rewritten. Purposes of Changes and New Matter: 1. Subsection (1) on goods: The phraseology of the prior uniform statutory provision has been changed so that: The denition of goods is based on the concept of movability and the term chattels personal is not used. It is not intended to deal with things which are not fairly identiable as movables before the contract is performed. Growing crops are included within the denition of goods since they are frequently intended for sale. The concept of industrial growing crops has been abandoned, for under modern practices fruit, perennial hay, nursery stock and the like must be brought within the scope of this Article. The young of animals are also included expressly in this denition since they, too, are frequently intended for sale and may be contracted for before birth. The period of gestation of domestic animals is such that the provisions of the section on identication can apply as in the case of crops to be planted. The reason of this denition also leads to the inclusion of a wool crop or the like as goods subject to identication under this Article. The exclusion of money in which the price is to be paid from the denition of goods does not mean that foreign currency which is included in the denition of money may not be the subject matter of a sales transaction. Goods is intended to cover the sale of money when money is being treated as a commodity but not to include it when money is the medium of payment. As to contracts to sell timber, minerals, or structures to be removed from the land Section 2-107(1) (Goods to be severed from Realty: recording) controls. The use of the word xtures is avoided in view of the diversity of denitions of that term. This Article in including within its scope things attached to realty adds the further test that they must be capable of severance without material harm thereto. As between the parties any identied things which fall within that denition become goods upon the making of the contract for sale. Investment securities are expressly excluded from the coverage of this Article. It is not intended by this exclusion, however, to prevent the application of a particular section of this Article by analogy to securities (as was done with the Original Sales Act in Agar v. Orda, 264 N.Y. 248, 190 N.E. 479, 99 A.L.R. 269 (1934)) when the reason of that section 60

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makes such application sensible and the situation involved is not covered by the Article of this Act dealing specically with such securities (Article 8). 2. References to the fact that a contract for sale can extend to future or contingent goods and that ownership in common follows the sale of a part interest have been omitted here as obvious without need for expression; hence no inference to negate these principles should be drawn from their omission. 3. Subsection (4) does not touch the question of how far an appropriation of a bulk of fungible goods may or may not satisfy the contract for sale. 4. Subsections (5) and (6) on lot and commercial unit are introduced to aid in the phrasing of later sections. 5. The question of when an identication of goods takes place is determined by the provisions of Section 2-501 and all that this section says is what kinds of goods may be the subject of a sale. Cross References: Point 1: Sections 2-107, 2-201, 2-501 and Article 8. Point 5: Section 2-501. See also Section 1-201. Denitional Cross References: Buyer. Section 2-103. Contract. Section 1-201. Contract for sale. Section 2-106. Fungible. Section 1-201. Money. Section 1-201. Present sale. Section 2-106. Sale. Section 2-106. Seller. Section 2-103.

2-106. Denitions: Contract; Agreement; Contract for Sale; Sale; Present Sale; Conforming to Contract; Termination; Cancellation. (1) In this Article unless the context otherwise requires contract and agreement are limited to those relating to the present or future sale of goods. Contract for sale includes both a present sale of goods and a contract to sell goods at a future time. A sale consists in the passing of title from the seller to the buyer for a price (Section 2-401). A present sale means a sale which is accomplished by the making of the contract. (2) Goods or conduct including any part of a performance are conforming or conform to the contract when they are in accordance with the obligations under the contract. (3) Termination occurs when either party pursuant to a power created by agreement or law puts an end to the contract otherwise than for its breach. On termination all obligations which are still executory on both sides are discharged but any right based on prior breach or performance survives. (4) Cancellation occurs when either party puts an end to the contract for breach by the other and its eect is the same as that of termination except that the cancelling party also retains any remedy for breach of the whole contract or any unperformed balance. Ocial Comment
Prior Uniform Statutory Provision: Subsection (1)Section 1(1) and (2), Uniform Sales Act; Subsection (2)none, but subsection generally continues policy of Sections 11, 44 and 69, Uniform Sales Act; Subsections (3) and (4)none. Changes: Completely rewritten. 61

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Purposes of Changes and New Matter: 1. Subsection (1): Contract for sale is used as a general concept throughout this Article, but the rights of the parties do not vary according to whether the transaction is a present sale or a contract to sell unless the Article expressly so provides. 2. Subsection (2): It is in general intended to continue the policy of requiring exact performance by the seller of his obligations as a condition to his right to require acceptance. However, the seller is in part safeguarded against surprise as a result of sudden technicality on the buyer's part by the provisions of Section 2-508 on seller's cure of improper tender or delivery. Moreover usage of trade frequently permits commercial leeways in performance and the language of the agreement itself must be read in the light of such custom or usage and also, prior course of dealing, and in a long term contract, the course of performance. 3. Subsections (3) and (4): These subsections are intended to make clear the distinction carried forward throughout this Article between termination and cancellation. Cross References: Point 2: Sections 1-203, 1-205,and 2-508. Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Contract. Section 1-201. Goods. Section 2-103. Party. Section 1-201. Remedy. Section 1-201. Rights. Section 1-201. Seller. Section 2-103.

2-107. Goods to Be Severed from Realty: Recording. (1) A contract for the sale of minerals or the like (including oil and gas) or a structure or its materials to be removed from realty is a contract for the sale of goods within this Article if they are to be severed by the seller but until severance a purported present sale thereof which is not eective as a transfer of an interest in land is eective only as a contract to sell. (2) A contract for the sale apart from the land of growing crops or other things attached to realty and capable of severance without material harm thereto but not described in subsection (1) or of timber to be cut is a contract for the sale of goods within this Article whether the subject matter is to be severed by the buyer or by the seller even though it forms part of the realty at the time of contracting, and the parties can by identication eect a present sale before severance. (3) The provisions of this section are subject to any third party rights provided by the law relating to realty records, and the contract for sale may be executed and recorded as a document transferring an interest in land and shall then constitute notice to third parties of the buyer's rights under the contract for sale. As amended in 1972.
See Appendix B for material relating to changes made in text in 1972.

Ocial Comment
Prior Uniform Statutory Provision: See Section 76, Uniform Sales Act on prior policy; Section 7, Uniform Conditional Sales Act. Purposes: 1. Subsection (1). Notice that this subsection applies only if the minerals or structures are to be severed by the seller. If the buyer is to sever, such transactions are considered contracts aecting land and all problems of the Statute of Frauds and of the recording of land rights apply to them. Therefore, the Statute of Frauds section of this Article does not 62

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apply to such contracts though they must conform to the Statute of Frauds aecting the transfer of interests in land. 2. Subsection (2). Things attached to the realty which can be severed without material harm are goods within this Article regardless of who is to eect the severance. The word xtures has been avoided because of the diverse denitions of this term, the test of severance without material harm being substituted. The provision in subsection (3) for recording such contracts is within the purview of this Article since it is a means of preserving the buyer's rights under the contract of sale. 3. The security phases of things attached to or to become attached to realty are dealt with in the Article on Secured Transactions (Article 9) and it is to be noted that the denition of goods in that Article diers from the denition of goods in this Article. However, both Articles treat as goods growing crops and also timber to be cut under a contract of severance. Cross References: Point 1: Section 2-201. Point 2: Sections 2-103 and 2-105. Point 3: Articles 9 and 9-105. Denitional Cross References: Buyer. Section 2-103. Contract. Section 1-201. Contract for sale. Section 2-106. Goods. Section 2-103. Party. Section 1-201. Present sale. Section 2-106. Rights. Section 1-201. Seller. Section 2-103.

2-108. Transactions Subject to Other Law. (1) A transaction subject to this article is also subject to any applicable: (a) [list any certicate of title statutes of this State covering automobiles, trailers, mobile homes, boats, farm tractors, or the like], except with respect to the rights of a buyer in ordinary course of business under Section 2-403(2) which arise before a certicate of title covering the goods is eective in the name of any other buyer; (b) rule of law that establishes a dierent rule for consumers; or (c) statute of this state applicable to the transaction, such as a statute dealing with: (i) the sale or lease of agricultural products; (ii) the transfer of human blood, blood products, tissues, or parts; (iii) the consignment or transfer by artists of works of art or ne prints; (iv) distribution agreements, franchises, and other relationships through which goods are sold; (v) the misbranding or adulteration of food products or drugs; and (vi) dealers in particular products, such as automobiles, motorized wheelchairs, agricultural equipment, and hearing aids. (2) Except for the rights of a buyer in ordinary course of business under subsection (1)(a), in the event of a conict between this article and a law referred to in subsection (1), that law governs. (3) For purposes of this article, failure to comply with a law referred to in subsection (1) has only the eect specied in that law.
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(4) This article modies, limits, and supersedes the federal Electronic Signatures in Global and National Commerce Act, 15 U.S.C. Section 7001 et seq., except that nothing in this article modies, limits, or supersedes Section 7001(c) of that Act or authorizes electronic delivery of any of the notices described in Section 7003(b) of that Act. As added in 2003. Ocial Comment
1. Section 2-108, which was not in the prior version of this Article, follows the form of Section 2A-104(1). 2. In subsection (1), it is assumed that this article is subject to any applicable federal law, such as the United Nations Convention on Contracts for the International Sale of Goods, 15 U.S.C. App., or the Magnuson-Moss Warranty Act, 15 U.S.C. Sections 2301 2312. 3. Subsection (1)(a) permits the states to list any applicable certicate-of-title statutes. It also provides that Article 2 is subject to their provisions on the transfer and eect of title except for the rights of a buyer in ordinary course of business in certain limited situations. In entrustment situations, the exception in subsection (1)(a) overrides those certicate-oftitle statutes that provide that a person cannot qualify as an owner unless a certicate has been issued in the person's name. In those cases where an owner in whose name a certicate has been issued entrusts a titled asset to a dealer that then sells it to a buyer in ordinary course of business, this section provides that the priority issue between the owner and the buyer is to be resolved by reference to the certicate-of-title statute. Illustration #1. A used car is stolen from the owner by a thief and the thief, by fraud, is able to obtain a clean certicate of title from State X. The thief sells the car to the buyer, a good faith purchaser for value but not a buyer in ordinary course of business, and the thief transfers the certicate of title to the buyer. The exception in subsection (1)(a) does not apply to protect the buyer. Furthermore, under Section 2-403(1), the buyer does not get good title from the thief, regardless of the certicate. The same result follows if the applicable state certicate of title law makes the certicate prima facie evidence of ownership. The buyer will prevail, however, if the applicable certicate of title law conicts with the result obtained under this Article by making issuance of the certificate conclusive on title. Illustration #2. The dealer sells a new car to buyer #1 and the dealer signs a form permitting buyer #1 to apply for a certicate of title. Buyer #1 leaves the car with the dealer so that the dealer can nish the preparation work on the car. While the car remains in the dealer's possession and before the state issues a certicate of title in buyer #1's name, buyer #2 makes the dealer a better oer on the car, which the dealer accepts. Buyer #1 entrusted the car to the dealer, and if buyer #2 qualies as a buyer in ordinary course of business, buyer #2's title to the car will be superior to that of buyer #1. Illustration #3. An owner in whose name a certicate of title has been issued leaves a car with a dealer for repair. The dealer sells the car to a buyer, who qualies as a buyer in ordinary course of business. If the certicate-of-title law in the state resolves the priority contest between the owner and the buyer, that solution should be implemented. Otherwise, the buyer prevails under Section 2-403(2). 4. This section also deals with the eect of a conict or failure to comply with any other state law that might apply to a transaction governed by this Article. Subsection (1) provides that a transaction subject to this Article is also subject to other applicable law, and subsection (2) provides that in the event of a conict the other law governs (except for the rights of a buyer in ordinary course of business under subsection (1)(a)). Subsection (1)(b) provides that this Article is also subject to any rule of law that establishes a dierent rule for consumers. Rule of law includes a statute, an administrative rule properly promulgated under the statute, and a nal court decision. The relationship between Article 2 and federal and state consumer laws will vary from transaction to transaction and from State to State. For example, the Magnuson-Moss Warranty Act, 15 U.S.C.A. 2301 et. seq., may or may not apply to the consumer dispute in question and the applicable state lemon law may provide more or less protection than Magnuson-Moss. To the extent that the other law applies and there is a conict with this 64

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Article, that law controls. Subsection (1)(c) provides an illustrative but not exhaustive list of other applicable state statutes that may preempt all or part of Article 2. For example, franchise contracts may be regulated by state franchise acts, the seller of unmerchantable blood or human tissue may be insulated from warranty liability and disclaimers of the implied warranty of merchantability may be invalidated by non-uniform amendments to Article 2. The existence, scope, and eect of these statutes must be assessed from State to State. Assuming that there is a conict, subsection (3) deals with the failure of parties to the contract to comply with the applicable law. The failure has the eect specied in the law. Thus, the failure to obtain a required license may make the contract illegal, and therefore unenforceable, while the nonnegligent supply of unmerchantable blood under a blood shield statute may mean only that the supplier is insulated from liability for injury to person or property. 5. Subsection (4) takes advantage of a provision of the federal Electronic Signatures in Global and National Commerce Act (E-Sign). E-Sign permits state law to modify, limit or supersede its provisions if the state law is consistent with Titles I and II of E-Sign, gives no special legal eect or validity to and does not require the implementation or application of specic technologies or technical specications, and if enacted subsequent to E-Sign makes specic reference to E-Sign. Subsection (4) does not apply to section 101(c) of E-Sign, nor does it authorize electronic delivery of the notices described in section 103(b) of E-Sign. Cross References: Point 3: Section 2-403. Denitional Cross References: Lease. Section 2A-103.

PART 2. FORM, FORMATION, TERMS AND READJUSTMENT OF CONTRACT; ELECTRONIC CONTRACTING

2-201. Formal Requirements; Statute of Frauds. (1) A contract for the sale of goods for the price of $5,000 or more is not enforceable by way of action or defense unless there is some record sufcient to indicate that a contract for sale has been made between the parties and signed by the party against which enforcement is sought or by the party's authorized agent or broker. A record is not insucient because it omits or incorrectly states a term agreed upon, but the contract is not enforceable under this subsection beyond the quantity of goods shown in the record. (2) Between merchants if within a reasonable time a record in conrmation of the contract and sucient against the sender is received and the party receiving it has reason to know its contents, it satises the requirements of subsection (1) against the recipient unless notice of objection to its contents is given in a record within 10 days after it is received. (3) A contract that does not satisfy the requirements of subsection (1) but which is valid in other respects is enforceable: (a) if the goods are to be specially manufactured for the buyer and are not suitable for sale to others in the ordinary course of the seller's business and the seller, before notice of repudiation is received and under circumstances that reasonably indicate that the goods are for the buyer, has made either a substantial beginning of their manufacture or commitments for their procurement; (b) if the party against which enforcement is sought admits in the
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party's pleading, or in the party's testimony or otherwise under oath that a contract for sale was made, but the contract is not enforceable under this paragraph beyond the quantity of goods admitted; or (c) with respect to goods for which payment has been made and accepted or which have been received and accepted (Sec. 2-606). (4) A contract that is enforceable under this section is not unenforceable merely because it is not capable of being performed within one year or any other period after its making. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. The record required by subsection (1) need not contain all of the material terms of the contract, and the material terms that are stated need not be precise or accurate. All that is required is that the record aord a reasonable basis to determine that the oered oral evidence rests on a real transaction. The record may be written on a piece of paper or entered into a computer. It need not indicate which party is the buyer and which party is the seller. The only term which must appear is the quantity term. A term indicating the manner by which the quantity is determined is sucient. Thus, for example, a term indicating that the quantity is based on the output of the seller or the requirements of the buyer satises the requirement. See e.g., Advent Systems v. Unisys, 925 F.2d 670 (3rd Cir. 1991); Gestetner Corp. v. Case Equip. Co., 815 F.2d 806 (1st Cir. 1987). The same reasoning can be extended to a term that indicates that the contract is similar to, but does not qualify as, an output or requirement contract. See e.g., PMC Corp. v. Houston Wire and Cable Co. 797 A.2d 125 (N.H. 2002). Similarly, a term that refers to a master contract that provides a basis for determining a quantity satises this requirement. See e.g., Reigel Fiber Corp. v. Anderson Gin Co., 512 F.2d 784 (5th Cir.1975). If a specic amount is stated in the record, even if not accurately stated, recovery is limited to the stated amount. However, the price, time and place of payment or delivery, the general quality of the goods, or any particular warranties need not be included. Special emphasis must be placed on the permissibility of omitting the price term. In many valid contracts for sale the parties do not mention the price in express terms. The buyer is bound to pay and the seller to accept a reasonable price, which the trier of the fact will determine. Frequently the price is not mentioned at all since the parties have based their agreement on a price list or catalogue known to both of them, and the list or catalogue serves as an ecient safeguard against perjury. Also, market prices and valuations that are current in the vicinity constitute a similar check. Of course, if the price consists of goods rather than money, the quantity of goods must be stated. There are only three denite and invariable requirements for the memorandum made by subsection (1). First, the memorandum must evidence a contract for the sale of goods; second, the memorandum must be signed; and third, the memorandum must have a quantity term or a method to determine the quantity. 2. The prior version of subsection (1) began with the phrase Except as otherwise provided in this section. This language has been deleted. This change was made to provide that the statement of the three statutory exceptions in subsection (3) should not be read as limiting under subsection (1) the possibility that a promisor will be estopped to raise the statute-offrauds defense in appropriate cases. 3. Partial performance as a substitute for the required record can validate the contract only for the goods which have been accepted or for which payment has been made and accepted. Receipt and acceptance either of goods or of the price constitutes an unambiguous overt admission by both parties that a contract exists. If the court can make a just apportionment, therefore, the agreed price of any goods actually delivered can be recovered without a writing or, if the price has been paid, the seller can be forced to deliver an apportionable part of the goods. The overt actions of the parties make admissible evidence of the other terms of the contract necessary to a just apportionment. This is true even though the actions of the parties are not in themselves inconsistent with a dierent transaction such as a 66

Art. 2

Sales

2-201

consignment for resale or a mere loan of money. Part performance by the buyer requires that the buyer deliver something that is accepted by the seller as the performance. Thus, part payment may be made by money or check accepted by the seller. If the agreed price consists of goods or services, then they must also have been delivered and accepted. When the seller accepts partial payment for a single item the statute is satised as to that item. See Lockwood v. Smigel, 18 Cal App.3d 800, 99 Cal Rept. 289 (1971). 4. Between merchants, failure to answer a conrmation of a contract in a record that satises the requirements of subsection (1) against the sender within ten days of receipt renders the record sucient against the recipient. The only eect, however, is to take away from the party that fails to answer the defense of the Statute of Frauds. The burden of persuading the trier of fact that a contract was in fact made orally prior to the record conrmation is unaected. A merchant includes a person that by occupation purports to have knowledge or skill peculiar to the practices or goods involved in the transaction. Section 2-104(1) (emphasis supplied). Thus, a professional or a farmer should be considered a merchant because the practice of objecting to an improper conrmation ought to be familiar to any person in business. 5. Failure to satisfy the requirements of this section does not render the contract void for all purposes, but merely prevents it from being judicially enforced in favor of a party to the contract. For example, a buyer that takes possession of goods provided for in an oral contract which the seller has not meanwhile repudiated is not a trespasser. Nor would the statute-of-frauds provisions of this section be a defense to a third person that wrongfully induces a party to refuse to perform an oral contract, even though the injured party cannot maintain an action for damages against the party that refuses to perform. 6. It is not necessary that the record be delivered to anybody, nor is this section intended to displace decisions that have given eect to lost records. It need not be signed by both parties, but except as stated in subsection (2), it is not sucient against a party that has not signed it. Prior to a dispute, no one can determine which party's signature may be necessary, but from the time of contracting each party should be aware that it is the signature of the other which is important. 7. If the making of a contract is admitted in court, either in a written pleading, by stipulation or by oral statement before the court, or is admitted under oath but not in court, as by testimony in a deposition or an adavit led with a motion, no additional record is necessary. Subsection (3)(b) makes it impossible to admit the contract in these contexts, and assert that the Statute of Frauds is still a defense. However, in these circumstances, the contract is not conclusively established. The admission is evidential only against the maker and only for the facts admitted. As against the other party, it is not evidential at all. 8. Subsection (4), which was not in prior versions of this Article, repeals the one year provision of the Statute of Frauds for contracts for the sale of goods. The phrase any other applicable period recognizes that some state statutes apply to periods longer than one year. The confused and contradictory interpretations under the so-called one year clause are illustrated by C.R. Klewin, Inc. v. Flagship Properties, Inc., 600 A.2d 772 (Conn. 1991). Cross References: See Sections 1-201, 2-202, 2-207, 2-209 and 2-304. Point 1: Sections 2-211 thru 2-213. Point 4: Section 2-104 Denitional Cross References: Action. Section 1-201. Between merchants. Section 2-104. Buyer. Section 2-103. Contract. Section 1-201. Contract for sale. Section 2-106. Goods. Section 2-103. Notice. Section 1-202. Party. Section 1-201. Reasonable time. Section 1-205. Record. Section 2-103. 67

 2-201
Sale. Section 2-106. Seller. Section 2-103. Sign. Section 2-103.

Uniform Commercial Code

Art. 2

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-202. Final Expression in a Record: Parol or Extrinsic Evidence. (1) Terms with respect to which the conrmatory records of the parties agree or which are otherwise set forth in a record intended by the parties as a nal expression of their agreement with respect to such terms as are included therein may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be supplemented by evidence of: (a) course of performance, course of dealing, or usage of trade (Section 1-303); and (b) consistent additional terms unless the court nds the record to have been intended also as a complete and exclusive statement of the terms of the agreement. (2) Terms in a record may be explained by evidence of course of performance, course of dealing, or usage of trade without a preliminary determination by the court that the language used is ambiguous.
Legislative Note: The cross-references in subsection (1)(a) should not be changed if the jurisdiction has not adopted revised Article 1.

As amended in 2001 and 2003.

See Appendix I contained within revised Article 1 for material relating to changes made in text in 2001. See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (1) codies the parol evidence rule. The operation of this rule depends on the intention of both parties that the terms in a record are the nal expression of their agreement with respect to the included terms. Without this mutual intention to integrate the record, the parol evidence rule does not apply to exclude evidence of other terms allegedly agreed to prior to or contemporaneously with the record. Unless there is a nal record, these alleged terms are provable as part of the agreement by relevant evidence from any credible source. When each party sends a conrmatory record, mutual intention to integrate the agreement is presumed for terms with respect to which the conrmatory records of the parties agree. 2. Because a record is nal for the included terms (an integration), this does not mean that the parties intended that the record contain all the terms of their agreement (a total integration). If a record is nal but not complete and exclusive, it cannot be contradicted by evidence of prior agreements reected in a record or prior or contemporaneous oral agreements, but it can be supplemented by other evidence, drawn from any source, of consistent additional terms. Even if the record is nal, complete and exclusive, it can be supplemented by evidence of noncontradictory terms drawn from an applicable course of performance, course of dealing, or usage of trade unless those sources are carefully negated by a term in the record. If the record is nal, complete and exclusive it cannot be supplemented by evidence of terms drawn from other sources, even terms that are consistent with the record. 3. Whether a writing is nal, and whether a nal writing is also complete, are issues for the court. This section rejects any assumption that because a record has been worked out which is nal on some matters, it is to be taken as including all the matters agreed upon. If the additional terms are those that, if agreed upon, would certainly have been included in 68

Art. 2

Sales

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the document in the view of the court, then evidence of their alleged making must be kept from the trier of fact. This section is not intended to suggest what should be the evidentiary strength of a merger clause as evidence of the mutual intent that the record be nal and complete. That determination depends upon the particular circumstances of each case. 4. This section does not exclude evidence introduced to show that the contract is avoidable for misrepresentation, mistake, or duress, or that the contract or a term is unenforceable because of unconscionability. This section also does not operate to exclude evidence of a subsequent modication or evidence that, for the purpose of claiming excuse, both parties assumed that a certain event would not occur. 5. Issues of interpretation are generally left to the courts. In interpreting terms in a record, subsection (2) permits either party to introduce evidence drawn from a course of performance, a course of dealing, or a usage of trade without any preliminary determination by the court that the term at issue is ambiguous. This article takes no position on whether a preliminary determination of ambiguity is a condition to the admissibility of evidence drawn from any other source or on whether a contract clause can exclude an otherwise applicable implied-in-fact source. Cross References: Point 2: Sections 2-206 and 2-207. Point 3: Section 2-207. Point 4: Section 2-302 Denitional Cross References: Agreement. Section 1-201. Course of dealing. Section 1-303. Course of performance. Section 1-303. Parties. Section 1-201. Record. Section 2-103. Term. Section 1-201. Usage of trade. Section 1-303.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-203. Seals Inoperative. The axing of a seal to a record evidencing a contract for sale or an oer to buy or sell goods does not constitute the record a sealed instrument. The law with respect to sealed instruments does not apply to such a contract or oer. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Section 3, Uniform Sales Act. Changes: Portion pertaining to seals rewritten. Purposes of Changes: 1. This section makes it clear that every eect of the seal which relates to sealed instruments as such is wiped out insofar as contracts for sale are concerned. However, the substantial eects of a seal, except extension of the period of limitations, may be had by appropriate drafting as in the case of rm oers (see Section 2-205). 2. This section leaves untouched any aspects of a seal which relate merely to signatures or to authentication of execution and the like. Thus, a statute providing that a purported signature gives prima facie evidence of its own authenticity or that a signature gives prima facie evidence of consideration is still applicable to sales transactions even though a seal may be held to be a signature within the meaning of such a statute. Similarly, the authorized axing of a corporate seal bearing the corporate name to a contractual writing purporting to be made by the corporation may have eect as a signature without any reference to the law of sealed instruments. 69

 2-203

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Art. 2

Cross Reference: Point 1: Section 2-205. Denitional Cross References: Contract for sale. Section 2-106. Goods. Section 2-103. Record. Section 2-103.

2-204. Formation in General. (1) A contract for sale of goods may be made in any manner sucient to show agreement, including oer and acceptance, conduct by both parties which recognizes the existence of a contract, the interaction of electronic agents, and the interaction of an electronic agent and an individual. (2) An agreement sucient to constitute a contract for sale may be found even if the moment of its making is undetermined. (3) Even if one or more terms are left open, a contract for sale does not fail for indeniteness if the parties have intended to make a contract and there is a reasonably certain basis for giving an appropriate remedy. (4) Except as otherwise provided in Sections 2-211 through 2-213, the following rules apply: (a) A contract may be formed by the interaction of electronic agents of the parties, even if no individual was aware of or reviewed the electronic agents' actions or the resulting terms and agreements. (b) A contract may be formed by the interaction of an electronic agent and an individual acting on the individual's own behalf or for another person. A contract is formed if the individual takes actions that the individual is free to refuse to take or makes a statement, and the individual has reason to know that the actions or statement will: (i) cause the electronic agent to complete the transaction or performance; or (ii) indicate acceptance of an oer, regardless of other expressions or actions by the individual to which the electronic agent cannot react. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (1) sets forth the basic policy to recognize any manner of expression of agreement. In addition to traditional contract formation by oral or written agreement, or by performance, subsection (1) provides that an agreement may be made by electronic means. Regardless of how the agreement is formed under this section, the legal eect of the agreement is subject to the other provisions of this Article. 2. Under subsection (1), appropriate conduct by the parties may be sucient to establish an agreement. Subsection (2) is directed primarily when the correspondence does not disclose the exact point at which the agreement was formed, but the conduct of the parties indicate that a binding obligation has been undertaken. 3. Subsection (3) states the principle for open terms which underlies later sections of this Article. If the parties intend to enter into a binding agreement, this subsection recognizes the agreement as valid in law, despite missing terms, if there is any reasonably certain basis for granting a remedy based on commercial standards of indeniteness. Neither certainty for what the parties were to do nor a nding of the exact amount of damages is required. Neither is the fact that one or more terms are left to be agreed upon enough by itself to defeat an otherwise adequate agreement. This Act makes provision elsewhere for missing terms needed for performance, open price, remedies and the like. 70

Art. 2

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2-205

The more terms the parties leave open, the less likely it is that the parties have intended to conclude a binding agreement, but their actions may be conclusive on the matter despite the omissions. 4. Subsections (4)(a) and (b) are derived from Sections 14(a) and (b) of the Uniform Electronic Transactions Act. Subsection (4)(a) conrms that contracts may be formed by machines functioning as electronic agents for the parties to a transaction. This subsection is intended to negate any claim that lack of human intent, at the time of contract formation, prevents contract formation. When machines are involved, the requisite intention to contract ows from the programing and use of the machine. This provision, along with sections 2-211, 2-212, and 2-213, is intended to remove barriers to electronic contract formation. 5. When the requisite intent to enter into a contract exists, subsection (4)(b) validates contracts formed by an individual and an electronic agent. This subsection validates an anonymous click-through transaction. As with subsection (4)(a), the intent to contract by means of an electronic agent comes from the programing and use of the machine. The requisite intent to contract by the individual is found by the acts of the individual that the individual has reason to know will be interpreted by the machine as allowing the machine to complete the transaction or performance, or that will be interpreted by the machine as signifying acceptance on the part of the individual. This intent is only found, though, when the individual is free to refuse to take the actions that the machine will interpret as acceptance or allowance to complete the transaction. For example, if A goes to a website that provides for purchasing goods over the Internet, and after choosing items to be purchased is confronted by a screen which advises her that the transaction will be completed if A clicks I agree, then A will be bound by the click if A knew or had reason to know that the click would be interpreted as signifying acceptance and A was also free to refuse to take the nal action. This provision does not, however, provide for a determination of what terms exist in the agreement. That question is governed by Section 2-207. 6. Nothing in this section is intended to restrict equitable defenses, such as fraud or mistake, in electronic contract formation. However, because the law of electronic mistake is not well developed, and because factual issues may arise that are not easily resolved by legal standards developed for nonelectronic transactions, courts should not automatically apply standards developed in other contexts. The specic dierences between electronic and nonelectronic transactions should also be factored in to resolve equitable claims in electronic contracts. Cross References: Point 1: Sections 1-103, 2-201, 2-211 thru 2-213. and 2-302. Point 2: Sections 2-205 through 2-209. Point 3: See Part 3. Point 4: Sections 2-211 thru 2-213. Point 5: Sections 2-211 thru 2-213. Denitional Cross References: Agreement. Section 1-201. Contract. Section 1-201. Contract for sale. Section 2-106. Electronic. Section 2-103. Electronic agent. Section 2-103. Goods. Section 2-103. Party. Section 1-201. Remedy. Section 1-201. Term. Section 1-201.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-205. Firm Oers. An oer by a merchant to buy or sell goods in a signed record that by its terms gives assurance that it will be held open is not revocable, for lack of
71

 2-205

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Art. 2

consideration, during the time stated or if no time is stated for a reasonable time, but in no event may the period of irrevocability exceed three months. Any such term of assurance in a form supplied by the oeree must be separately signed by the oeror. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Sections 1 and 3, Uniform Sales Act. Changes: Completely rewritten by this and other sections of this Article. Purposes of Changes: 1. This section is intended to modify the former rule which required that rm oers be sustained by consideration in order to bind, and to require instead that they must merely be characterized as such and expressed in signed writings. 2. The primary purpose of this section is to give eect to the deliberate intention of a merchant to make a current rm oer binding. The deliberation is shown in the case of an individualized document by the merchant's signature to the oer, and in the case of an oer included on a form supplied by the other party to the transaction by the separate signing of the particular clause which contains the oer. Signed here also includes authentication but the reasonableness of the authentication herein allowed must be determined in the light of the purpose of the section. The circumstances surrounding the signing may justify something less than a formal signature or initialing but typically the kind of authentication involved here would consist of a minimum of initialing of the clause involved. A handwritten memorandum on the writer's letterhead purporting in its terms to conrm a rm oer already made would be enough to satisfy this section, although not subscribed, since under the circumstances it could not be considered a memorandum of mere negotiation and it would adequately show its own authenticity. Similarly, an authorized telegram will suce, and this is true even though the original draft contained only a typewritten signature. However, despite settled courses of dealing or usages of the trade whereby rm oers are made by oral communication and relied upon without more evidence, such oers remain revocable under this Article since authentication by a writing is the essence of this section. 3. This section is intended to apply to current rm oers and not to long term options, and an outside time limit of three months during which such oers remain irrevocable has been set. The three month period during which rm oers remain irrevocable under this section need not be stated by days or by date. If the oer states that it is guaranteed or rm until the happening of a contingency which will occur within the three month period, it will remain irrevocable until that event. A promise made for a longer period will operate under this section to bind the oeror only for the rst three months of the period but may of course be renewed. If supported by consideration it may continue for as long as the parties specify. This section deals only with the oer which is not supported by consideration. 4. Protection is aorded against the inadvertent signing of a rm oer when contained in a form prepared by the oeree by requiring that such a clause be separately authenticated. If the oer clause is called to the oeror's attention and he separately authenticates it, he will be bound; Section 2-302 may operate, however, to prevent an unconscionable result which otherwise would ow from other terms appearing in the form. 5. Safeguards are provided to oer relief in the case of material mistake by virtue of the requirement of good faith and the general law of mistake. Cross References: Point 1: Section 1-102. Point 2: Section 1-102. Point 3: Section 2-201. Point 5: Section 2-302. Denitional Cross References: Goods. Section 2-103. Merchant. Section 2-104. Record. Section 2-103. Signed. Section 2-103. 72

Art. 2

Sales

2-206

2-206. Oer and Acceptance in Formation of Contract. (1) Unless otherwise unambiguously indicated by the language or circumstances: (a) an oer to make a contract shall be construed as inviting acceptance in any manner and by any medium reasonable in the circumstances; (b) an order or other oer to buy goods for prompt or current shipment shall be construed as inviting acceptance either by a prompt promise to ship or by the prompt or current shipment of conforming or nonconforming goods, but the shipment of nonconforming goods is not an acceptance if the seller seasonably noties the buyer that the shipment is oered only as an accommodation to the buyer. (2) If the beginning of a requested performance is a reasonable mode of acceptance, an oeror that is not notied of acceptance within a reasonable time may treat the oer as having lapsed before acceptance. (3) A denite and seasonable expression of acceptance in a record operates as an acceptance even if it contains terms additional to or dierent from the oer. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (1)(b) deals with a shipment that contains defective goods which is made following an order for the goods. The nonconforming shipment is normally understood as intended to close the bargain even though it constitutes a breach. However, the seller by stating that the shipment is nonconforming and is oered only as an accommodation to the buyer keeps the shipment of from operating as an acceptance. 2. The mirror image rule is rejected in subsection (3), but any responsive record must still be reasonably understood as an acceptance and not as a proposal for a dierent transaction. See Ocial Comment 2 to Section 2-207. 3. Subsection (3) makes it clear that an expression of acceptance can operate as an acceptance (i.e., create a contract) even though it contains terms that are not identical to those in the oer. This rule applies, however, only to an expression of acceptance that is not only seasonable but also denite. A purported expression of acceptance containing additional or dierent terms would not be a denite acceptance when the oeree's expression clearly communicates to the oeror the oeree's unwillingness to do business unless the oeror assents to those additional or dierent terms. This is not a denite acceptance since the offeree's expression makes it clear that the oeree is not accepting anything; but rather that the oeree is indicating a willingness to do business only on the oeree's terms and that the oeree is awaiting the oeror's assent to those terms. (This result is consistent with the nal clause of former Section 2-207(1).) In a situation in which the oer clearly indicates that the oeror is unwilling to do business on any terms other than those contained in the oer, and the oeree responds with an expression of acceptance that contains additional or dierent terms, a court could also conclude that the oeree's response does not constitute a denite expression of acceptance. Denitional Cross References: Buyer. Section 2-103. Conforming. Section 2-106. Contract. Section 1-201. Goods. Section 2-103. Noties. Section 1-202. Reasonable time. Section 1-205.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.
73

 2-207

Uniform Commercial Code

Art. 2

2-207. Terms of Contract; Eect of Conrmation. Subject to Section 2-202, if (i) conduct by both parties recognizes the existence of a contract although their records do not otherwise establish a contract, (ii) a contract is formed by an oer and acceptance, or (iii) a contract formed in any manner is conrmed by a record that contains terms additional to or dierent from those in the contract being conrmed, the terms of the contract are: (a) terms that appear in the records of both parties; (b) terms, whether in a record or not, to which both parties agree; and (c) terms supplied or incorporated under any provision of this Act. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. This section applies to all contracts for the sale of goods, and it is not limited only to those contracts where there has been a battle of the forms. 2. This section applies only when a contract has been created under another section of this Article. The purpose of this section is solely to determine the terms of the contract. When forms are exchanged before or during performance, the result from the application of this section diers from the prior Section 2-207 of this Article and the common law in that this section gives no preference to either the rst or the last form; the same test is applied to the terms in each. Terms in a record that insist on all of that record's terms and no other terms as a condition of contract formation have no eect on the operation of this section. When one party insists in that party's record that its own terms are a condition to contract formation, if that party does not subsequently perform or otherwise acknowledge the existence of a contract, if the other party does not agree to those terms, the record's insistence on its own terms will keep a contract from being formed under Sections 2-204 or 2-206, and this section is not applicable. As with original Section 2-207, the courts will have to distinguish between conrmations that are addressed in this section and modications that are addressed in Section 2-209. 3. Terms of a contract may be found not only in the consistent terms of records of the parties but also from a straightforward acceptance of an oer, and an expression of acceptance accompanied by one or more additional terms might demonstrate the oeree's agreement to the terms of the oer. If, for example, a buyer sent a purchase order with technical specications and the seller responded with a record stating Thank you for your order. We will ll it promptly. Note that we do not make deliveries after 3:00 p.m. on Fridays. it might be reasonable to conclude that both parties agreed to the technical specications. Similarly, an oeree's performance is sometimes the acceptance of an oer. If, for example, a buyer sends a purchase order, there is no oral or other agreement, and the seller delivers the goods in response to the purchase order-but the seller does not send the seller's own acknowledgment or acceptance-the seller should normally be treated as having agreed to the terms of the purchase order. If, however, parties exchange records with conicting or inconsistent terms, but conduct by both parties recognizes the existence of a contract, subsection (a) provides that the terms of the contract are terms that appear in the records of both parties. But even when both parties send records, there could be nonverbal agreement to additional or dierent terms that appear in only one of two records. If, for example, both parties' forms called for the sale of 700,000 nuts and bolts but the purchase order or another record of the buyer conditioned the sale on a test of a sample to see if the nuts and bolts would perform properly, the seller's sending a small sample to the buyer might be construed to be an agreement to the buyer's condition. It might also be found that the contract called for arbitration when both forms provided for arbitration but each contained immaterially different arbitration provisions. In a rare case the terms in the records of both parties might not become part of the contract. This could be the case, for example, when the parties contemplated an agreement to a single negotiated record, and each party submitted to the other party similar proposals 74

Art. 2

Sales

2-209

and then commenced performance, but the parties never reached a negotiated agreement because of the dierences over crucial terms. There is a variety of verbal and nonverbal behavior that may be suggest agreement to another's record. This section leaves the interpretation of that behavior to the discretion of the courts. 4. An agreement may include terms derived from a course of performance, a course of dealing, and usage of trade. See Sections 1-201(a)(2) and 1-303. If the members of a trade, or if the contracting parties, expect to be bound by a term that appears in the record of only one of the contracting parties, that term is part of the agreement. However, repeated use of a particular term or repeated failure to object to a term on another's record is not normally sucient in itself to establish a course of performance, a course of dealing or a trade usage. 5. The section omits any specic treatment of terms attached to the goods, or in or on the container in which the goods are delivered. This article takes no position on whether a court should follow the reasoning in Step-Saver Data Systems, Inc. v. Wyse Technology, 939 F.2d 91 (3d Cir. 1991) and Klocek v. Gateway, Inc., 104 F. Supp. 2d 1332 (D. Kan. 2000) (original 2-207 governs) or the contrary reasoning in Hill v. Gateway 2000, 105 F. 3d 1147(7th Cir. 1997) (original 2-207 inapplicable). Cross References: Point 1: Sections 2-204 and 2-206. Point 2: Sections 2-204, 2-206, and 2-209. Point 3: Sections 1-303, 2-204, 2-206, and 2-209. Point 4: Sections 1-201, and 1-303. Denitional Cross References: Acceptance. Section 2-206. Agree. Section 1-201. Contract. Section 1-201. Oer. Section 2-204. Parties. Section 1-201. Records. Section 2-103. Terms. Section 1-201.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-208. Reserved.
Legislative Note: This section should not be repealed if the jurisdiction has not adopted revised Article 1.

2-209. Modication; Rescission and Waiver. (1) An agreement modifying a contract within this Article needs no consideration to be binding. (2) An agreement in a signed record which excludes modication or rescission except by a signed record may not be otherwise modied or rescinded, but except as between merchants such a requirement in a form supplied by the merchant must be separately signed by the other party. (3) The requirements of Section 2-201 must be satised if the contract as modied is within its provisions. (4) Although an attempt at modication or rescission does not satisfy the requirements of subsection (2) or (3), it may operate as a waiver. (5) A party that has made a waiver aecting an executory portion of a contract may retract the waiver by reasonable notication received by the other party that strict performance will be required of any term waived, unless the retraction would be unjust in view of a material change of position in reliance on the waiver.
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 2-209

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Art. 2

As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Subsection (1)Compare Section 1, Uniform Written Obligations Act; Subsections (2) to (5)none. Purposes of Changes and New Matter: 1. This section seeks to protect and make eective all necessary and desirable modications of sales contracts without regard to the technicalities which at present hamper such adjustments. 2. Subsection (1) provides that an agreement modifying a sales contract needs no consideration to be binding. However, modications made thereunder must meet the test of good faith imposed by this Act. The eective use of bad faith to escape performance on the original contract terms is barred, and the extortion of a modication without legitimate commercial reason is ineective as a violation of the duty of good faith. Nor can a mere technical consideration support a modication made in bad faith. The test of good faith between merchants or as against merchants includes observance of reasonable commercial standards of fair dealing in the trade (Section 2-103), and may in some situations require an objectively demonstrable reason for seeking a modication. But such matters as a market shift which makes performance come to involve a loss may provide such a reason even though there is no such unforeseen diculty as would make out a legal excuse from performance under Sections 2-615 and 2-616. 3. Subsections (2) and (3) are intended to protect against false allegations of oral modications. Modication or rescission includes abandonment or other change by mutual consent, contrary to the decision in Green v. Doniger, 300 N.Y. 238, 90 N.E.2d 56 (1949); it does not include unilateral termination or cancellation as dened in Section 2-106. The Statute of Frauds provisions of this Article are expressly applied to modications by subsection (3). Under those provisions the delivery and acceptance test is limited to the goods which have been accepted, that is, to the past. Modication for the future cannot therefore be conjured up by oral testimony if the price involved is $500.00 or more since such modication must be shown at least by an authenticated memo. And since a memo is limited in its eect to the quantity of goods set forth in it there is safeguard against oral evidence. Subsection (2) permits the parties in eect to make their own Statute of Frauds as regards any future modication of the contract by giving eect to a clause in a signed agreement which expressly requires any modication to be by signed writing. But note that if a consumer is to be held to such a clause on a form supplied by a merchant it must be separately signed. 4. Subsection (4) is intended, despite the provisions of subsections (2) and (3), to prevent contractual provisions excluding modication except by a signed writing from limiting in other respects the legal eect of the parties' actual later conduct. The eect of such conduct as a waiver is further regulated in subsection (5). Cross References: Point 1: Section 1-203. Point 2: Sections 1-201, 1-203, 2-615 and 2-616. Point 3: Sections 2-106, 2-201 and 2-202. Point 4: Sections 2-202. Denitional Cross References: Agreement. Section 1-201. Between merchants. Section 2-104. Contract. Section 1-201. Merchant. Section 2-104. Notication. Section 1-202. Signed. Section 1-201. Term. Section 1-201. 76

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2-210. Delegation of Performance; Assignment of Rights. (1) If the seller or buyer assigns rights under a contract, the following rules apply: (a) Subject to paragraph (b) and except as otherwise provided in Section 9-406 or as otherwise agreed, all rights of the seller or the buyer may be assigned unless the assignment would materially change the duty of the other party, increase materially the burden or risk imposed on that party by the contract, or impair materially that party's chance of obtaining return performance. A right to damages for breach of the whole contract or a right arising out of the assignor's due performance of its entire obligation may be assigned despite an agreement otherwise. (b) The creation, attachment, perfection, or enforcement of a security interest in the seller's interest under a contract is not an assignment that materially changes the duty of or materially increases the burden or risk imposed on the buyer or materially impairs the buyer's chance of obtaining return performance under paragraph (a) unless, and only to the extent that, enforcement of the security interest results in a delegation of a material performance of the seller. Even in that event, the creation, attachment, perfection, and enforcement of the security interest remain eective. However, the seller is liable to the buyer for damages caused by the delegation to the extent that the damages could not reasonably be prevented by the buyer, and a court may grant other appropriate relief, including cancellation of the contract or an injunction against enforcement of the security interest or consummation of the enforcement. (2) If the seller or buyer delegates performance of its duties under a contract, the following rules apply: (a) A party may perform its duties through a delegate unless otherwise agreed or unless the other party has a substantial interest in having the original promisor perform or control the acts required by the contract. Delegation of performance does not relieve the delegating party of any duty to perform or liability for breach. (b) Acceptance of a delegation of duties by the assignee constitutes a promise to perform those duties. The promise is enforceable by either the assignor or the other party to the original contract. (c) The other party may treat any delegation of duties as creating reasonable grounds for insecurity and may without prejudice to its rights against the assignor demand assurances from the assignee under Section 2-609. (d) A contractual term prohibiting the delegation of duties otherwise delegable under paragraph (a) is enforceable, and an attempted delegation is not eective. (3) An assignment of the contract or of all my rights under the contract or an assignment in similar general terms is an assignment of rights and unless the language or the circumstances, as in an assignment for security, indicate the contrary, it is also a delegation of performance of the duties of the assignor. (4) Unless the circumstances indicate the contrary, a prohibition of assignment of the contract is to be construed as barring only the delegation to the assignee of the assignor's performance.
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As amended in 1999 and 2003.

See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999. See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. This section conforms with revised Article 9. 2. The principles in this section are consistent with the recognition that both the assignment of rights and the delegation of duties are generally normal and permissible incidents of a contract for the sale of goods. 3. Subsection (1)(a) sets out the eect of an assignment by either the seller or the buyer of the rights but not the duties arising under the contract for sale. These rights may effectively be assigned to a third party unless the assignment materially increases the duty, burden or risk, or materially impairs expected performance to the other party, or, subject to subsection (1)(b) and Section 9-406, unless the parties have agreed otherwise. Even then, a right to damages for breach of the whole contract or a right arising out of the assignor's due performance of the assignor's entire obligation can be assigned despite contrary agreement. An assignment, however, is not eective if it would materially change the duty of the other party, increase materially the burden or risk imposed on that party by the contract, or increase materially that party's likelihood of obtaining return performance. Subsection (1)(a). The cases where these limitations apply are rare. For example, a seller that has fully performed the contract should always be able to assign the right to payment. This is the basis for most accounts receivable nancing. If, however, the contract is still executory, the assignment of the right to payment to a third person might decrease the seller's incentive to perform and, thus, increase the buyer's risk. Similarly, the buyer's assignment of the right to receive a xed quantity of goods should not usually be objectionable but if the parties have a requirements contract, the assignment could increase materially the seller's risk. Subsection (1)(a) is subject to Section 9-406 of revised Article 9. That provision makes rights to payment for goods sold (accounts), whether or not earned, freely alienable notwithstanding a contrary agreement or rule of law. 4. Subsection (1)(a) is subject to subsection (1)(b), which conforms with revised Article 9. If an assignment of rights creates a security interest in the seller's interest under the contract, including a right to future payments, subsection (1)(b) states that there is no material impairment under subsection (1)(a) unless the creation, attachment, perfection and enforcement results in a delegation of material performance of the seller. This is unlikely in most assignments, and the buyer's basic protection is to demand adequate assurance of due performance from the seller if the assignment creates reasonable grounds for insecurity. 5. Occasionally a seller or buyer will delegate duties under the contract without also assigning rights. For example, a dealer might delegate its duty to procure and deliver a xed quantity of goods to the buyer to a third party. In these cases, subsection (2) sets the limitations on that power. A contract term prohibiting the delegation of duties renders an attempted delegation ineective. Subsection (2)(d). If the third person accepts the delegation, an enforceable promise is made both to the delegator and the person entitled under the contract to perform those duties. Subsection (2)(b). In short, as to the person entitled under the contract a third party beneciary contract is created. However, the delegator's duty to perform under the contract is not discharged unless the person entitled to performance agrees to substitute the delegatee for the delegator (a novation). See subsection (2)(a), last sentence. The person entitled under the contract may treat any delegation of duties as reasonable grounds for insecurity and may demand adequate assurance of due performance for the assignee-delegatee. Subsection (2)(c). In any event, a delegation of duties is not eective if the person entitled under the contract has a substantial interest in having the original promisor perform or control the performance required by the contract. Subsection (2)(a). 6. In the case of ambiguity, subsection (3) provides a rule of interpretation to determine when an assignment of rights should also be considered a delegation of duties. The preference is to construe the language as both a delegation of duties as well as an assignment of 78

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rights. 7. This section is not intended as a complete statement of the law of delegation and assignment but is limited to clarifying a few points doubtful under the case law. In particular, neither this section nor this Article touches directly on the questions as the need or effect of notice of the assignment, the rights of successive assignees, or any question of the form of an assignment, either as between the parties or as against any third parties. Some of these questions are dealt with in Article 9. Cross References: Point 1: Article 9. Point 3: Articles 5 and 9. Point 4: Article 9. Point 5: Sections 2-318, 2-609 Point 7: Article 9. Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Contract. Section 1-201. Party. Section 1-201. Rights. Section 1-201. Seller. Section 2-103. Term. Section 1-201.

2-211. Legal Recognition of Electronic Contracts, Records, and Signatures. (1) A record or signature may not be denied legal eect or enforceability solely because it is in electronic form. (2) A contract may not be denied legal eect or enforceability solely because an electronic record was used in its formation. (3) This article does not require a record or signature to be created, generated, sent, communicated, received, stored, or otherwise processed by electronic means or in electronic form. (4) A contract formed by the interaction of an individual and an electronic agent under Section 2-204(4)(b) does not include terms provided by the individual if the individual had reason to know that the agent could not react to the terms as provided. As added in 2003. Ocial Comment
1. Subsections (1) and (2) are derived from Section 7(a) and (b) of the Uniform Electronic Transactions Act (UETA), and subsection (3) is derived from Section 5(b) of UETA. Subsection (4) is based on Section 206(c) of the Uniform Computer Information Transactions Act (UCITA). Each subsection conforms to the federal Electronic Signatures in Global and National Commerce Act (15 U.S.C. 7001 et seq.). 2. This section sets forth the premise that the medium in which a record, signature, or contract is created, presented or retained does not aect its legal signicance. Subsections (1) and (2) are designed to eliminate the single element of medium as a reason to deny effect or enforceability to a record, signature, or contract. The fact that the information is set forth in an electronic, as opposed to paper, medium is irrelevant. 3. A contract may have legal eect and yet be unenforceable. See Restatement 2d Contracts Section 8. To the extent that a contract in electronic form may have legal eect but be unenforceable, because it is in electronic form, subsection (2) validates its legality. Likewise, to the extent that a record or signature in electronic form may have legal eect but be unenforceable, because it is in electronic form, subsection (1) validates the legality of the record or signature. For example, though a contract may be unenforceable, the parties' electronic records may 79

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have collateral eects, as in the case of a buyer that insures goods purchased under a contract that is unenforceable under Section 2-201. The insurance company may not deny a claim on the ground that the buyer is not the owner, though the buyer may have no direct remedy against the seller for failure to deliver. See Restatement 2d Contracts, Section 8, Illustration 4. Whether an electronic record or signature is valid under other law is not addressed by this Act. 4. While subsection (2) validates the legality of an electronic contract, it does not in any way diminish the requirements for the formation of contracts under Sections 2-204 and 2-206. Cross References: Point 3: Section 2-201 Point 4: Section 2-204 and 2-206. Denitional Cross References: Contract. Section 1-201. Electronic. Section 2-103. Electronic agent. Section 2-103. Electronic record. Section 2-103. Record. Section 2-103. Signature. Section 2-103.

2-212. Attribution. An electronic record or electronic signature is attributable to a person if it was the act of the person or the person's electronic agent or the person is otherwise legally bound by the act. As added in 2003. Ocial Comment
1. This section is based on Section 9 of the Uniform Electronic Transactions Act (UETA). 2. As long as an electronic record is created by a person or the electronic signature results from a person's action it is attributed to that person. The legal eect of the attribution is derived from other provisions of this Act or from other law. This section simply assures that these rules will be applied in the electronic environment. A person's actions include actions taken by a human agent of the person as well as actions taken by an electronic agent, of the person. Although this section may appear to state the obvious, it assures that the record or signature is not ascribed to a machine, as opposed to the person operating or programming the machine. 3. In each of the following cases, both the electronic record and electronic signature would be attributable to a person under this section: A. The person types his or her name as part of an e-mail purchase order; B. The person's employee, pursuant to authority, types the person's name as part of an e-mail purchase order; C. The person's computer, programmed to order goods upon receipt of inventory information within particular parameters, issues a purchase order which includes the person's name, or other identifying information, as part of the order. In each of these cases, law other than this Act would ascribe both the signature and the action to the person if done in a paper medium. This section provides that the same result will occur when an electronic medium is used. 4. Nothing in this section aects the use of an electronic signature as a means of attributing a record to a person. Once an electronic signature is attributed to the person, the electronic record with which it is associated would also be attributed to the person unless the person established fraud, forgery, or other invalidating cause. However, an electronic signature is not the only method for attribution of a record. 5. In the context of attribution of records, normally the content of the record will provide the necessary information for a nding of attribution. It is also possible that an established course of dealing between parties may result in a nding of attribution. Just as with a paper record, evidence of forgery or counterfeiting may be introduced to rebut the evidence of attribution. The use of facsimile transmissions provides a number of examples of attribu80

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tion using information other than a signature. A facsimile may be attributed to a person because of the information printed across the top of the page that indicates the machine from which it was sent. Similarly, the transmission may contain a letterhead which identies the sender. Some cases have held that the letterhead actually constituted a signature because it was a symbol adopted by the sender with intent to sign the record. See Cox Engineering v. Funston Mach. & Supply, 749 S.W.2d 508, 511 (Tex. App.1988) (plainti's letterhead, including address, appearing at top of invoice, provides authentication that identies the party to be charged and thus satises the statute of frauds' signature requirement); Owen v. Kroger Co., 936 F. Supp. 579 (S.D. Ind. 1996) (determining that a letterhead satises the signature requirement of the UCC). However, the signature determination resulted from the necessary nding of intention in that case. Other cases have found letterheads not to be signatures because the requisite intention was not present. See First National Bank in Alamosa v. Ford Motor Credit Co., 748 F. Supp 1464 (D. Colo, 1990) (determining that a pre-printed name on a draft was not a signature for the purpose of accepting a draft). The critical point is that with or without a signature, information within the electronic record may well suce to provide the facts resulting in attribution of an electronic record to a particular party. 6. Certain information may be present in an electronic environment that does not appear to attribute but which clearly links a person to a particular record. Numerical codes, personal identication numbers, public and private key combinations, all serve to establish the party to which an electronic record should be attributed. Security procedures will be another piece of evidence available to establish attribution. 7. Once it is established that a record or signature is attributable to a particular person, the legal signicance of the record or signature is determined by the context and surrounding circumstances in which the recorder signature is created, including the parties' agreement, if any. This will primarily be governed by other sections of this article. See, e.g., Sections 2-201, 2-202, 2-204, 2-206, 2-207, and 2-209. Cross References: Point 3: Section 2-201. Point 5: Section 1-303. Point 7: Sections 2-201, 2-202, 2-204, 2-206, and 2-209. Denitional Cross References: Electronic. Section 2-103. Electronic agent. Section 2-103. Electronic record. Section 2-103. Record. Section 2-103. Signature. Section 2-103.

2-213. Electronic Communication. (1) If the receipt of an electronic communication has a legal eect, it has that eect even if no individual is aware of its receipt. (2) Receipt of an electronic acknowledgment of an electronic communication establishes that the communication was received but, in itself, does not establish that the content sent corresponds to the content received. As added in 2003. Ocial Comment
1. This section is adapted from Sections 15(e) and (f) of the Uniform Electronic Transactions Act (UETA). 2. This section deals with electronic communications generally, and it is not limited to electronic records which must be retrievable in perceivable form. The section does not resolve the questions of when or where electronic communications are determined to be sent or received, nor does it indicate that a communication has any particular substantive legal eect. 3. Under subsection (1), receipt is not dependent on a person having notice of the communication. An analogy in a paper based transaction is the recipient that does not read a notice received in the mail. Although receipt as dened in Article 1 applies by its terms 81

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only to notices, the same concept would apply equally to a communication that is not a notice. 4. Subsection (2) provides legal certainty about the eect of an electronic acknowledgment. This subsection only addresses the fact of the receipt, and it does not set forth the legal signicance of the quality of the content, nor whether the electronic communication was read or opened. 5. This section does not address the question of whether the exchange of electronic communications constitutes the formation of a contract. Those questions are addressed by Sections 2-204 and 2-206. Cross References: Point 5: Section 2-204 and 2-206. Denitional Cross References: Electronic. Section 2-103. Sent. Section 1-201.

PART 3. GENERAL OBLIGATION AND CONSTRUCTION OF CONTRACT

2-301. General Obligations of Parties. The obligation of the seller is to transfer and deliver and that of the buyer is to accept and pay in accordance with the contract. Ocial Comment
Prior Uniform Statutory Provision: Sections 11 and 41, Uniform Sales Act. Changes: Rewritten. Purposes of Changes: This section uses the term obligation in contrast to the term duty in order to provide for the condition aspects of delivery and payment insofar as they are not modied by other sections of this Article such as those on cure of tender. It thus replaces not only the general provisions of the Uniform Sales Act on the parties' duties, but also the general provisions of that Act on the eect of conditions. In order to determine what is in accordance with the contract under this Article usage of trade, course of dealing and performance, and the general background of circumstances must be given due consideration in conjunction with the lay meaning of the words used to dene the scope of the conditions and duties. Cross References: Section 1-106, 1-205, 2-209, 2-508 and 2-612. Denitional Cross References: Buyer. Section 2-103. Contract. Section 1-201. Party. Section 1-201. Seller. Section 2-103.

2-302. Unconscionable Contract or Term. (1) If the court as a matter of law nds the contract or any term of the contract to have been unconscionable at the time it was made, the court may refuse to enforce the contract, or it may enforce the remainder of the contract without the unconscionable term, or it may so limit the application of any unconscionable term as to avoid any unconscionable result. (2) If it is claimed or appears to the court that the contract or any term thereof may be unconscionable, the parties shall be aorded a reasonable opportunity to present evidence as to its commercial setting, purpose, and eect to aid the court in making the determination. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.
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Ocial Comment
1. This section makes it possible for a court to police explicitly against the contracts or terms which the court nds to be unconscionable instead of attempting to achieve the result by an adverse construction of language, by manipulation of the rules of oer and acceptance, or by a determination that the term is contrary to public policy or to the dominant purpose of the contract. The section allows a court to pass directly on the unconscionability of the contract or a particular term of the contract and to make a conclusion of law as to its unconscionability. Courts have been particularly vigilant when the contract at issue is set forth in a standard form. The principle is one of prevention of oppression and unfair surprise and not of disturbance of allocation of risks because of superior bargaining power. The basic test is whether, in the light of the general commercial background and the commercial needs of the particular trade or case, the term or contract involved is so one-sided as to be unconscionable under the circumstances existing at the time of the making of the contract. 2. Under this section, the court, in its discretion, may refuse to enforce the contract as a whole if the whole contract is determined to be unconscionable, or the court may strike any single term or group of terms which are unconscionable or which are contrary to the essential purpose of the agreement or to material terms to which the parties have expressly agreed, or the court may simply limits the unconscionable results. 3. This section is addressed to the court, and the decision is to be made by the court. The evidence referred to in subsection (2) is for the court's consideration, not the trier of fact. Only the agreement which results from the court's action on these matters is to be submitted to the general trier of the facts. Denitional Cross Reference: Contract. Section 1-201. Term. Section 1-201.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-303. Allocation or Division of Risks. Where this Article allocates a risk or a burden as between the parties unless otherwise agreed, the agreement may not only shift the allocation but may also divide the risk or burden. Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: 1. This section is intended to make it clear that the parties may modify or allocate unless otherwise agreed risks or burdens imposed by this Article as they desire, always subject, of course, to the provisions on unconscionability. Compare Section 1-102(4). 2. The risk or burden may be divided by the express terms of the agreement or by the attending circumstances, since under the denition of agreement in this Act the circumstances surrounding the transaction as well as the express language used by the parties enter into the meaning and substance of the agreement. Cross References: Point 1: Sections 1-102, 2-302. Point 2: Section 1-201. Denitional Cross References: Party. Section 1-201. Agreement. Section 1-201.

2-304. Price Payable in Money, Goods, Realty, or Otherwise. (1) The price may be made payable in money or otherwise. If it is payable in whole or in part in goods, each party is a seller of the goods that the party is to transfer.
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(2) Even if all or part of the price is payable in an interest in real property the transfer of the goods, and the seller's obligations with reference to them are subject to this Article, but not the transfer of the interest in real property or the transferor's obligations in connection therewith. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Subsections (2) and (3) of Section 9, Uniform Sales Act. Changes: Rewritten. Purposes of Changes: 1. This section corrects the phrasing of the Uniform Sales Act so as to avoid misconstruction and produce greater accuracy in commercial result. While it continues the essential intent and purpose of the Uniform Sales Act it rejects any purely verbalistic construction in disregard of the underlying reason of the provisions. 2. Under subsection (1) the provisions of this Article are applicable to transactions where the price of goods is payable in something other than money. This does not mean, however, that this whole Article applies automatically and in its entirety simply because an agreed transfer of title to goods is not a gift. The basic purposes and reasons of the Article must always be considered in determining the applicability of any of its provisions. 3. Subsection (2) lays down the general principle that when goods are to be exchanged for realty, the provisions of this Article apply only to those aspects of the transaction which concern the transfer of title to goods but do not aect the transfer of the realty since the detailed regulation of various particular contracts which fall outside the scope of this Article is left to the courts and other legislation. However, the complexities of these situations may be such that each must be analyzed in the light of the underlying reasons in order to determine the applicable principles. Local statutes dealing with realty are not to be lightly disregarded or altered by language of this Article. In contrast, this Article declares denite policies in regard to certain matters legitimately within its scope though concerned with real property situations, and in those instances the provisions of this Article control. Cross References: Point 1: Section 1-102. Point 3: Sections 1-102, 1-103, 1-104 and 2-107. Denitional Cross References: Goods. Section 2-103. Money. Section 1-201. Party. Section 1-201. Seller. Section 2-103.

2-305. Open Price Term. (1) The parties if they so intend may conclude a contract for sale even if the price is not settled. In such a case the price is a reasonable price at the time for delivery if: (a) nothing is said as to price; (b) the price is left to be agreed by the parties and they fail to agree; or (c) the price is to be xed in terms of some agreed market or other standard as set or recorded by a third person or agency and it is not so set or recorded. (2) A price to be xed by the seller or by the buyer means a price to be xed in good faith. (3) If a price left to be xed otherwise than by agreement of the parties fails to be xed through fault of one party, the other may at the party's option treat the contract as canceled or the party may x a reasonable price.
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(4) If, however, the parties intend not to be bound unless the price is xed or agreed and it is not xed or agreed, there is no contract. In such a case the buyer must return any goods already received or if unable to do so must pay their reasonable value at the time of delivery and the seller must return any portion of the price paid on account. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Sections 9 and 10, Uniform Sales Act. Changes: Completely rewritten. Purposes of Changes: 1. This section applies when the price term is left open on the making of an agreement which is nevertheless intended by the parties to be a binding agreement. This Article rejects in these instances the formula that an agreement to agree is unenforceable if the case falls within subsection (1) of this section, and rejects also defeating such agreements on the ground of indeniteness. Instead this Article recognizes the dominant intention of the parties to have the deal continue to be binding upon both. As to future performance, since this Article recognizes remedies such as cover (Section 2-712), resale (Section 2-706) and specic performance (Section 2-716) which go beyond any mere arithmetic as between contract price and market price, there is usually a reasonably certain basis for granting an appropriate remedy for breach so that the contract need not fail for indeniteness. 2. Under some circumstances the postponement of agreement on price will mean that no deal has really been concluded, and this is made express in the preamble of subsection (1) (The parties if they so intend) and in subsection (4). Whether or not this is so is, in most cases, a question to be determined by the trier of fact. 3. Subsection (2), dealing with the situation where the price is to be xed by one party rejects the uncommercial idea that an agreement that the seller may x the price means that he may x any price he may wish by the express qualication that the price so xed must be xed in good faith. Good faith includes observance of reasonable commercial standards of fair dealing in the trade if the party is a merchant. (Section 2-103). But in the normal case a posted price or a future seller's or buyer's given price, price in eect, market price, or the like satises the good faith requirement. 4. The section recognizes that there may be cases in which a particular person's judgment is not chosen merely as a barometer or index of a fair price but is an essential condition to the parties' intent to make any contract at all. For example, the case where a known and trusted expert is to value a particular painting for which there is no market standard diers sharply from the situation where a named expert is to determine the grade of cotton, and the dierence would support a nding that in the one the parties did not intend to make a binding agreement if that expert were unavailable whereas in the other they did so intend. Other circumstances would of course aect the validity of such a nding. 5. Under subsection (3), wrongful interference by one party with any agreed machinery for price xing in the contract may be treated by the other party as a repudiation justifying cancellation, or merely as a failure to take cooperative action thus shifting to the aggrieved party the reasonable leeway in xing the price. 6. Throughout the entire section, the purpose is to give eect to the agreement which has been made. That eect, however, is always conditioned by the requirement of good faith action which is made an inherent part of all contracts within this Act. (Section 1-203). Cross References: Point 1: Sections 2-204(3), 2-706, 2-712 and 2-716. Point 3: Section 2-103. Point 5: Sections 2-311 and 2-610. Point 6: Section 1-203. Denitional Cross References: Agreement. Section 1-201. Burden of establishing. Section 1-201. Buyer. Section 2-103. 85

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Cancellation. Section 2-106. Contract. Section 1-201. Contract for sale. Section 2-106. Fault. Section 1-201. Goods. Section 2-103. Party. Section 1-201. Receipt of goods. Section 2-103. Seller. Section 2-103. Term. Section 1-201.

2-306. Output, Requirements and Exclusive Dealings. (1) A term which measures the quantity by the output of the seller or the requirements of the buyer means such actual output or requirements as may occur in good faith, except that no quantity unreasonably disproportionate to any stated estimate or in the absence of a stated estimate to any normal or otherwise comparable prior output or requirements may be tendered or demanded. (2) A lawful agreement by either the seller or the buyer for exclusive dealing in the kind of goods concerned imposes unless otherwise agreed an obligation by the seller to use best eorts to supply the goods and by the buyer to use best eorts to promote their sale. Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: 1. Subsection (1) of this section, in regard to output and requirements, applies to this specic problem the general approach of this Act which requires the reading of commercial background and intent into the language of any agreement and demands good faith in the performance of that agreement. It applies to such contracts of nonproducing establishments such as dealers or distributors as well as to manufacturing concerns. 2. Under this Article, a contract for output or requirements is not too indenite since it is held to mean the actual good faith output or requirements of the particular party. Nor does such a contract lack mutuality of obligation since, under this section, the party who will determine quantity is required to operate his plant or conduct his business in good faith and according to commercial standards of fair dealing in the trade so that his output or requirements will approximate a reasonably foreseeable gure. Reasonable elasticity in the requirements is expressly envisaged by this section and good faith variations from prior requirements are permitted even when the variation may be such as to result in discontinuance. A shut-down by a requirements buyer for lack of orders might be permissible when a shut-down merely to curtail losses would not. The essential test is whether the party is acting in good faith. Similarly, a sudden expansion of the plant by which requirements are to be measured would not be included within the scope of the contract as made but normal expansion undertaken in good faith would be within the scope of this section. One of the factors in an expansion situation would be whether the market price had risen greatly in a case in which the requirements contract contained a xed price. Reasonable variation of an extreme sort is exemplied in Southwest Natural Gas Co. v. Oklahoma Portland Cement Co., 102 F.2d 630 (C.C.A.10, 1939). This Article takes no position as to whether a requirements contract is a provable claim in bankruptcy. 3. If an estimate of output or requirements is included in the agreement, no quantity unreasonably disproportionate to it may be tendered or demanded. Any minimum or maximum set by the agreement shows a clear limit on the intended elasticity. In similar fashion, the agreed estimate is to be regarded as a center around which the parties intend the variation to occur. 4. When an enterprise is sold, the question may arise whether the buyer is bound by an existing output or requirements contract. That question is outside the scope of this Article, and is to be determined on other principles of law. Assuming that the contract continues, 86

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the output or requirements in the hands of the new owner continue to be measured by the actual good faith output or requirements under the normal operation of the enterprise prior to sale. The sale itself is not grounds for sudden expansion or decrease. 5. Subsection (2), on exclusive dealing, makes explicit the commercial rule embodied in this Act under which the parties to such contracts are held to have impliedly, even when not expressly, bound themselves to use reasonable diligence as well as good faith in their performance of the contract. Under such contracts the exclusive agent is required, although no express commitment has been made, to use reasonable eort and due diligence in the expansion of the market or the promotion of the product, as the case may be. The principal is expected under such a contract to refrain from supplying any other dealer or agent within the exclusive territory. An exclusive dealing agreement brings into play all of the good faith aspects of the output and requirement problems of subsection (1). It also raises questions of insecurity and right to adequate assurance under this Article. Cross References: Point 4: Section 2-210. Point 5: Sections 1-203 and 2-609. Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Contract for sale. Section 2-106. Good faith. Section 2-103. Goods. Section 2-103. Party. Section 1-201. Term. Section 1-201. Seller. Section 2-103.

2-307. Delivery in Single Lot or Several Lots. Unless otherwise agreed all goods called for by a contract for sale must be tendered in a single delivery and payment is due only on such tender but where the circumstances give either party the right to make or demand delivery in lots the price if it can be apportioned may be demanded for each lot. Ocial Comment
Prior Uniform Statutory Provision: Section 45(1), Uniform Sales Act. Changes: Rewritten and expanded. Purposes of Changes: 1. This section applies where the parties have not specically agreed whether delivery and payment are to be by lots and generally continues the essential intent of original Act, Section 45(1) by assuming that the parties intended delivery to be in a single lot. 2. Where the actual agreement or the circumstances do not indicate otherwise, delivery in lots is not permitted under this section and the buyer is properly entitled to reject for a deciency in the tender, subject to any privilege in the seller to cure the tender. 3. The but clause of this section goes to the case in which it is not commercially feasible to deliver or to receive the goods in a single lot as for example, where a contract calls for the shipment of ten carloads of coal and only three cars are available at a given time. Similarly, in a contract involving brick necessary to build a building the buyer's storage space may be limited so that it would be impossible to receive the entire amount of brick at once, or it may be necessary to assemble the goods as in the case of cattle on the range, or to mine them. In such cases, a partial delivery is not subject to rejection for the defect in quantity alone, if the circumstances do not indicate a repudiation or default by the seller as to the expected balance or do not give the buyer ground for suspending his performance because of insecurity under the provisions of Section 2-609. However, in such cases the undelivered balance of goods under the contract must be forthcoming within a reasonable time and in a reasonable manner according to the policy of Section 2-503 on manner of tender of delivery. This is reinforced by the express provisions of Section 2-608 that if a lot has been accepted on 87

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the reasonable assumption that its nonconformity will be cured, the acceptance may be revoked if the cure does not seasonably occur. The section rejects the rule of Kelly Construction Co. v. Hackensack Brick Co., 91 N.J.L. 585, 103 A. 417, 2 A.L.R. 685 (1918) and approves the result in Lynn M. Ranger, Inc. v. Gildersleeve, 106 Conn. 372, 138 A. 142 (1927) in which a contract was made for six carloads of coal then rolling from the mines and consigned to the seller but the seller agreed to divert the carloads to the buyer as soon as the car numbers became known to him. He arranged a diversion of two cars and then notied the buyer who then repudiated the contract. The seller was held to be entitled to his full remedy for the two cars diverted because simultaneous delivery of all of the cars was not contemplated by either party. 4. Where the circumstances indicate that a party has a right to delivery in lots, the price may be demanded for each lot if it is apportionable. Cross References: Point 1: Section 1-201. Point 2: Sections 2-508 and 2-601. Point 3: Sections 2-503, 2-608 and 2-609. Denitional Cross References: Contract for sale. Section 2-106. Goods. Section 2-103. Lot. Section 2-105. Party. Section 1-201. Rights. Section 1-201.

2-308. Absence of Specied Place for Delivery. Unless otherwise agreed: (a) the place for delivery of goods is the seller's place of business or if none, the seller's residence; but (b) in a contract for sale of identied goods that to the knowledge of the parties at the time of contracting are in some other place, that place is the place for their delivery; and (c) documents of title may be delivered through customary banking channels. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Paragraphs (a) and (b)Section 43(1), Uniform Sales Act; Paragraph (c)none. Changes: Slight modication in language. Purposes of Changes and New Matter: 1. Paragraphs (a) and (b) provide for those noncommercial sales and for those occasional commercial sales where no place or means of delivery has been agreed upon by the parties. Where delivery by carrier is required or authorized by the agreement, the seller's duties as to delivery of the goods are governed not by this section but by Section 2-504. 2. Under paragraph (b) when the identied goods contracted for are known to both parties to be in some location other than the seller's place of business or residence, the parties are presumed to have intended that place to be the place of delivery. This paragraph also applies (unless, as would be normal, the circumstances show that delivery by way of documents is intended) to a bulk of goods in the possession of a bailee. In such a case, however, the seller has the additional obligation to procure the acknowledgment by the bailee of the buyer's right to possession. 3. Where customary banking channels call only for due notication by the banker that the documents are available, leaving the buyer himself to see to the physical receipt of the goods, tender at the buyer's address is not required under paragraph (c). But that paragraph merely eliminates the possibility of a default by the seller if customary banking channels 88

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have been properly used in giving notice to the buyer. Where the bank has purchased a draft accompanied by or associated with documents or has undertaken its collection on behalf of the seller, Part 5 of Article 4 spells out its duties and relations to its customer. Where the documents move forward under a letter of credit the Article on Letters of Credit spells out the duties and relations between the bank, the seller and the buyer. Delivery in relationship to either tangible or electronic documents of title is dened in Article 1, Section 1-201. 4. The rules of this section apply only unless otherwise agreed. The surrounding circumstances, usage of trade, course of dealing and course of performance, as well as the express language of the parties, may constitute an otherwise agreement. Cross References: Point 1: Sections 2-504 and 2-505. Point 2: Section 2-503. Point 3: Section 2-512, Articles 4, Part 5, and 5. Denitional Cross References: Contract for sale. Section 2-106. Delivery. Section 2-103. Document of title. Section 1-201. Goods. Section 2-103. Party. Section 1-201. Seller. Section 2-103.

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

2-309. Absence of Specic Time Provisions; Notice of Termination. (1) The time for shipment or delivery or any other action under a contract if not provided in this Article or agreed upon shall be a reasonable time. (2) If the contract provides for successive performances but is indenite in duration, it is valid for a reasonable time but unless otherwise agreed may be terminated at any time by either party. (3) Termination of a contract by one party except on the happening of an agreed event requires that reasonable notication be received by the other party and an agreement dispensing with notication is invalid if its operation would be unconscionable. A term specifying standards for the nature and timing of notice is enforceable if the standards are not manifestly unreasonable. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Subsection (1)see Sections 43(2), 45(2), 47(1) and 48, Uniform Sales Act, for policy continued under this Article; Subsection (2)none; Subsection (3)none. Changes: Completely dierent in scope. Purposes of Changes and New Matter: 1. Subsection (1) requires that all actions taken under a sales contract must be taken within a reasonable time where no time has been agreed upon. The reasonable time under this provision turns on the criteria as to reasonable time and on good faith and commercial standards set forth in Sections 1-203, 1-204 and 2-103. It thus depends upon what constitutes acceptable commercial conduct in view of the nature, purpose and circumstances of the action to be taken. Agreement as to a denite time, however, may be found in a term implied from the contractual circumstances, usage of trade or course of dealing or 89

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performance as well as in an express term. Such cases fall outside of this subsection since in them the time for action is agreed by usage. 2. The time for payment, where not agreed upon, is related to the time for delivery; the particular problems which arise in connection with determining the appropriate time of payment and the time for any inspection before payment which is both allowed by law and demanded by the buyer are covered in Section 2-513. 3. The facts in regard to shipment and delivery dier so widely as to make detailed provision for them in the text of this Article impracticable. The applicable principles, however, make it clear that surprise is to be avoided, good faith judgment is to be protected, and notice or negotiation to reduce the uncertainty to certainty is to be favored. 4. When the time for delivery is left open, unreasonably early oers of or demands for delivery are intended to be read under this Article as expressions of desire or intention, requesting the assent or acquiescence of the other party, not as nal positions which may amount without more to breach or to create breach by the other side. See Sections 2-207 and 2-609. 5. The obligation of good faith under this Act requires reasonable notication before a contract may be treated as breached because a reasonable time for delivery or demand has expired. This operates both in the case of a contract originally indenite as to time and of one subsequently made indenite by waiver. When both parties let an originally reasonable time go by in silence, the course of conduct under the contract may be viewed as enlarging the reasonable time for tender or demand of performance. The contract may be terminated by abandonment. 6. Parties to a contract are not required in giving reasonable notication to x, at peril of breach, a time which is in fact reasonable in the unforeseeable judgment of a later trier of fact. Eective communication of a proposed time limit calls for a response, so that failure to reply will make out acquiescence. Where objection is made, however, or if the demand is merely for information as to when goods will be delivered or will be ordered out, demand for assurances on the ground of insecurity may be made under this Article pending further negotiations. Only when a party insists on undue delay or on rejection of the other party's reasonable proposal is there a question of at breach under the present section. 7. Subsection (2) applies a commercially reasonable view to resolve the conict which has arisen in the cases as to contracts of indenite duration. The reasonable time of duration appropriate to a given arrangement is limited by the circumstances. When the arrangement has been carried on by the parties over the years, the reasonable time can continue indenitely and the contract will not terminate until notice. 8. Subsection (3) recognizes that the application of principles of good faith and sound commercial practice normally call for such notication of the termination of a going contract relationship as will give the other party reasonable time to seek a substitute arrangement. An agreement dispensing with notication or limiting the time for the seeking of a substitute arrangement is, of course, valid under this subsection unless the results of putting it into operation would be the creation of an unconscionable state of aairs. 9. Justiable cancellation for breach is a remedy for breach and is not the kind of termination covered by the present subsection. 10. The requirement of notication is dispensed with where the contract provides for termination on the happening of an agreed event. Event is a term chosen here to contrast with option or the like. 11. The last sentence of subsection (3) is new and is based on Section 1-302(b). It provides for greater party autonomy. In an appropriate circumstance, the parties may agree that the standard for notice is no notice at all. Cross References: Point 1: Sections 1-102, 1-203, 1-204 and 2-103. Point 2: Sections 2-504, and 2-511 through 2-514. Point 5: Section 1-203. Point 6: Section 2-609. Point 7: Section 2-204. Point 9: Sections 2-106, 2-318, 2-610 and 2-703. Point 11: Section 1-102(3). Denitional Cross References: 90

Art. 2
Agreement. Section 1-201. Contract. Section 1-201. Notication. Section 1-202. Party. Section 1-201. Reasonable time. Section 1-205. Termination. Section 2-106.

Sales

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As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-310. Open Time for Payment or Running of Credit; Authority to Ship under Reservation. Unless otherwise agreed: (a) payment is due at the time and place at which the buyer is to receive the goods even though the place of shipment is the place of delivery; (b) if the seller is required or authorized to send the goods, the seller may ship them under reservation, and may tender the documents of title, but the buyer may inspect the goods after their arrival before payment is due unless the inspection is inconsistent with the terms of the contract (Section 2-513); (c) if tender of delivery is agreed to be made by way of documents of title otherwise than by paragraph (b), then payment is due regardless of where the goods are to be received (i) at the time and place at which the buyer is to receive delivery of the tangible documents, or (ii) at the time the buyer is to receive delivery of the electronic documents and at the seller's place of business or if none, the seller's residence; and (d) if the seller is required or authorized to ship the goods on credit, the credit period runs from the time of shipment but postdating the invoice or delaying its dispatch will correspondingly delay the starting of the credit period. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Sections 42 and 47(2), Uniform Sales Act. Changes: Completely rewritten in this and other sections. Purposes of Changes: This section is drawn to reect modern business methods of dealing at a distance rather than face to face. Thus: 1. Paragraph (a) provides that payment is due at the time and place the buyer is to receive the goods rather than at the point of delivery except in documentary shipment cases (paragraph (c)). This grants an opportunity for the exercise by the buyer of his preliminary right to inspection before paying even though under the delivery term the risk of loss may have previously passed to him or the running of the credit period has already started. 2. Paragraph (b) while providing for inspection by the buyer before he pays, protects the seller. He is not required to give up possession of the goods until he has received payment, where no credit has been contemplated by the parties. The seller may collect through a bank by a sight draft against an order bill of lading hold until arrival; inspection allowed. The obligations of the bank under such a provision are set forth in Part 5 of Article 4. Under subsection (c), in the absence of a credit term, the seller is permitted to ship under reservation and if he does payment is then due where and when the buyer is to receive 91

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delivery of the tangible documents of title. In the case of an electronic document of title, payment is due when the buyer is to receive delivery of the electronic document and at the seller's place of business, or if none, the seller's residence. Delivery as to documents of title is stated in Article 1, Section 1-201. 3. Unless otherwise agreed, the place for the delivery of the documents and payment is the buyer's city but the time for payment is only after arrival of the goods, since under paragraph (b), and Sections 2-512 and 2-513 the buyer is under no duty to pay prior to inspection. Tender of a document of title requires that the seller be ready, willing and able to transfer possession of a tangible document of title or control of an electronic document of title to the buyer. 4. Where the mode of shipment is such that goods must be unloaded immediately upon arrival, too rapidly to permit adequate inspection before receipt, the seller must be guided by the provisions of this Article on inspection which provide that if the seller wishes to demand payment before inspection, he must put an appropriate term into the contract. Even requiring payment against documents will not of itself have this desired result if the documents are to be held until the arrival of the goods. But under (b) and (c) if the terms are C.I.F., C.O.D., or cash against documents payment may be due before inspection. 5. Paragraph (d) states the common commercial understanding that an agreed credit period runs from the time of shipment or from that dating of the invoice which is commonly recognized as a representation of the time of shipment. The provision concerning any delay in sending forth the invoice is included because such conduct results in depriving the buyer of his full notice and warning as to when he must be prepared to pay. Cross References: Generally: Part 5. Point 1: Sections 2-504 and 2-509. Point 2: Sections 2-505, 2-511, 2-512, 2-513 and Article 4. Point 3: Sections 2-308(b), 2-512 and 2-513. Point 4: Section 2-513(3)(b). Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Delivery. Section 2-103. Document of title. Section 1-201. Goods. Section 2-103. Receipt of goods. Section 2-103. Seller. Section 2-103. Send. Section 1-201. Tender of delivery. Sections 2-503 and 2-507. Term. Section 1-201.

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

2-311. Options and Cooperation Respecting Performance. (1) An agreement for sale which is otherwise suciently denite (Section 2-204(3)) to be a contract is not made invalid by the fact that it leaves particulars of performance to be specied by one of the parties. Any such specication must be made in good faith and within limits set by commercial reasonableness. (2) Unless otherwise agreed, specications relating to assortment of the goods are at the buyer's option and specications or arrangements relating to shipment are at the seller's option. (3) If the specication would materially aect the other party's performance but is not seasonably made or if one party's cooperation is neces92

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sary to the agreed performance of the other but is not seasonably forthcoming, the other party in addition to all other remedies: (a) is excused for any resulting delay in that party's performance; and (b) may also either proceed to perform in any reasonable manner or after the time for a material part of that party's performance treat the failure to specify or to cooperate as a breach by failure to deliver or accept the goods. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: 1. Subsection (1) permits the parties to leave certain detailed particulars of performance to be lled in by either of them without running the risk of having the contract invalidated for indeniteness. The party to whom the agreement gives power to specify the missing details is required to exercise good faith and to act in accordance with commercial standards so that there is no surprise and the range of permissible variation is limited by what is commercially reasonable. The agreement which permits one party so to specify may be found as well in a course of dealing, usage of trade, or implication from circumstances as in explicit language used by the parties. 2. Options as to assortment of goods or shipping arrangements are specically reserved to the buyer and seller respectively under subsection (2) where no other arrangement has been made. This section rejects the test which mechanically and without regard to usage or the purpose of the option gave the option to the party rst under a duty to move and applies instead a standard commercial interpretation to these circumstances. The unless otherwise agreed provision of this subsection covers not only express terms but the background and circumstances which enter into the agreement. 3. Subsection (3) applies when the exercise of an option or cooperation by one party is necessary to or materially aects the other party's performance, but it is not seasonably forthcoming; the subsection relieves the other party from the necessity for performance or excuses his delay in performance as the case may be. The contract-keeping party may at his option under this subsection proceed to perform in any commercially reasonable manner rather than wait. In addition to the special remedies provided, this subsection also reserves all other remedies. The remedy of particular importance in this connection is that provided for insecurity. Request may also be made pursuant to the obligation of good faith for a reasonable indication of the time and manner of performance for which a party is to hold himself ready. 4. The remedy provided in subsection (3) is one which does not operate in the situation which falls within the scope of Section 2-614 on substituted performance. Where the failure to cooperate results from circumstances set forth in that Section, the other party is under a duty to proer or demand (as the case may be) substitute performance as a condition to claiming rights against the noncooperating party. Cross References: Point 1: Sections 1-201, 1-203, 2-204 and 2-708. Point 3: Sections 1-203 and 2-609. Point 4: Section 2-614. Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Contract for sale. Section 2-106. Goods. Section 2-103. Party. Section 1-201. Remedy. Section 1-201. Seasonably. Section 1-205. Seller. Section 2-103. 93

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2-312. Warranty of Title and Against Infringement; Buyer's Obligation Against Infringement. (1) Subject to subsection (3), there is in a contract for sale a warranty by the seller that: (a) the title conveyed shall be good and its transfer rightful and shall not unreasonably expose the buyer to litigation because of any colorable claim to or interest in the goods; and (b) the goods shall be delivered free from any security interest or other lien or encumbrance of which the buyer at the time of contracting has no knowledge. (2) Unless otherwise agreed, a seller that is a merchant regularly dealing in goods of the kind warrants that the goods shall be delivered free of the rightful claim of any third person by way of infringement or the like but a buyer that furnishes specications to the seller must hold the seller harmless against any such claim that arises out of compliance with the specications. (3) A warranty under this section may be disclaimed or modied only by specic language or by circumstances that give the buyer reason to know that the seller does not claim title, that the seller is purporting to sell only the right or title as the seller or a third person may have, or that the seller is selling subject to any claims of infringement or the like. As amended in 1999 and 2003.
See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999. See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (1) provides for a buyer's basic needs for a title which the buyer in good faith expects to acquire by the purchase, namely, that the buyer receive a good, clean title transferred also in a rightful manner so that the buyer will not be exposed to a lawsuit to protect the title. Under subsection (1), the seller warrants that (1) the title conveyed is good, (2) the transfer is rightful, and (3) the transfer does not unreasonably expose the buyer to litigation because a third person has or asserts a colorable claim to or interest in the goods. In addition to sales in which there is an actual cloud on the title, a warranty that the title conveyed is good and its transfer rightful also covers cases when the title is good but the transfer is not rightful. For example, a wrongful transfer with good title occurs where a merchant bailee to which goods are entrusted for repair sells them without authority to a buyer in the ordinary course of business. See Section 2-403(2); Sumner v. Fel-Air, Inc., 680 P.2d 1109 (Alaska 1984). The subsection now expressly states what the courts have long recognized; further protection for the buyer is needed when the title is burdened by colorable claims that aect the value of the goods. See Frank Arnold KRS, Inc. v. L.S. Meier Auction Co., Inc., 806 F.2d 462 (3d Cir. 1986) (two lawsuits contest title); Jeanneret v. Vichey, 693 F.2d 259 (2d Cir. 1982) (export restrictions in country from which painting was taken aect value); Colton v. Decker, 540 N.W.2d 172 (S.D. 1995) (conicting vehicle identication numbers). Therefore, not only is the buyer entitled to a good title, but the buyer is also entitled to a marketable title, and until the colorable claim is resolved the market for the goods is impaired. See Wright v. Vickaryous, 611 P.2d 20 (Alaska 1980). The justication for this rule is that the buyer of goods that are warranted for title has a right to rely on the fact that there will be no need later to have to contest ownership. The mere casting of a substantial shadow over the buyer's title, regardless of the ultimate outcome, violates the warranty of good title. See American Container Corp. v. Hanley Trucking Corp., 111 N.J. Super. 322, 268 A.2d 313,318 (1970). It should be noted that not 94

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any assertion of a claim by a third party will constitute a breach of the warranty of title. The claim must be reasonable and colorable. See C.F. Sales, Inc. v. Amfert, 344 N.W.2d 543 (Iowa 1983). The warranty of title extends to a buyer whether or not the seller was in possession of the goods at the time the sale or contract to sell was made. Consistent with original Article 2, this section does not provide for a separate warranty of quiet possession in addition to the warranty of title. Disturbance of quiet possession, although not mentioned specically, is one way, among many, in which the breach of the warranty of title might be established. 2. Knowledge as referred to in subsection (1)(b) is actual knowledge as distinct from notice. 3. The provisions of this Article that require notication to the seller within a reasonable time after the buyer's discovery of a breach (Section 2-607(3)(a)) apply to notice of a breach of the warranty of title when the seller's breach was innocent. However, if the seller's breach were in bad faith, the seller cannot claim prejudice by the delay in giving notice. 4. Subsection (2) provides the warranty against infringement. Unlike the warranty of title, this warranty is limited to sellers that are merchants that regularly dealing in goods of the kind sold. When the goods are part of the seller's normal stock, and are sold in the normal course of business, it is the seller's duty to see that no claim of infringement of a patent or trademark by a third party will impair the buyer's title. A sale by a person other than a dealer, however, raises no implication in its circumstances of the warranty. Nor is there an implication when the buyer orders goods to be assembled, prepared or manufactured on the buyer's own specications. If, in such a case, the resulting product infringes a patent or trademark, the liability will run from buyer to seller. There is, under these circumstances, a tacit representation on the part of the buyer that the seller will be safe in manufacturing according to the specications, and the buyer is under an obligation in good faith to indemnify the seller for any loss suered. 5. Under this section, the cases which recognize the principle that infringements violate the warranty of title but deny the buyer a remedy unless he has been expressly prevented from using the goods are rejected. Under this Article eviction is not a necessary condition to the buyer's remedy since the buyer's remedy arises immediately upon receipt of notice of infringement; it is merely one way of establishing the fact of breach. 6. Subsection (3) is concerned with the disclaimer or modication of the warranties of title or against infringement. This is a self-contained provision that govern the modication or disclaimer of warranties under this section. The warranties in this section are not designated as implied warranties, and hence these warranties are not subject to the modication and disclaimer provisions of Section 2-316(2) and (3). Unlike Section 2-316, subsection (3) of this section does not create any specic requirements that the disclaimer or modication be contained in a record or be conspicuous. Under subsection (3), sales by sheris, executors, certain foreclosing lienors and persons similarly situated are recognized as possibly being so out of the ordinary commercial course that their peculiar character is immediately apparent to the buyer, and therefore no personal obligation is imposed upon the seller that is purporting to sell only an unknown or limited right. This subsection is not intended to touch upon, and it leaves open, all questions of restitution that arise in these cases, such as when a unique article that is sold is reclaimed by a third party as the rightful owner. For a foreclosure sale under Article 9, Section 9-610 of revised Article 9 provides that a disposition of collateral under that section includes warranties such as those imposed by this section on a voluntary disposition of property. Consequently, unless properly excluded under subsection (3) or under the special provisions for exclusion in Section 9-610, a disposition under that section of collateral consisting of goods includes the warranties imposed by subsection (1) and, if applicable, subsection (2). 7. The statute of limitations for a breach of warranty under this section is determined under the provisions set out in Section 2-725(1) and (3)(c). Cross References: Point 1: Section 2-403. Point 3: Sections 2-607 and 2-725. Point 4: Section 1-203. 95

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Point 6: Sections 2-316, 2-609, 2-610 and 2-725. Point 7: Section 2-316 and 2-725. Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Contract for sale. Section 2-106. Goods. Section 2-103. Merchant. Section 2-104. Person. Section 1-201. Right. Section 1-201. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-313. Express Warranties by Armation, Promise, Description, Sample; Remedial Promise. (1) In this section, immediate buyer means a buyer that enters into a contract with the seller. (2) Express warranties by the seller to the immediate buyer are created as follows: (a) Any armation of fact or promise made by the seller which relates to the goods and becomes part of the basis of the bargain creates an express warranty that the goods shall conform to the armation or promise. (b) Any description of the goods which is made part of the basis of the bargain creates an express warranty that the goods shall conform to the description. (c) Any sample or model that is made part of the basis of the bargain creates an express warranty that the whole of the goods shall conform to the sample or model. (3) It is not necessary to the creation of an express warranty that the seller use formal words such as warrant or guarantee or that the seller have a specic intention to make a warranty, but an armation merely of the value of the goods or a statement purporting to be merely the seller's opinion or commendation of the goods does not create a warranty. (4) Any remedial promise made by the seller to the immediate buyer creates an obligation that the promise will be performed upon the happening of the specied event. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. In subsections (2) and (4) the term immediate buyer is used to make clear that the section is limited to express warranties and remedial promises made by a seller to a buyer with which the seller has a contractual relationship. Sections 2-313A and 2-313B address obligations that run directly from a seller to a remote purchaser. 2. Subsection (4) uses the term remedial promise, which was not used in original Article 2. This section deals with remedial promises to immediate buyers. Sections 2-313A and 2-313B deal with remedial promises running directly from a seller to a remote purchaser. Remedial promise is dened in Section 2-103(1)(n). 96

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3. Express warranties rest on dickered aspects of the individual bargain, and go so clearly to the essence of that bargain that words of disclaimer in a form are repugnant to the basic dickered terms. Implied warranties rest so clearly on a common factual situation or set of conditions that no particular language or action is necessary to evidence them and they will arise in such a situation unless unmistakably negated. As with original Article 2, warranties of description and sample are designated express rather than implied. 4. This section is limited in its scope and direct purpose to express warranties and remedial promises made by the seller to the immediate buyer as part of a contract for sale. It is not designed in any way to disturb those lines of case law which have recognized that warranties need not be conned to contracts within the scope of this Article. Under Section 2-313B, a seller may incur an obligation to a remote purchaser through a medium for communication to the public such as advertising. An express warranty to an immediate buyer may also arise through a medium for communication to the public if the elements of this section are satised. The fact that a buyer has rights against an immediate seller under this section does not preclude the buyer from also asserting rights against a remote seller under Section 2-313A or 2-313B. 5. The present section deals with armations of fact or promises made by the seller, descriptions of the goods, or exhibitions of samples or models, exactly as it deals with any other part of a negotiation which ends in a contract. No specic intention to make a warranty is necessary if any of these factors is made part of the basis of the bargain. In actual practice armations of fact and promises made by the seller about the goods during a bargain are regarded as part of the description of those goods; hence no particular reliance on these statements need be shown in order to weave them into the fabric of the agreement. Rather, any fact which is to take these armations or promises, once made, out of the agreement requires clear armative proof. The issue normally is one of fact. 6. In view of the principle that the whole purpose of the law of warranty is to determine what it is that the seller has in essence agreed to sell, the policy is adopted of those cases which refuse except in unusual circumstances to recognize a material deletion of the seller's obligation. Thus, a contract is normally a contract for a sale of something describable and described. A clause generally disclaiming all warranties, express or implied cannot reduce the seller's obligation for the description and therefore cannot be given literal effect under Section 2-316(1). This is not intended to mean that the parties, if they consciously desire, cannot make their own bargain as they wish. But in determining what they have agreed upon good faith is a factor and consideration should be given to the fact that the probability is small that a real price is intended to be exchanged for a pseudo-obligation. 7. Subsection (2)(b) makes specic some of the principles set forth above when a description of the goods is given by the seller. A description need not be by words. Technical specications, blueprints and the like can aord more exact description than mere language and if made part of the basis of the bargain goods must conform with them. Past deliveries may set the description of quality, either expressly or impliedly by course of dealing. Of course, all descriptions by merchants must be read against the applicable trade usages with the general rules as to merchantability resolving any doubts. 8. The basic situation as to statements aecting the true essence of the bargain is no different when a sample or model is involved in the transaction. This section includes both a sample actually drawn from the bulk of goods which is the subject matter of the sale, and a model which is oered for inspection when the subject matter is not at hand and which has not been drawn from the bulk of the goods. Although the underlying principles are unchanged, the facts are often ambiguous when something is shown as illustrative, rather than as a straight sample. In general, the presumption is that any sample or model, just as any armation of fact, is intended to become a basis of the bargain. But there is no escape from the question of fact. When the seller exhibits a sample purporting to be drawn from an existing bulk, good faith of course requires that the sample be fairly drawn. But in mercantile experience the mere exhibition of a sample does not of itself show whether it is merely intended to suggest or to be the character of the subject-matter of the contract. The question is whether the seller has 97

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so acted with reference to the sample as to become responsible that the whole shall have at least the values shown by it. The circumstances aid in answering this question. If the sample has been drawn from an existing bulk, it must be regarded as describing values of the goods contracted for unless it is accompanied by an unmistakable denial of responsibility. If, on the other hand, a model of merchandise not on hand is oered, the mercantile presumption that it has become a literal description of the subject matter is not so strong, and particularly so if modication on the buyer's initiative impairs any feature of the model. 9. The precise time when words of description or armation are made or samples are shown is not material. The sole question is whether the language or samples or models are fairly to be regarded as part of the contract. If language that would otherwise create an obligation under this section is used after the closing of the deal (as when the buyer when taking delivery asks and receives an additional assurance), an obligation will arise if the requirements for a modication are satised. See Downie v. Abex Corp., 741 F.2d 1235 (10th Cir. 1984). 10. Concerning armations of value or a seller's opinion or commendation under subsection (3), the basic question remains the same: What statements of the seller have in the circumstances and in objective judgment become part of the basis of the bargain? As indicated above, all of the statements of the seller do so unless good reason is shown to the contrary. The provisions of subsection (3) are included, however, since common experience discloses that some statements or predictions cannot fairly be viewed as entering into the bargain. Even as to false statements of value, however, the possibility is left open that a remedy may be provided by the law relating to fraud or misrepresentation. There are a number of factors relevant to determine whether an expression creates a warranty under this section or is merely pung. For example, the relevant factors may include whether the seller's representations taken in context, (1) were general rather than specic, (2) related to the consequences of buying rather than the goods themselves, (3) were hedged in some way, (4) were related to experimental rather than standard goods, (5) were concerned with some aspects of the goods but not a hidden or unexpected nonconformity, (6) were informal statements made in a formal contracting process, (7) were phrased in terms of opinion rather than fact, or (8) were not capable of objective measurement. 11. The use of the word promise in subsection (2)(a) refers to statements about the quality or performance characteristics of the goods. For example, a seller might make an armation of fact to the buyer that the goods are of a certain quality, or may promise that the goods when delivered will be of a certain quality, or may promise that the goods will perform in a certain manner after delivery. In normal usage, promise refers to a what a person, not goods, will do; that is, a promise is a commitment to act, or refrain from acting, in a certain manner in the future. A promise about the quality or performance characteristics of the goods creates an express warranty if the other elements of a warranty are present whereas a promise by which the seller commits itself to take remedial action upon the happening of a specied event is a remedial promise. The distinction has meaning in the context of the statute of limitations. A right of action for breach of an express warranty accrues when the goods are tendered to the immediate buyer (Section 2-725(3)(a)) unless the warranty consists of a promise that explicitly extends to the future performance of the goods and discovery must await the time for performance, in which case accrual occurs when the immediate buyer discovers or should have discovered the breach (Section 2-725(3) (d)). Section 2-725(2)(c) separately addresses the accrual of a right of action for breach of a remedial promise. The concept of remedial promise is dealt with in a separate subsection to make clear that it is a concept separate and apart from express warranty and that the elements of an express warranty, such as basis of the bargain, are not applicable. Cross References: Point 1: Sections 2-313A and 2-313B. Point 2: Sections 2-103, 2-313A and 2-313B. Point 3: Section 2-316(2)(b). Point 4: Section 2-316. Point 5: Sections 1-205(4) and 2-314. Point 6: Section 2-316. 98

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Point 7: Section 2-209. Point 8: Section 1-103. Point 11: Section 2-313 and 2-725. Denitional Cross References: Buyer. Section 2-103. Conforming. Section 2-106. Goods. Section 2-103. Remedial promise. Section 2-103. Seller. Section 2-103. Tender of delivery. Sections 2-503 and 2-507.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-313A. Obligation to Remote Purchaser Created by Record Packaged with or Accompanying Goods. (1) In this section: (a) Immediate buyer means a buyer that enters into a contract with the seller. (b) Remote purchaser means a person that buys or leases goods from an immediate buyer or other person in the normal chain of distribution. (2) This section applies only to new goods and goods sold or leased as new goods in a transaction of purchase in the normal chain of distribution. (3) If in a record packaged with or accompanying the goods the seller makes an armation of fact or promise that relates to the goods, provides a description that relates to the goods, or makes a remedial promise, and the seller reasonably expects the record to be, and the record is, furnished to the remote purchaser, the seller has an obligation to the remote purchaser that: (a) the goods will conform to the armation of fact, promise, or description unless a reasonable person in the position of the remote purchaser would not believe that the armation of fact, promise, or description created an obligation; and (b) the seller will perform the remedial promise. (4) It is not necessary to the creation of an obligation under this section that the seller use formal words such as warrant or guarantee or that the seller have a specic intention to undertake an obligation, but an armation merely of the value of the goods or a statement purporting to be merely the seller's opinion or commendation of the goods does not create an obligation. (5) The following rules apply to the remedies for breach of an obligation created under this section: (a) The seller may modify or limit the remedies available to the remote purchaser if the modication or limitation is furnished to the remote purchaser no later than the time of purchase or if the modication or limitation is contained in the record that contains the armation of fact, promise, or description. (b) Subject to a modication or limitation of remedy, a seller in breach is liable for incidental or consequential damages under Section 2-715, but not for lost prots.
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(c) The remote purchaser may recover as damages for breach of a seller's obligation arising under subsection (3) the loss resulting in the ordinary course of events as determined in any reasonable manner. (6) An obligation that is not a remedial promise is breached if the goods did not conform to the armation of fact, promise, or description creating the obligation when the goods left the seller's control.
Legislative Note: To maintain their relative positions in this Act, Sections 2-313A and 2-313B may have to be renumbered according to the convention used by a particular state. For example, in some states they may be designated as 2-313.1 and 2-313.2.

As added in 2003. Ocial Comment

1. Sections 2-313A and 2-313B are new, and they follow case law and practice in extending a seller's obligations regarding new goods to remote purchasers. Section 2-313A deals with what are commonly called pass-through warranties. The usual transaction in which this obligation arises is when a manufacturer sells goods in a package to a retailer and include in the package a record that sets forth the obligations that the manufacturer is willing to undertake in favor of the nal party in the distributive chain, who is the person that buys or leases the goods from the retailer. If the manufacturer had sold the goods directly to the nal party in the distributive chain, whether the manufacturer would incur liability is determined by Section 2-313 and this section is inapplicable. No direct contract exists between the seller and the remote purchaser, and thus the seller's obligation under this section is not referred to as an express warranty. Use of obligation rather than express warranty avoids any inference that the obligation arises as part of the basis of the bargain as would be required to create an express warranty under section 2-313. The test for whether an obligation other than a remedial promise arises is similar in some respects to the basis of the bargain requirement in section 2-313, but the test set forth in this section is exclusive. Because remedial promise in Section 2-313 is not subject to the requirement that it arise as part of the basis of the bargain, the term is used in this section. 2. The party to which an obligation runs under this section may either buy or lease the goods, and thus the term remote purchaser is used. The term is more limited than purchaser in Article 1, however, and does not include a donee or any voluntary transferee who is not a buyer or lessee. Moreover, the remote purchaser must be part of the normal chain of distribution for the particular product. That chain will, by denition, include at least three parties and may well include more. For example, the manufacturer might sell rst to a wholesaler that would then resell the goods to a retailer for sale or lease to the public. A buyer or lessee from the retailer would qualify as a remote purchaser and could invoke this section against either the manufacturer or the wholesaler (if the wholesaler provided a record to the retailer to be furnished to the nal party in the distribution chain), but no subsequent transferee, such as a used-goods buyer or sublessee, would qualify. The law governing assignment and third-party beneciary, including Section 2-318, should be consulted to determine whether a party other than the remote purchaser can enforce an obligation created under this section. 3. The application of this section is limited to new goods and goods sold or leased as new goods within the normal chain of distribution. It does not apply to goods that are sold outside the normal chain, such as gray goods or salvaged goods, nor does it apply if the goods are unused but sold as seconds. The concept is exible, and to determine whether goods have been sold or leased in the normal chain of distribution requires consideration of the seller's expectations for the manner in which its goods will reach the remote purchaser. For example, a car manufacturer may be aware that certain of its dealers transfer cars among themselves, and under the particular circumstances of the case a court might nd that a new car sold initially to one dealer but leased to the remote purchaser by another dealer was leased in the normal chain of distribution. The concept may also include such practices as door-to-door sales and distribution through a nonprot organization. The phrase goods sold or leased as new goods refers to goods that in the normal course of business would be considered new. There are many instances in which goods might be used for a limited purpose yet be sold or leased in the normal chain of distribution as new 100

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goods. For example, goods that have been returned to a dealer by a purchaser and placed back into the dealer's inventory might be sold or leased as new goods in the normal chain of distribution. Other examples might include goods that have been used for the purpose of inspection (e.g., a car that has been test-driven) and goods that have been returned by a sale-or-return buyer (Section 2-326). 4. This section applies only to obligations set forth in a record that is packaged with the goods or otherwise accompanies them (subsection (2)). Examples include a label axed to the outside of a container, a card inside a container, or a booklet handed to the remote purchaser at the time of purchase. In addition, the seller must be able to anticipate that the remote purchaser will acquire the record, and therefore this section is limited to records that the seller reasonably expects to be furnished, and that are in fact furnished, to the remote purchaser. Neither this section nor Section 2-313B are intended to overrule cases that impose liability on facts outside the direct scope of one of the sections. For example, the sections are not intended to overrule a decision imposing liability on a seller that distributes a sample to a remote purchaser. 5. Obligations other than remedial promises created under this section are analogous to express warranties and are subject to a test that is akin to the basis of the bargain test of Section 2-313(2). The seller is entitled to shape the scope of the obligation, and the seller's language tending to create an obligation must be considered in context. If a reasonable person in the position of the remote purchaser, reading the seller's language in its entirety, would not believe that an armation of fact, promise or description created an obligation, there is no liability under this section. 6. There is no dierence between remedial promise as used in this section (and Section 2-313B) and the same term as used in Section 2-313. 7. Subsection (5)(a) makes clear that the seller may employ the provisions of Section 2-719 to modify or limit the remedies available to the remote purchaser for breach of the seller's obligation in this section. The modication or limitation may appear on the same record as the one which creates the obligation, or it may be provided to the remote purchaser separately, but in no event may it be furnished to the remote purchaser any later than the time of purchase. The requirements and limitations set forth in Section 2-719, such as the requirement of an express statement of exclusivity and the tests for failure of essential purpose (Section 2-719(2)) and unconscionability (Section 2-719(3)) are applicable to a modication or limitation of remedy under this section. 8. As with express warranties, no specic language or intention is necessary to create an obligation, and whether an obligation exists is normally an issue of fact. Subsection (3) is virtually identical to Section 2-313(3), and the tests developed under the common law and under that section to determine whether a statement creates an obligation or is mere puing are applicable to this section. Just as a seller can limit the extent to which its language creates an express warranty under Section 2-313 by placing that language in a broader context, a seller under this section or Section 2-313B can limit the extent of its liability to a remote purchaser (subsection(4)(a)). In other words, the seller, in undertaking an obligation under these sections, can control the scope and limits of that obligation. 9. As a rule, a remote purchaser may recover monetary damages measured in the same manner as in the case of an aggrieved buyer under Section 2-714 as well as incidental and consequential damages under Section 2-715 to the extent they would be available to an aggrieved buyer. Subsection (5)(c) parallels Section 2-714(1) in allowing the buyer to recover for loss resulting in the ordinary course of events as determined in any manner which is reasonable. In the case of an obligation that is not a remedial promise, the normal measure of damages would be the dierence between the value of the goods if they had conformed to the seller's statements and their actual value, and the normal measure of damages for breach of a remedial promise would be the dierence between the value of the promised remedial performance and the value of the actual performance received. Subsection (5)(b) precludes a remote purchaser from recovering consequential damages in the form of lost prots. Cross References: Point 1: Sections 2-313, 2-313A and 2-313B. 101

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Point 2: Section 2-318. Point 3: Section 2-326. Point 4: Section 2-313B. Point 5: Section 2-313. Point 6: Section 2-313 and 2-313B. Point 7: Section 2-719. Point 8: Section 2-313 and 2-313B. Point 9: Sections 2-714 and 2-715. Denitional Cross References: Buyer. Section 2-103. Conforming. Section 2-106. Goods. Section 2-103. Lease. Section 2A-103. Purchase. Section 1-201. Record. Section 2-103. Remedial promise. Section 2-103. Remedy. Section 1-201. Sale. Section 2-106. Seller. Section 2-103.

2-313B. Obligation to Remote Purchaser Created by Communication to the Public. (1) In this section: (a) Immediate buyer means a buyer that enters into a contract with the seller. (b) Remote purchaser means a person that buys or leases goods from an immediate buyer or other person in the normal chain of distribution. (2) This section applies only to new goods and goods sold or leased as new goods in a transaction of purchase in the normal chain of distribution. (3) If in an advertisement or a similar communication to the public a seller makes an armation of fact or promise that relates to the goods, provides a description that relates to the goods, or makes a remedial promise, and the remote purchaser enters into a transaction of purchase with knowledge of and with the expectation that the goods will conform to the armation of fact, promise, or description, or that the seller will perform the remedial promise, the seller has an obligation to the remote purchaser that: (a) the goods will conform to the armation of fact, promise, or description unless a reasonable person in the position of the remote purchaser would not believe that the armation of fact, promise, or description created an obligation; and (b) the seller will perform the remedial promise. (4) It is not necessary to the creation of an obligation under this section that the seller use formal words such as warrant or guarantee or that the seller have a specic intention to undertake an obligation, but an armation merely of the value of the goods or a statement purporting to be merely the seller's opinion or commendation of the goods does not create an obligation. (5) The following rules apply to the remedies for breach of an obligation created under this section: (a) The seller may modify or limit the remedies available to the remote
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purchaser if the modication or limitation is furnished to the remote purchaser no later than the time of purchase. The modication or limitation may be furnished as part of the communication that contains the afrmation of fact, promise, or description. (b) Subject to a modication or limitation of remedy, a seller in breach is liable for incidental or consequential damages under Section 2-715, but not for lost prots. (c) The remote purchaser may recover as damages for breach of a seller's obligation arising under subsection (3) the loss resulting in the ordinary course of events as determined in any reasonable manner. (6) An obligation that is not a remedial promise is breached if the goods did not conform to the armation of fact, promise, or description creating the obligation when the goods left the seller's control.
Legislative Note: In order to maintain their relative positions in this Act, Sections 2-313A and 2-313B may have to be renumbered according to the convention used by a particular state. For example, in some states they may be designated as 2-313.1 and 2-313.2.

As added in 2003. Ocial Comment

1. Sections 2-313B and 2-313A are new, and they follow case law and practice in extending a seller's obligations for new goods to remote purchasers. This section deals with obligations to a remote purchaser created by advertising or a similar communication to the public. The normal situation where this obligation will arise is when a manufacturer engages in an advertising campaign directed towards all or part of the market for its product and will make statements that if made to an immediate buyer would amount to an express warranty or remedial promise under Section 2-313. The goods, however, are sold to someone other than the recipient of the advertising and are then resold or leased to the recipient. By imposing liability on the seller, this section adopts the approach of cases such as Randy Knitwear, Inc. v. American Cyanamid Co., 11 N.Y.2d 5, 226 N.Y.S.2d 363, 181 N.E.2d 399 (Ct. App. 1962). If the seller's advertisement is made to an immediate buyer, whether the seller incurs liability is determined by Section 2-313 and this section is inapplicable. 2. This section parallels Section 2-313A in most respects, and the Ocial Comments to that section should be consulted. In particular, the reasoning of Comment 1 (scope and terminology), Comment 2 (denition of remote purchaser), Comment 3 (new goods and goods sold as new goods in the normal chain of distribution), Comment 4 (reasonable person in the position of the remote purchaser), Comment 7 (modication or limitation of remedy), Comment 8 (pung and limitations on extent of obligation) and Comment 9 (damages) is adopted here. 3. This section provides an additional test for enforceability not found in Section 2-313A. For the obligation to be created the remote purchaser must, at the time of purchase, have knowledge of the armation of fact, promise, description or remedial promise and must also have an expectation that the goods will conform or that the seller will comply. This test is entirely subjective, while the reasonable person test in subsection (3)(a) is objective in nature. Both tests must be met. Thus, the seller will incur no liability to the remote purchaser if: i) the purchaser did not have knowledge of the seller's statement at the time of purchase; ii) the remote purchaser knew of the seller's statement at the time of purchase but did not expect the goods to conform or the seller to comply; iii) a reasonable person in the position of the remote purchaser would not believe that the seller's statement created an obligation (this test does not apply to remedial promises), or iv) the seller's statement is pung. 4. To determine whether the tests set forth in this section are satised the temporal relationship between the communication and the purchase should be considered by the court. For example, the remote purchaser may acquire the goods years after the seller's advertising campaign. In this circumstance, it would be highly unusual for the advertisement to have created the level of expectation in the remote purchaser or belief in the reasonable 103

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person in the position of the remote person necessary for the creation of an obligation under this section. 5. To determine whether an obligation arises under this Section, all information known to the remote purchaser at the time of contracting must be considered. For example, a news release by a manufacturer limiting the statements made in its advertising and which are known by the remote purchaser, or a communication to the remote purchaser by the immediate seller limiting the statements made in the manufacturer's advertising must be considered to determine whether the expectation requirement applicable to the remote purchaser and the belief requirement applicable to the reasonable person in the position of the remote purchaser are satised. 6. The remedies for breach of an obligation arising under this section may be modied or limited as set forth in Section 2-719. The modication or limitation may be contained in the advertisement that creates the obligation, or it may be separately furnished to the remote purchaser no later than the time of purchase. 7. Section 2-318 deals with the extension of obligations to certain third-party beneciaries. Of course, no extension is necessary if the goods are purchased by an agent. In this case, the knowledge and expectation of the principal, not the agent, are relevant in determining whether an obligation arises under this section. Nothing in this Act precludes a court from determining that a household operates as a buying unit under the law of agency. Cross References: Point 1: Sections 2-313, 2-313A and 2-313B. Point 2: Section 2-313A. Point 3: Section 2-313A. Point 6: Section 2-719. Point 7: Section 2-318. Denitional Cross References: Buyer. Section 2-103. Conforming. Section 2-106. Goods. Section 2-103. Lease. Section 2A-103. Purchase. Section 1-201. Record. Section 2-103. Remedial promise. Section 2-103. Remedy. Section 1-201. Sale. Section 2-106. Seller. Section 2-103.

2-314. Implied Warranty: Merchantability; Usage of Trade. (1) Unless excluded or modied (Section 2-316), a warranty that the goods shall be merchantable is implied in a contract for their sale if the seller is a merchant with respect to goods of that kind. Under this section the serving for value of food or drink to be consumed either on the premises or elsewhere is a sale. (2) Goods to be merchantable must be at least such as: (a) pass without objection in the trade under the contract description; (b) in the case of fungible goods, are of fair average quality within the description; (c) are t for the ordinary purposes for which goods of that description are used; (d) run, within the variations permitted by the agreement, of even kind, quality and quantity within each unit and among all units involved; (e) are adequately contained, packaged, and labeled as the agreement may require; and
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(f) conform to the promise or armations of fact made on the container or label if any. (3) Unless excluded or modied (Section 2-316) other implied warranties may arise from course of dealing or usage of trade. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. The phrase goods of that description rather than the language from the original Article 2 for which such goods are used is used in subsection (2)(c). This change emphasizes the importance of the agreed description in determining tness for ordinary purposes. 2. The seller's obligation applies to present sales as well as to contracts to sell subject to the eects of any examination of specic goods. See Section 2-316(3)(b). The warranty of merchantability also applies to sales for use as well as to sales for resale. 3. The question when the warranty is imposed turns basically on the meaning of the terms of the agreement as recognized in the trade. Goods delivered under an agreement made by a merchant in a given line of trade must be of a quality comparable to that generally acceptable in that line of trade under the description or other designation of the goods used in the agreement. The responsibility imposed rests on any merchant-seller. 4. A specic designation of goods by the buyer does not exclude the seller's obligation that they be t for the general purposes appropriate to the goods. A contract for the sale of second-hand goods, however, involves only an obligation as is appropriate to the goods according to their contract description. A person making an isolated sale of goods is not a merchant within the meaning of the full scope of this section and, thus, no warranty of merchantability would apply. The seller's knowledge of any defects not apparent on inspection would, however, without need for express agreement and in keeping with the underlying reason of the present section and the provisions on good faith, impose an obligation that known material but hidden defects be fully disclosed. 5. Although a seller may not be a merchant for the goods in question, if the seller states generally that the goods are guaranteed, the provisions of this section may furnish a guide to the content of the resulting express warranty. This has particular signicance in the case of second-hand sales, and has further signicance in limiting the eect of neprint disclaimer clauses where their eect would be inconsistent with large-print assertions of guarantee. 6. The second sentence of subsection (1) covers the warranty for food and drink. The serving for value of food or drink for consumption on the premises or elsewhere is treated as a sale. 7. Suppose that an unmerchantable lawn mower causes personal injury to the buyer, who is operating the mower. Without more, the buyer can sue the seller for breach of the implied warranty of merchantability and recover for injury to person proximately resulting from the breach. Section 2-715(2)(b). This opportunity does not resolve the tension between warranty law and tort law where goods cause personal injury or property damage. The primary source of that tension arises from disagreement over whether the concept of defect in tort and the concept of merchantability in Article 2 are coextensive where personal injuries are involved, i.e., if goods are merchantable under warranty law, can they still be defective under tort law, and if goods are not defective under tort law, can they be unmerchantable under warranty law? The answer to both questions should be no, and the tension between merchantability in warranty and defect in tort where personal injury or property damage is involved should be resolved as follows:
When recovery is sought for injury to person or property, whether goods are merchantable is to be determined by applicable state products liability law. When, however, a claim for injury to person or property is based on an implied warranty of tness under Section 2-315 or an express warranty under Section 2-313 or an obligation arising under Section 2-313A or 2-313B, this Article determines whether an implied warranty of tness or an express warranty was made and breached, as well as what damages are recoverable under Section 2-715.

To illustrate, suppose that the seller makes a representation about the safety of a lawn mower that becomes part of the basis of the buyer's bargain. The buyer is injured when the 105

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gas tank cracks and a re breaks out. If the lawnmower without the representation is not defective under applicable tort law, it is not unmerchantable under this section. On the other hand, if the lawnmower did not conform to the representation about safety, the seller made and breached an express warranty and the buyer may sue under Article 2. 8. Subsection (2) does not purport to exhaust the meaning of merchantable nor to negate any of its attributes not specically mentioned in the text of the statute but that arise by usage of trade or through case law. The language used is must be at least such as . . . , and the intention is to leave open other possible attributes of merchantability. 9. Paragraphs (a) and (b) of subsection (2) are to be read together. Both refer to the standards of that line of the trade which ts the transaction and the seller's business. Fair average is a term directly appropriate to agricultural bulk products and means goods centering around the middle belt of quality, not the least or the worst that can be understood in the particular trade by the designation, but such as can pass without objection. Of course a fair percentage of the least is permissible but the goods are not fair average if they are all of the least or worst quality possible under the description. In cases of doubt about what quality is intended, the price at which a merchant closes a contract is an excellent indication of the nature and scope of the merchant's obligation under the present section. 10. Fitness for the ordinary purposes for which goods of the type are used is a fundamental concept of the present section and is covered in paragraph (2)(c). As stated above, merchantability is also a part of the obligation owing to the buyer for use. Correspondingly, protection, under this aspect of the warranty, of the person buying for resale to the ultimate consumer is equally necessary, and merchantable goods must therefore be honestly resalable in the normal course of business because they are what they purport to be. 11. Paragraph (2)(d) on evenness of kind, quality and quantity follows case law. But precautionary language has been added as a remainder of the frequent usages of trade which permit substantial variations both with and without an allowance or an obligation to replace the varying units. 12. Paragraph (2)(e) applies only where the nature of the goods and of the transaction require a certain type of container, package or label. Paragraph (2)(f) applies, on the other hand, wherever there is a label or container on which representations are made, even though the original contract, either by express terms or usage of trade, may not have required either the labeling or the representation. This follows from the general obligation of good faith which requires that a buyer should not be placed in the position of reselling or using goods delivered under false representations appearing on the package or container. No problem of extra consideration arises in this connection since, under this Article, an obligation is imposed by the original contract not to deliver mislabeled articles, and the obligation is imposed where mercantile good faith so requires and without reference to the doctrine of consideration. 13. Exclusion or modication of the warranty of merchantability, or of any part of it, is dealt with in Section 2-316. That section must be read with particular reference to subsection (4) on limitation of remedies. The warranty of merchantability, wherever it is normal, is so commonly taken for granted that its exclusion from the contract is a matter threatening surprise and therefore requiring special precaution. 14. Subsection (3) is to make explicit that usage of trade and course of dealing can create warranties and that they are implied rather than express warranties and thus subject to exclusion or modication under Section 2-316. A typical instance would be the obligation to provide pedigree papers to evidence conformity of the animal to the contract in the case of a pedigreed dog or blooded bull. 15. In an action based on breach of warranty, it is of course necessary to show not only the existence of the warranty but the fact that the warranty was broken and that the breach of the warranty was the proximate cause of the loss sustained. An armative showing by the seller that the loss resulted from some action or event following the seller's delivery of the goods can operate as a defense. Equally, evidence indicating that the seller exercised care in the manufacture, processing or selection of the goods is relevant to the issue of whether the warranty was in fact broken. An action by the buyer following an examination of the goods which ought to have indicated the defect complained of can be shown as matter bearing on whether the breach itself was the cause of the injury. 106

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Cross References: Point 1: Section 2-316. Point 2: Section 2-316. Point 3: Sections 1-203 and 2-104. Point 5: Section 2-315. Point 7: Section 2-715. Point 11: Section 2-316. Point 12: Sections 1-201, 1-205 and 2-316. Point 13: Section 2-316. Point 14: Section 2-316. Denitional Cross References: Agreement. Section 1-201. Contract. Section 1-201. Contract for sale. Section 2-106. Goods. Section 2-103. Merchant. Section 2-104. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-315. Implied Warranty: Fitness for Particular Purpose. Where the seller at the time of contracting has reason to know any particular purpose for which the goods are required and that the buyer is relying on the seller's skill or judgment to select or furnish suitable goods, there is unless excluded or modied under the next section an implied warranty that the goods shall be t for such purpose. Ocial Comment
Prior Uniform Statutory Provision: Section 15(1), (4), (5), Uniform Sales Act. Changes: Rewritten. Purposes of Changes: 1. Whether or not this warranty arises in any individual case is basically a question of fact to be determined by the circumstances of the contracting. Under this section the buyer need not bring home to the seller actual knowledge of the particular purpose for which the goods are intended or of his reliance on the seller's skill and judgment, if the circumstances are such that the seller has reason to realize the purpose intended or that the reliance exists. The buyer, of course, must actually be relying on the seller. 2. A particular purpose diers from the ordinary purpose for which the goods are used in that it envisages a specic use by the buyer which is peculiar to the nature of his business whereas the ordinary purposes for which goods are used are those envisaged in the concept of merchantability and go to uses which are customarily made of the goods in question. For example, shoes are generally used for the purpose of walking upon ordinary ground, but a seller may know that a particular pair was selected to be used for climbing mountains. A contract may of course include both a warranty of merchantability and one of tness for a particular purpose. The provisions of this Article on the cumulation and conict of express and implied warranties must be considered on the question of inconsistency between or among warranties. In such a case any question of fact as to which warranty was intended by the parties to apply must be resolved in favor of the warranty of tness for particular purpose as against all other warranties except where the buyer has taken upon himself the responsibility of furnishing the technical specications. 3. In connection with the warranty of tness for a particular purpose the provisions of this Article on the allocation or division of risks are particularly applicable in any transaction in which the purpose for which the goods are to be used combines requirements both 107

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as to the quality of the goods themselves and compliance with certain laws or regulations. How the risks are divided is a question of fact to be determined, where not expressly contained in the agreement, from the circumstances of contracting, usage of trade, course of performance and the like, matters which may constitute the otherwise agreement of the parties by which they may divide the risk or burden. 4. The absence from this section of the language used in the Uniform Sales Act in referring to the seller, whether he be the grower or manufacturer or not, is not intended to impose any requirement that the seller be a grower or manufacturer. Although normally the warranty will arise only where the seller is a merchant with the appropriate skill or judgment, it can arise as to non-merchants where this is justied by the particular circumstances. 5. The elimination of the patent or other trade name exception constitutes the major extension of the warranty of tness which has been made by the cases and continued in this Article. Under the present section the existence of a patent or other trade name and the designation of the article by that name, or indeed in any other denite manner, is only one of the facts to be considered on the question of whether the buyer actually relied on the seller, but it is not of itself decisive of the issue. If the buyer himself is insisting on a particular brand he is not relying on the seller's skill and judgment and so no warranty results. But the mere fact that the article purchased has a particular patent or trade name is not sucient to indicate nonreliance if the article has been recommended by the seller as adequate for the buyer's purposes. 6. The specic reference forward in the present section to the following section on exclusion or modication of warranties is to call attention to the possibility of eliminating the warranty in any given case. However it must be noted that under the following section the warranty of tness for a particular purpose must be excluded or modied by a conspicuous writing. Cross References: Point 2: Sections 2-314 and 2-317. Point 3: Section 2-303. Point 6: Section 2-316. Denitional Cross References: Buyer. Section 2-103. Goods. Section 2-103. Seller. Section 2-103.

2-316. Exclusion or Modication of Warranties. (1) Words or conduct relevant to the creation of an express warranty and words or conduct tending to negate or limit warranty shall be construed wherever reasonable as consistent with each other; but subject to Section 2-202, negation or limitation is inoperative to the extent that such construction is unreasonable. (2) Subject to subsection (3), to exclude or modify the implied warranty of merchantability or any part of it in a consumer contract the language must be in a record, be conspicuous, and state The seller undertakes no responsibility for the quality of the goods except as otherwise provided in this contract, and in any other contract the language must mention merchantability and in case of a record must be conspicuous. Subject to subsection (3), to exclude or modify the implied warranty of tness, the exclusion must be in a record and be conspicuous. Language to exclude all implied warranties of tness in a consumer contract must state The seller assumes no responsibility that the goods will be t for any particular purpose for which you may be buying these goods, except as otherwise provided in the contract, and in any other contract the language is sufcient if it states, for example, that There are no warranties that extend beyond the description on the face hereof. Language that satises the
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requirements of this subsection for the exclusion or modication of a warranty in a consumer contract also satises the requirements for any other contract. (3) Notwithstanding subsection (2): (a) unless the circumstances indicate otherwise, all implied warranties are excluded by expressions like as is, with all faults or other language that in common understanding calls the buyer's attention to the exclusion of warranties, makes plain that there is no implied warranty, and, in a consumer contract evidenced by a record, is set forth conspicuously in the record; (b) if the buyer before entering into the contract has examined the goods or the sample or model as fully as desired or has refused to examine the goods after a demand by the seller there is no implied warranty with regard to defects that an examination in the circumstances should have revealed to the buyer; and (c) an implied warranty may also be excluded or modied by course of dealing or course of performance or usage of trade. (4) Remedies for breach of warranty may be limited in accordance with Sections 2-718 and 2-719. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (1) is designed principally to deal with those frequent clauses in sales contracts which seek to exclude all warranties, express or implied. It seeks to protect a buyer from unexpected and unbargained language of disclaimer by denying eect to this language when inconsistent with language of express warranty and permitting the exclusion of implied warranties only by language or other circumstances which protect the buyer from surprise. The seller is protected against false allegations of oral warranties by this Article's provisions on parol and extrinsic evidence and against unauthorized representations by the customary lack of authority clauses. This Article treats the limitation or avoidance of consequential damages as a matter of limiting remedies for breach, separate from the matter of creation of liability under a warranty. If no warranty exists, there is of course no problem of limiting remedies for breach of warranty. Under subsection (4), the question of limitation of remedy is governed by the sections referred to rather than by this section. 2. The general test for disclaimers of implied warranties remains in subsection (3)(a), and the more specic tests are in subsection (2). A disclaimer that satises the requirements of subsection (3)(a) need not also satisfy any of the requirements of subsection (2). 3. Subsection (2) distinguishes between commercial and consumer contracts. In a commercial contract, language that disclaims the implied warranty of merchantability need not be in a record, but if it is in a record it must be conspicuous. Under this subsection, a conspicuous record is required to disclaim the implied warranty of merchantability in a consumer contract and to disclaim the implied warranty of tness in any contract. Use of the language required by this subsection for consumer contracts satises the language requirements for other contracts governed by this subsection. 4. Subsection (2) presupposes that the implied warranty in question exists unless excluded or modied. Whether or not language of disclaimer satises the requirements of this section, the language may be relevant under other sections to the question of whether the warranty was ever in fact created. Thus, unless the provisions of this Article on parol and extrinsic evidence prevent its introduction, oral language of a disclaimer may raise issues of fact about whether reliance by the buyer occurred and whether the seller had reason to know under the section on implied warranty of tness for a particular purpose. 5. Subsection (3)(a) deals with general terms such as as is, as they stand, with all 109

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faults, and the like. These terms in ordinary commercial usage are understood to mean that the buyer takes the entire risk as to the quality of the goods involved. The terms covered by the subsection are in fact merely a particularization of subsection (3)(c), which provides for exclusion or modication of implied warranties by usage of trade. Nothing in subsection (3)(a) prevents a term such as there are no implied warranties from being effective in appropriate circumstances, as when the term is a negotiated term between commercial parties. Satisfaction of subsection (3)(a) does not require that the language be set forth in a record, but if there is a record the language must be conspicuous if the contract is a consumer contract. 6. The exceptions to the general rule set forth in subsections (3)(b) and (3)(c) are common factual situations in which the circumstances surrounding the transaction are in themselves sucient to call the buyer's attention to the fact that no implied warranties are made or that a certain implied warranty is being excluded. Under subsection (3)(b), warranties may be excluded or modied by the circumstances when the buyer examines the goods or a sample or model of them before entering into the contract. Examination as used in this paragraph is not synonymous with inspection before acceptance or at any other time after the contract has been made. Of course if the buyer discovers the defect and uses the goods anyway, or if the buyer unreasonably fails to examine the goods before using them, the resulting injuries may be found to have resulted from the buyer's own action rather than have been proximately caused by a breach of warranty. See Sections 2-314 and 2-715. To bring the transaction within the scope of refused to examine in subsection (3)(b), it is not sucient that the goods are available for inspection. There must in addition be an actual examination by the buyer or a demand by the seller that the buyer examine the goods fully. The seller's demand must place the buyer on notice that the buyer is assuming the risk of defects which the examination ought to reveal. Application of the doctrine of caveat emptor in all cases where the buyer examines the goods regardless of statements made by the seller is, however, rejected by this Article. Thus, if the oer of examination is accompanied by words about their merchantability or specic attributes, and the buyer indicates clearly a reliance on those words rather than on the buyer's examination, the words give rise to an express warranty. In these cases, the question is one of fact about whether a warranty of merchantability has been expressly incorporated in the agreement. The particular buyer's skill and the normal method of examining goods in the circumstances determine what defects are excluded by the examination. A failure to notice defects which are obvious cannot excuse the buyer because of the lack of notice. However, an examination under circumstances which do not permit chemical or other testing of the goods does not exclude defects which could be ascertained only by testing. Nor can latent defects be excluded by a simple examination. A professional buyer examining a product in the buyer's eld will be held to have assumed the risk for all defects which a professional in the eld ought to observe, while a nonprofessional buyer will be held to have assumed the risk only for the defects as a layperson might be expected to observe. 7. The situation in which the buyer gives precise and complete specications to the seller is not explicitly covered in this section, but this is a frequent circumstance by which the implied warranties may be excluded. The warranty of tness for a particular purpose would not normally arise since in this situation there is usually no reliance on the seller by the buyer. The warranty of merchantability in a transaction of this type, however, must be considered in connection with the next section on the cumulation and conict of warranties. Under paragraph(c) of that section in case of an inconsistency the implied warranty of merchantability is displaced by the express warranty that the goods will comply with the specications. Thus, where the buyer gives detailed specications as to the goods, neither of the implied warranties as to quality will normally apply to the transaction unless consistent with the specications. Cross References: Point 1: Sections 2-202, 2-718 and 2-719. Point 6: Sections 1-205, 2-314 and 2-715. Denitional Cross References: Agreement. Section 1-201. 110

Art. 2
Buyer. Section 2-103. Conspicuous. Section 2-103. Consumer contract. Section 2-103. Contract. Section 1-201. Course of dealing. Section 1-303. Goods. Section 2-103. Record. Section 2-103. Remedy. Section 1-201. Seller. Section 2-103. Usage of trade. Section 1-303.

Sales

2-317

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-317. Cumulation and Conict of Warranties Express or Implied. Warranties whether express or implied shall be construed as consistent with each other and as cumulative, but if such construction is unreasonable the intention of the parties shall determine which warranty is dominant. In ascertaining that intention the following rules apply: (a) Exact or technical specications displace an inconsistent sample or model or general language of description. (b) A sample from an existing bulk displaces inconsistent general language of description. (c) Express warranties displace inconsistent implied warranties other than an implied warranty of tness for a particular purpose. Ocial Comment
Prior Uniform Statutory Provision: On cumulation of warranties see Sections 14, 15, and 16, Uniform Sales Act. Changes: Completely rewritten into one section. Purposes of Changes: 1. The present section rests on the basic policy of this Article that no warranty is created except by some conduct (either armative action or failure to disclose) on the part of the seller. Therefore, all warranties are made cumulative unless this construction of the contract is impossible or unreasonable. This Article thus follows the general policy of the Uniform Sales Act except that in case of the sale of an article by its patent or trade name the elimination of the warranty of tness depends solely on whether the buyer has relied on the seller's skill and judgment; the use of the patent or trade name is but one factor in making this determination. 2. The rules of this section are designed to aid in determining the intention of the parties as to which of inconsistent warranties which have arisen from the circumstances of their transaction shall prevail. These rules of intention are to be applied only where factors making for an equitable estoppel of the seller do not exist and where he has in perfect good faith made warranties which later turn out to be inconsistent. To the extent that the seller has led the buyer to believe that all of the warranties can be performed, he is estopped from setting up any essential inconsistency as a defense. 3. The rules in subsections (a), (b) and (c) are designed to ascertain the intention of the parties by reference to the factor which probably claimed the attention of the parties in the rst instance. These rules are not absolute but may be changed by evidence showing that the conditions which existed at the time of contracting make the construction called for by the section inconsistent or unreasonable. Cross Reference: Point 1: Section 2-315. Denitional Cross Reference: 111

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Party. Section 1-201.

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2-318. Third-Party Beneciaries of Warranties and Obligations. (1) In this section: (a) Immediate buyer means a buyer that enters into a contract with the seller. (b) Remote purchaser means a person that buys or leases goods from an immediate buyer or other person in the normal chain of distribution.
Alternative A to subsection (2)

(2) A seller's warranty to an immediate buyer, whether express or implied, a seller's remedial promise to an immediate buyer, or a seller's obligation to a remote purchaser under Section 2-313A or 2-313B extends to any individual who is in the family or household of the immediate buyer or the remote purchaser or who is a guest in the home of either if it is reasonable to expect that the person may use, consume, or be aected by the goods and who is injured in person by breach of the warranty, remedial promise, or obligation. A seller may not exclude or limit the operation of this section.
Alternative B to subsection (2)

(2) A seller's warranty to an immediate buyer, whether express or implied, a seller's remedial promise to an immediate buyer, or a seller's obligation to a remote purchaser under Section 2-313A or 2-313B extends to any individual who may reasonably be expected to use, consume, or be aected by the goods and who is injured in person by breach of the warranty, remedial promise, or obligation. A seller may not exclude or limit the operation of this section.
Alternative C to subsection (2)

(2) A seller's warranty to an immediate buyer, whether express or implied, a seller's remedial promise to an immediate buyer, or a seller's obligation to a remote purchaser under Section 2-313A or 2-313B extends to any person that may reasonably be expected to use, consume, or be affected by the goods and that is injured by breach of the warranty, remedial promise, or obligation. A seller may not exclude or limit the operation of this section with respect to injury to the person of an individual to whom the warranty, remedial promise, or obligation extends. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. This section retains original Article 2's alternative approaches but expands each alternative to cover obligations arising under Sections 2-313A and 2-313B and remedial promises. 2. The last sentence of each alternative to subsection (2) is not meant to suggest that a seller is precluded from excluding or disclaiming a warranty which might otherwise arise in connection with the sale provided the exclusion or modication is permitted by Section 2-316. Nor is it intended to suggest that the seller is precluded from limiting the remedies of the immediate buyer or remote purchaser in any manner provided in Sections 2-718 or 2-719. See also Section 2-313A(4) and Section 2-313B(4). To the extent that the contract of sale contains provisions under which warranties are excluded or modied, or remedies for breach are limited, the provisions are equally operative against beneciaries of warranties 112

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under this section. What this last sentence forbids is exclusion of liability by the seller to the persons to whom the warranties, obligations and remedial promises accruing to the immediate buyer or remote purchaser would extend under this section. Alternative A extends protection to a third party beneciaries who is a guest in the home of the immediate buyer or remoter purchaser. The status of guest in the home describes the category of beneciaries covered by this provision, and it does not limit the situs of the breach. Thus, a guest in the home that would otherwise have rights under this section could be injured in the automobile of the immediate buyer or remote purchaser. Beyond this, the section is neutral and is not intended to enlarge or restrict the developed or developing case law on whether the seller's warranties, given to his buyer who resells, extend to other persons in the distributive chain. The last sentence of Alternative C permits a seller to reduce its obligations to third-party beneciaries to a level commensurate with that imposed on the seller under Alternative B-that is, to eliminate liability to persons that are not individuals and to eliminate liability for damages other than personal injury. 3. As used in this section, the term remote purchaser refers to the party to whom an obligation initially runs under Section 2-313A or 2-313B. It does not refer to any subsequent purchaser of the goods. 4. As applied to warranties and remedial promises arising under Sections 2-313, 2-314 and 2-315, the purpose of this section is to give certain beneciaries the benet of the warranties and remedial promises which the immediate buyer received in the contract of sale, thereby freeing any beneciaries from any technical rules as to privity. It seeks to accomplish this purpose without any derogation of any right or remedy arising under the law of torts. Implicit in the section is that any beneciary of a warranty may bring a direct action for breach of warranty against the seller whose warranty extends to the beneciary. Obligations and remedial promises under Sections 2-313A and 2-313B arise initially in a non-privity context but are extended under this section to the same extent as warranties and remedial promises running to a buyer in privity. Cross References: Point 1: Sections 2-313A, 2-313B. Point 2: Sections 2-313A, 2-313B, 2-316, 2-718 and 2-719. Point 3: Sections 2-313A, 2-313B. Point 4: Section 2-313, 2-313A, 2-313B, 2-314, 2-315. Denitional Cross References: Buyer. Section 2-103. Contract. Section 1-201. Goods. Section 2-103. Lease. Section 2A-103. Remedial promise. Section 2-103. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-319. Reserved.
Legislative Note: Sections 2-319 through 2-324 have been eliminated because they are inconsistent with modern commercial practices.

Ocial Comment
Sections 2-319 through 2-324 have been repealed. The eect of a party's use of shipping terms such as FOB, CIF, or the like, absent any express agreement to the meaning of the terms, must be interpreted in light of any applicable usage of trade and any course of performance or course of dealing between the parties.

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2-320. Reserved. 2-321. Reserved. 2-322. Reserved. 2-323. Reserved. 2-324. Reserved. 2-325. Failure to Pay by Agreed Letter of Credit. If the parties agree that the primary method of payment will be by letter of credit, the following rules apply: (a) The buyer's obligation to pay is suspended by seasonable delivery to the seller of a letter of credit issued or conrmed by a nancing agency of good repute in which the issuer and any conrmer undertake to pay against presentation of documents that evidence delivery of the goods. (b) Failure of a party seasonably to furnish a letter of credit as agreed is a breach of the contract for sale. (c) If the letter of credit is dishonored or repudiated, the seller, on seasonable notication, may require payment directly from the buyer. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. This section conforms to revised Article 5. 2. Subsection (c) follows the general policy of this Article and Article 3 (Section 3-310) on conditional payment, under which payment by check or other short-term instrument is not ordinarily nal between the parties if the recipient presents the instrument and it is not paid. Thus the furnishing of a letter of credit does not substitute the nancing agency's obligation for the buyer's, but the seller must rst give the buyer reasonable notice of his intention to demand direct payment from the buyer. Cross References: Point 2: Sections 2-403, 2-511(3) and 3-802 and Article 5. Denitional Cross References: Agree. Section 1-201. Buyer. Section 2-103. Delivery. Section 2-103. Dishonored. Section 3-502. Financing agency. Section 2-104. Letter of credit. Section 5-102(a)(10). Notication. Section 1-202. Party. Section 1-201. Seasonable. Section 1-205. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-326. Sale on Approval and Sale or Return. (1) Unless otherwise agreed, if delivered goods may be returned by the buyer even if they conform to the contract, the transaction is:
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(a) a sale on approval if the goods are delivered primarily for use; and (b) a sale or return if the goods are delivered primarily for resale. (2) Goods held on approval are not subject to the claims of the buyer's creditors until acceptance; goods held on sale or return are subject to such claims while in the buyer's possession. (3) Any or return term of a contract for sale is to be treated as a separate contract for sale under Section 2-201 and as contradicting the sale aspect of the contract under Section 2-202. As amended in 1999 and 2003.
See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999. See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Both a sale on approval and a sale or return should be distinguished from other types of transactions with which they frequently have been confused. A sale on approval, sometimes also called a sale on trial or on satisfaction, deals with a contract under which the seller undertakes a risk in order to satisfy its prospective buyer with the appearance or performance of the goods that are sold. The goods are delivered to the prospective purchaser but they remain the property of the seller until the buyer accepts them. The price has already been agreed. The buyer's willingness to receive and test the goods is the consideration for the seller's engagement to deliver and sell. A sale or return, on the other hand, typically is a sale to a merchant whose unwillingness to buy is overcome by the seller's engagement to take back the goods (or any commercial unit of goods) in lieu of payment if they fail to be resold. A sale or return is a present sale of goods which may be undone at the buyer's option. Accordingly, subsection (2) provides that goods delivered on approval are not subject to the prospective buyer's creditors until acceptance, and goods delivered in a sale or return are subject to the buyer's creditors while in the buyer's possession. These two transactions are so strongly delineated in practice and in general understanding that every presumption runs against a delivery to a consumer being a sale or return and against a delivery to a merchant for resale being a sale on approval. 2. The right to return goods for failure to conform to the contract of sale does not make the transaction a sale on approval or sale or return and has nothing to do with this section or Section 2-327. This section is not concerned with remedies for breach of contract. It deals instead with a power given by the contract to turn back the goods even though they are wholly as warranted. This section nevertheless presupposes that a contract for sale is contemplated by the parties, although that contract may be of the particular character that this section addresses (i.e., a sale on approval or a sale or return). If a buyer's obligation as a buyer is conditioned not on its personal approval but on the article's passing a described objective test, the risk of loss by casualty pending the test is properly the seller's and proper return is at its expense. On the point of satisfaction as meaning reasonable satisfaction when an industrial machine is involved, this Article takes no position. 3. Subsection (3) resolves a conict in the pre-UCC case law by recognizing that an or return provision is so denitely at odds with any ordinary contract for sale of goods that if written agreement is involved the return term must be contained in a written memorandum. The or return aspect of a sales contract must be treated as a separate contract under the statute of frauds section and as contradicting the sale insofar as questions of parol or extrinsic evidence are concerned. 4. Certain true consignments transactions were dealt with in former Sections 2-326(3) and 9-114. These provisions have been deleted and have been replaced by new provisions of Article 9. See e.g., Sections 9-109(a)(4); 9-103(d); 9-319. Cross References: Point 1: Article 9. 115

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Point 2: Sections 2-20, 2-202 and 2-327. Point 4: Section 2-326 and Article 9. Denitional Cross References: Buyer. Section 2-103. Conform to the contract. Section 2-106. Creditor. Section 1-201. Delivered. Section 2-103. Goods. Section 2-103. Sale. Section 2-106. Sale on approval. Section 2-326. Sale on return. Section 2-326.

As amended in 1999, 2000 and 2003.

See Appendix I contained within revised Article 9 for material relating to changes made in Ocial Comment in 2001. See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-327. Special Incidents of Sale on Approval and Sale or Return. (1) Under a sale on approval unless otherwise agreed (a) although the goods are identied to the contract the risk of loss and the title do not pass to the buyer until acceptance; and (b) use of the goods consistent with the purpose of trial is not acceptance but failure seasonably to notify the seller of election to return the goods is acceptance, and if the goods conform to the contract acceptance of any part is acceptance of the whole; and (c) after due notication of election to return, the return is at the seller's risk and expense but a merchant buyer must follow any reasonable instructions. (2) Under a sale or return unless otherwise agreed (a) the option to return extends to the whole or any commercial unit of the goods while in substantially their original condition, but must be exercised seasonably; and (b) the return is at the buyer's risk and expense. Ocial Comment
Prior Uniform Statutory Provision: Section 19(3), Uniform Sales Act. Changes: Completely rewritten in preceding and this section. Purposes of Changes: To make it clear that: 1. In the case of a sale on approval: If all of the goods involved conform to the contract, the buyer's acceptance of part of the goods constitutes acceptance of the whole. Acceptance of part falls outside the normal intent of the parties in the on approval situation and the policy of this Article allowing partial acceptance of a defective delivery has no application here. A case where a buyer takes home two dresses to select one commonly involves two distinct contracts; if not, it is covered by the words unless otherwise agreed. 2. In the case of a sale or return, the return of any unsold unit merely because it is unsold is the normal intent of the sale or return provision, and therefore the right to return for this reason alone is independent of any other action under the contract which would turn on wholly dierent considerations. On the other hand, where the return of goods is for breach, including return of items resold by the buyer and returned by the ultimate purchasers because of defects, the return procedure is governed not by the present section but by the provisions on the eects and revocation of acceptance. 3. In the case of a sale on approval the risk rests on the seller until acceptance of the 116

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goods by the buyer, while in a sale or return the risk remains throughout on the buyer. 4. Notice of election to return given by the buyer in a sale on approval is sucient to relieve him of any further liability. Actual return by the buyer to the seller is required in the case of a sale or return contract. What constitutes due giving of notice, as required in on approval sales, is governed by the provisions on good faith and notice. Seasonable is used here as dened in Section 1-204. Nevertheless, the provisions of both this Article and of the contract on this point must be read with commercial reason and with full attention to good faith. Cross References: Point 1: Sections 2-501, 2-601 and 2-603. Point 2: Sections 2-607 and 2-608. Point 4: Sections 1-201 and 1-204. Denitional Cross References: Agreed. Section 1-201. Buyer. Section 2-103. Commercial unit. Section 2-105. Conform. Section 2-106. Contract. Section 1-201. Goods. Section 2-103. Merchant. Section 2-104. Noties. Section 1-202. Notication. Section 1-202. Sale on approval. Section 2-326. Sale or return. Section 2-326. Seasonably. Section 1-205. Seller. Section 2-103.

2-328. Sale by Auction. (1) In a sale by auction, if goods are put up in lots, each lot is the subject of a separate sale. (2) A sale by auction is complete when the auctioneer so announces by the fall of the hammer or in other customary manner. If a bid is made during the process of completing the sale but before a prior bid is accepted, the auctioneer has discretion to reopen the bidding or to declare the goods sold under the prior bid. (3) A sale by auction is subject to the seller's right to withdraw the goods unless at the time the goods are put up or during the course of the auction it is announced in express terms that the right to withdraw the goods is not reserved. In an auction in which the right to withdraw the goods is reserved, the auctioneer may withdraw the goods at any time until completion of the sale is announced by the auctioneer. In an auction in which the right to withdraw the goods is not reserved, after the auctioneer calls for bids on an article or lot, the article or lot may not be withdrawn unless no bid is made within a reasonable time. In either case a bidder may retract a bid until the auctioneer's announcement of completion of the sale, but a bidder's retraction does not revive any previous bid. (4) If the auctioneer knowingly receives a bid on the seller's behalf or the seller makes or procures such a bid, and notice has not been given that liberty for such bidding is reserved, the buyer may at the buyer's option avoid the sale or take the goods at the price of the last good-faith bid prior to the completion of the sale. This subsection shall not apply to any bid at an auction required by law.
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As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. The auctioneer may use discretion either in reopening the bidding or closing the sale on a bid made during the process of completing the sale when a bid is made at that moment. The recognition of a bid of this kind by the auctioneer does not mean a closing in favor of the bidder, but only that the bid has been accepted as a continuation of the bidding. If recognized, this bid discharges the bid made during the process of completing the sale. 2. An auction with the right to withdraw the goods is the normal procedure. Because of dierent usage, the phrases with reserve and without reserve are no longer used in this section. Nevertheless, auction sales subject to the seller's power to withdraw the goods are known as sales with reserve, while auction sales where the seller has no power to withdraw the goods are known as sales without reserve or absolute sales. 3. Suppose, during the course of an auction where the seller reserves power to withdraw the goods, the auctioneer expressly announces that the seller no longer reserves power to withdraw the goods. Original Section 2-328(3) did not recognize this possibility, which exists in practice. Such a conversion, in eect, announces a reserve bid in that the goods will not be sold below the last bid before the conversion. A sale without reserve can also be converted to a sale with reserve during the course of the auction. Cross Reference: Point 2: Section 2-205. Denitional Cross References: Buyer. Section 2-103. Goods. Section 2-103. Lot. Section 2-105. Notice. Section 1-202. Reasonable time. Section 1-205. Sale. Section 2-106. Seller. Section 2-103. Terms. Section 1-201.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

PART 4. TITLE, CREDITORS, AND GOOD-FAITH PURCHASERS

2-401. Passing of Title; Reservation for Security; Limited Application of this Section. Each provision of this Article with regard to the rights, obligations, and remedies of the seller, the buyer, purchasers, or other third parties applies irrespective of title to the goods except where the provision refers to such title. Insofar as situations are not covered by the other provisions of this Article and matters concerning title become material, the following rules apply: (1) Title to goods cannot pass under a contract for sale prior to their identication to the contract (Section 2-501), and unless otherwise explicitly agreed, the buyer acquires by their identication a special property as limited by this Act. Any retention or reservation by the seller of the title (property) in goods shipped or delivered to the buyer is limited in eect to a reservation of a security interest. Subject to these provisions and to Article 9, title to goods passes from the seller to the
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buyer in any manner and on any conditions explicitly agreed on by the parties. (2) Unless otherwise explicitly agreed title passes to the buyer at the time and place at which the seller completes performance with reference to the delivery of the goods, despite any reservation of a security interest and even if a document of title is to be delivered at a dierent time or place; and in particular and despite any reservation of a security interest by the bill of lading: (a) if the contract requires or authorizes the seller to send the goods to the buyer but does not require the seller to deliver them at destination, title passes to the buyer at the time and place of shipment; but (b) if the contract requires delivery at destination, title passes on tender there. (3) Unless otherwise explicitly agreed, if delivery is to be made without moving the goods: (a) if the seller is to deliver a tangible document of title, title passes at the time when and the place where the seller delivers the document, and if the seller is to deliver an electronic document of title, title passes when the seller delivers the document; or (b) if the goods are at the time of contracting already identied and no documents of title are to be delivered, title passes at the time and place of contracting. (4) A rejection or other refusal by the buyer to receive or retain the goods, whether or not justied, or a justied revocation of acceptance revests title to the goods in the seller. Such revesting occurs by operation of law and is not a sale. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: See generally, Sections 17, 18, 19 and 20, Uniform Sales Act. Purposes: To make it clear that: 1. This Article deals with the issues between seller and buyer in terms of step by step performance or non-performance under the contract for sale and not in terms of whether or not title to the goods has passed. That the rules of this section in no way alter the rights of either the buyer, seller or third parties declared elsewhere in the Article is made clear by the preamble of this section. This section, however, in no way intends to indicate which line of interpretation should be followed in cases where the applicability of public regulation depends upon a sale or upon location of title without further denition. The basic policy of this Article that known purpose and reason should govern interpretation cannot extend beyond the scope of its own provisions. It is therefore necessary to state what a sale is and when title passes under this Article in case the courts deem any public regulation to incorporate the dened term of the private law. 2. Future goods cannot be the subject of a present sale. Before title can pass the goods must be identied in the manner set forth in Section 2-501. The parties, however, have full liberty to arrange by specic terms for the passing of title to goods which are existing. 3. The special property of the buyer in goods identied to the contract is excluded from the denition of security interest; its incidents are dened in provisions of this Article such as those on the rights of the seller's creditors, on good faith purchase, on the buyer's right to goods on the seller's insolvency, and on the buyer's right to specic performance or replevin. 4. The factual situations in subsections (2) and (3) upon which passage of title turn actu119

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ally base the test upon the time when the seller has nally committed himself in regard to specic goods. Thus in a shipment contract he commits himself by the act of making the shipment. If shipment is not contemplated subsection (3) turns on the seller's nal commitment, i.e. the delivery of documents or the making of the contract. As to delivery of an electronic document of title, see denition of delivery in Article 1, Section 1-201. This Article does not state a rule as to the place of title passage as to goods covered by an electronic document of title. Cross References: Point 2: Sections 2-102, 2-501 and 2-502. Point 3: Sections 1-201, 2-402, 2-403, 2-502 and 2-716. Denitional Cross References: Agreement. Section 1-201. Bill of lading. Section 1-201. Buyer. Section 2-103. Contract. Section 1-201. Contract for sale. Section 2-106. Delivery. Section 2-103. Document of title. Section 1-201. Goods. Section 2-103. Party. Section 1-201. Purchaser. Section 1-201. Receipt of goods. Section 2-103. Remedy. Section 1-201. Rights. Section 1-201. Sale. Section 2-106. Security interest. Section 1-201. Seller. Section 2-103. Send. Section 1-201.

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

2-402. Rights of Seller's Creditors Against Sold Goods. (1) Except as provided in subsections (2) and (3), rights of unsecured creditors of the seller with respect to goods that have been identied to a contract for sale are subject to the buyer's rights to recover the goods under Sections 2-502 and 2-716. (2) A creditor of the seller may treat a sale or an identication of goods to a contract for sale as void if as against the creditor a retention of possession by the seller is fraudulent under any rule of law of the state where the goods are situated. However, retention of possession in good faith and current course of trade by a merchant-seller for a commercially reasonable time after a sale or identication is not fraudulent. (3) Except as otherwise provided in Section 2-403(2), nothing in this Article shall be deemed to impair the rights of creditors of the seller: (a) under Article 9; or (b) if identication to the contract or delivery is made not in current course of trade but in satisfaction of or as security for a preexisting claim for money, security, or the like and is made under circumstances that under any rule of law of the state where the goods are situated would apart from this Article constitute the transaction a fraudulent transfer or voidable preference.
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As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Subsection (2)Section 26, Uniform Sales Act; Subsections (1) and (3)none. Changes: Rephrased. Purposes of Changes and New Matter: To avoid confusion on ordinary issues between current sellers and buyers and issues in the eld of preference and hindrance by making it clear that: 1. Local law on questions of hindrance of creditors by the seller's retention of possession of the goods are outside the scope of this Article, but retention of possession in the current course of trade is legitimate. Transactions which fall within the law's policy against improper preferences are reserved from the protection of this Article. 2. The retention of possession of the goods by a merchant seller for a commercially reasonable time after a sale or identication in current course is exempted from attack as fraudulent. Similarly, the provisions of subsection (3) have no application to identication or delivery made in the current course of trade, as measured against general commercial understanding of what a current transaction is. 3. The cross reference in subsection (3) to Section 2-403(2) shows the relationship of these sections and Article 9. A transfer under Section 2-403(2) can cause impairment of the rights of a secured party under Article 9. (Section 9-315(a)). Cross References: Point 3: Sections 2-403 and 9-315. Denitional Cross References: Contract for sale. Section 2-106. Creditor. Section 1-201. Goods. Section 2-103. Merchant. Section 2-104. Money. Section 1-201. Reasonable time. Section 1-205. Rights. Section 1-201. Sale. Section 2-106. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-403. Power to Transfer; Good Faith Purchase of Goods; Entrusting. (1) A purchaser of goods acquires all title that the purchaser's transferor had or had power to transfer except that a purchaser of a limited interest acquires rights only to the extent of the interest purchased. A person with voidable title has power to transfer a good title to a good-faith purchaser for value. If goods have been delivered under a transaction of purchase, the purchaser has such power even if: (a) the transferor was deceived as to the identity of the purchaser; (b) the delivery was in exchange for a check that is later dishonored; (c) it was agreed that the transaction was to be a cash sale; or (d) the delivery was procured through criminal fraud. (2) Any entrusting of goods to a merchant that deals in goods of that kind gives the merchant power to transfer all of the entruster's rights to the goods and to transfer the goods free of any interest of the entruster to a buyer in ordinary course of business.
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(3) Entrusting includes any delivery and any acquiescence in retention of possession regardless of any condition expressed between the parties to the delivery or acquiescence and regardless of whether the procurement of the entrusting or the possessor's disposition of the goods was punishable under the criminal law.
[Legislative Note: If a state adopts the repealer of Article 6Bulk Transfers (Alternative A), subsection (4) should read as follows:]

(4) The rights of other purchasers of goods and of lien creditors are governed by Articles 7 and 9.
[Legislative Note: If a state adopts revised Article 6Bulk Sales (Alternative B), subsection (4) should read as follows:]

(4) The rights of other purchasers of goods and of lien creditors are governed by Articles 6, 7, and 9. As amended in 1998 and 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. The basic policy that allows the transfer of such title as the transferor has is recognized under subsection (1). In this respect, the provisions of the section are applicable to a person taking by any form of purchase as dened by this Act. (Section 1-201(a)(29)). Moreover the policy of this Act expressly providing for the application of supplementary general principles of law to sales transactions wherever appropriate (Section 1-103) joins with the present section to continue unimpaired all rights acquired under the law of agency or of apparent agency or ownership or other estoppel, whether based on statutory provisions or on case law. The section also leaves unimpaired the powers given to selling factors under the earlier Factors Acts. In addition, subsection (1) provides specically for the protection of the good faith purchaser for value in a number of specic situations which were troublesome under prior law. On the other hand, the contract of purchase is of course limited by its own terms, as in a case of pledge for a limited amount, or of sale of a fractional interest in goods. 2. The many particular situations in which a buyer in ordinary course of business has been protected against a reservation of a property right or other interest are gathered by subsections (2) and (3) into a single principle protecting persons that buy in ordinary course of business. Consignors have no reason to complain, nor have lenders who hold a security interest in the inventory, since the very purpose of goods in inventory is to be turned into cash by sale. (Section 9-109, which provides that a consignment is within the scope of Article 9; Section 9-315(a), which provides that Article 9 security interests are defeated by the rights of a buyer in ordinary course of business under Section 2-403(2).). The principle is extended in subsection (3) to t with the abolition of the old law of cash sale by subsection (1)(c). It is freed from any local or specic technicalities, and it extends law to any criminal fraud or conduct punishable under criminal law. The policy is extended, in the interest of simplicity and sense, to any entrusting by a bailor. This is in consonance with the explicit provisions of Section 7-205 on the powers of a warehouse that is also in the business of buying and selling goods of the kind that are warehoused. As to entrusting by a secured party, subsection (2) provides that a buyer in ordinary course of business takes free of the security interest. (See Section 9-315(a)). 3. Except as provided in subsection (1), the rights of purchasers other than buyers in ordinary course are left to the Articles on Secured Transactions (Article 9) and Documents of Title (Article 7). Cross References: Point 1: Sections 1-103 and 1-201. Point 2: Sections 2-315, 2-403, 7-205 and Article 9. Point 3: Sections 1-102, 1-201, 2-104, 2-707 and Articles 6, 7 and 9. Point 4: Sections 1-102, 1-201, 2-104, 2-707 and Articles 6, 7 and 9. 122

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Denitional Cross References: Buyer in ordinary course of business. Section 1-201. Delivery. Section 2-103. Dishonor. Section 3-502. Goods. Section 2-103. Person. Section 1-201. Purchaser. Section 1-201. Term. Section 1-201. Value. Section 1-204.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

PART 5. PERFORMANCE
2-501. Insurable Interest in Goods; Manner of Identication of Goods. (1) The buyer obtains a special property and an insurable interest in goods by identication of existing goods as goods to which the contract refers even if the goods so identied are nonconforming and the buyer has an option to return or reject them. Such identication may be made at any time and in any manner explicitly agreed to by the parties. In the absence of explicit agreement identication occurs: (a) when the contract is made if it is for the sale of goods already existing and identied; (b) if the contract is for the sale of future goods other than those described in paragraph (c), when goods are shipped, marked, or otherwise designated by the seller as goods to which the contract refers; (c) when the crops are planted or otherwise become growing crops or the young are conceived if the contract is for the sale of unborn young to be born within 12 months after contracting or for the sale of crops to be harvested within 12 months or the next normal harvest season after contracting whichever is longer. (2) The seller retains an insurable interest in goods so long as title to or any security interest in the goods remains in the seller. If the identication is by the seller alone, the seller may until default or insolvency or notication to the buyer that the identication is nal substitute other goods for those identied. (3) Nothing in this section impairs any insurable interest recognized under any other statute or rule of law. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: See Sections 17 and 19, Uniform Sales Act. Purposes: 1. The present section deals with the manner of identifying goods to the contract so that an insurable interest in the buyer and the rights set forth in the next section will accrue. Generally speaking, identication may be made in any manner explicitly agreed to by the parties. The rules of paragraphs (a), (b) and (c) apply only in the absence of such explicit agreement. 123

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2. In the ordinary case identication of particular existing goods as goods to which the contract refers is unambiguous and may occur in one of many ways. It is possible, however, for the identication to be tentative or contingent. In view of the limited eect given to identication by this Article, the general policy is to resolve all doubts in favor of identication. 3. The provision of this section as to explicit agreement claries the present confusion in the law of sales which has arisen from the fact that under prior uniform legislation all rules of presumption with reference to the passing of title or to appropriation (which in turn depended upon identication) were regarded as subject to the contrary intention of the parties or of the party appropriating. Such uncertainty is reduced to a minimum under this section by requiring explicit agreement of the parties before the rules of paragraphs (a), (b) and (c) are displacedas they would be by a term giving the buyer power to select the goods. An explicit agreement, however, need not necessarily be found in the terms used in the particular transaction. Thus, where a usage of the trade has previously been made explicit by reduction to a standard set of rules and regulations currently incorporated by reference into the contracts of the parties, a relevant provision of those rules and regulations is explicit within the meaning of this section. 4. In view of the limited function of identication there is no requirement in this section that the goods be in deliverable state or that all of the seller's duties with respect to the processing of the goods be completed in order that identication occur. For example, despite identication the risk of loss remains on the seller under the risk of loss provisions until completion of his duties as to the goods and all of his remedies remain dependent upon his not defaulting under the contract. 5. Undivided shares in an identied fungible bulk, such as grain in an elevator or oil in a storage tank, can be sold. The mere making of the contract with reference to an undivided share in an identied fungible bulk is enough under subsection (a) to eect an identication if there is no explicit agreement otherwise. The seller's duty, however, to segregate and deliver according to the contract is not aected by such an identication but is controlled by other provisions of this Article. 6. Identication of crops under paragraph (c) is made upon planting only if they are to be harvested within the year or within the next normal harvest season. The phrase next normal harvest season fairly includes nursery stock raised for normally quick harvest, but plainly excludes a timber crop to which the concept of a harvest season is inapplicable. Paragraph (c) is also applicable to a crop of wool or the young of animals to be born within twelve months after contracting. The product of a lumbering, mining or shing operation, though seasonal, is not within the concept of growing. Identication under a contract for all or part of the output of such an operation can be eected early in the operation. Cross References: Point 1: Section 2-502. Point 4: Sections 2-509, 2-510 and 2-703. Point 5: Sections 2-103, 2-105, 2-308, 2-503 and 2-509. Point 6: Sections 2-103, 2-107(1) and 2-402. Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Contract. Section 1-201. Contract for sale. Section 2-106. Future goods. Section 2-105. Goods. Section 2-103. Notication. Section 1-202. Party. Section 1-201. Sale. Section 2-106. Security interest. Section 1-201. Seller. Section 2-103. 124

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2-502. Buyer's Right to Goods on Seller's Insolvency, Repudiation, or Failure to Deliver. (1) Subject to subsections (2) and (3) and even if the goods have not been shipped, a buyer that has paid a part or all of the price of goods in which the buyer has a special property under Section 2-501 may on making and keeping good a tender of any unpaid portion of their price recover them from the seller if: (a) in the case of goods bought by a consumer, the seller repudiates or fails to deliver as required by the contract; or (b) in all cases, the seller becomes insolvent within 10 days after receipt of the rst installment on their price. (2) The buyer's right to recover the goods under subsection (1) vests upon acquisition of a special property, even if the seller had not then repudiated or failed to deliver. (3) If the identication creating a special property has been made by the buyer, the buyer acquires the right to recover the goods only if they conform to the contract for sale. As amended in 1999 and 2003.
See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999. See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. This section gives an additional right to the buyer as a result of identication of the goods to the contract in the manner provided in Section 2-501. The buyer is given a right to recover the goods, conditioned upon making and keeping good a tender of any unpaid portion of the price, in two limited circumstances. First, a consumer buyer may recover the goods if the seller repudiates the contract or fails to deliver the goods. Second, in any case, the buyer may recover the goods if the seller becomes insolvent within 10 days after the seller receives the rst installment on their price. The buyer's right to recover the goods under this section is an exception to the usual rule, under which the disappointed buyer must resort to an action to recover damages. 2. The question of whether the buyer also acquires a security interest in identied goods and has rights to the goods when insolvency takes place after the ten day period provided in this section depends upon compliance with the provisions of the Article on Secured Transactions (Article 9). 3. Under subsection (2), the buyer's right to recover goods under subsection (1) vests upon acquisition of a special property, which occurs upon identication of the goods to the contract. See Section 2-501. Inasmuch as a secured party normally acquires no greater rights in its collateral than its debtor had or had power to convey, see Section 2-403(1) (rst sentence), a buyer who acquires a right to recover under this section will take free of a security interest created by the seller if it attaches to the goods after the goods have been identied to the contract. The buyer will take free, even if the buyer does not buy in ordinary course and even if the security interest is perfected. Of course, to the extent that the buyer pays the price after the security interest attaches, the payments will constitute proceeds of the security interest. 4. Subsection (3) is included to preclude the possibility of unjust enrichment which would exist if the buyer were permitted to recover goods even though they were greatly superior in quality or quantity to that called for by the contract for sale. Cross References: Point 1: Sections 1-201 and 2-702. Point 2: Article 9. Denitional Cross References: Buyer. Section 2-103. 125

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Consumer. Section 2-103. Conform. Section 2-106. Contract for sale. Section 2-106. Deliver. Section 2-103. Goods. Section 2-103. Insolvent. Section 1-201. Rights. Section 1-201. Seller. Section 2-103.

As amended in 1999 and 2003.

See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-503. Manner of Seller's Tender of Delivery. (1) Tender of delivery requires that the seller put and hold conforming goods at the buyer's disposition and give the buyer any notication reasonably necessary to enable the buyer to take delivery. The manner, time, and place for tender are determined by the agreement and this Article, and in particular: (a) tender must be at a reasonable hour, and if it is of goods they must be kept available for the period reasonably necessary to enable the buyer to take possession; but (b) unless otherwise agreed the buyer must furnish facilities reasonably suited to the receipt of the goods. (2) If the case is within Section 2-504, tender requires that the seller comply with its provisions. (3) If the seller is required to deliver at a particular destination, tender requires that the seller comply with subsection (1) and also in any appropriate case tender documents as described in subsections (4) and (5) of this section. (4) If goods are in the possession of a bailee and are to be delivered without being moved: (a) tender requires that the seller either tender a negotiable document of title covering such goods or procure acknowledgment by the bailee to the buyer of the buyer's right to possession of the goods; but (b) tender to the buyer of a nonnegotiable document of title or of a record directing the bailee to deliver is sucient tender unless the buyer seasonably objects, and except as otherwise provided in Article 9 receipt by the bailee of notication of the buyer's rights xes those rights as against the bailee and all third persons; but risk of loss of the goods and of any failure by the bailee to honor the nonnegotiable document of title or to obey the direction remains on the seller until the buyer has had a reasonable time to present the document or direction. Refusal by the bailee to honor the document or to obey the direction defeats the tender. (5) If the contract requires the seller to deliver documents: (a) the seller must tender all such documents in correct form; and (b) tender through customary banking channels is sucient and dishonor of a draft accompanying or associated with the documents constitutes nonacceptance or rejection. As amended in 2003.
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See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. The major general rules governing the manner of proper or due tender of delivery are gathered in this section. The term tender is used in this Article in two dierent senses. In one sense it refers to due tender, which contemplates an oer coupled with a present ability to fulll all the conditions that rest on the tendering party, and it must be followed by actual performance if the other party shows readiness to proceed. Unless the context unmistakably indicates otherwise this is the meaning of tender in this Article, and the occasional addition of the word due is only for clarity and emphasis. At other times it is used to refer to an oer of goods or documents under a contract as if in fulllment of its conditions even though there is a defect when measured against the contract obligation. Used in either sense, however, tender connotes performance by the tendering party that the other party in default if the other party fails to proceed in some manner. These concepts of tender would apply to tender of either tangible or electronic documents of title. 2. The seller's general duty to tender and deliver is set out in Section 2-301 and more particularly in Section 2-507. The seller's right to a receipt if the seller demands one, if receipts are customary, is governed by Section 1-303. Subsection (1) of this section sets forth two primary requirements of tender: rst, that the seller put and hold conforming goods at the buyer's disposition and, second, that the sellergive the buyer any notice reasonably necessary to enable the buyer to take delivery. In cases in which payment is due and demanded upon delivery, the buyer's disposition is qualied by the seller's right to reclaim the goods under Section 2-507(2). However, where the seller is demanding payment on delivery the seller must rst allow the buyer to inspect the goods to avoid impairing the tender unless the contract contains standard shipping terms or other terms that would negate the right of inspection before payment. (See Section 2-513(3)). In the case of contracts of sale involving documents, the seller can put and hold conforming goods at the buyer's disposition under subsection (1) by tendering documents which give the buyer complete control of the goods under the provisions of Article 7. 3. Under paragraph (a) of subsection (1) usage of the trade and the circumstances of the particular case determine what is a reasonable hour for tender and what constitutes a reasonable period of holding the goods available. 4. The buyer must furnish reasonable facilities for the receipt of the goods tendered by the seller under subsection (1), paragraph (b). This obligation of the buyer is not part of the seller's tender. 5. For the purposes of subsections (2) and (3) there is omitted from this Article the rule under prior uniform legislation that a term requiring the seller to pay the freight or cost of transportation to the buyer is equivalent to an agreement by the seller to deliver to the buyer or at an agreed destination. This omission is with the specic intention of negating the rule, for under this Article a shipment contract is regarded as the normal one and a destination contract as the variant type. The seller is not obligated to deliver at a named destination and bear the concurrent risk of loss until arrival unless the seller has specically agreed to deliver or the commercial understanding of the terms used by the parties contemplates a destination contract. 6. Under Subsection (4)(a) the bailee's acknowledgment must be made to the buyer. See Jason's Foods, Inc. V. Peter Eckrick & Sons, Inc., 774 F.2d 214 (7th Cir. 1985) Paragraph (b) of subsection (4) adopts the rule, subject to Article 9, that between the buyer and the seller the risk of loss remains on the seller during a period reasonable for securing acknowledgment of the transfer from the bailee while as against all other parties the buyer's rights are xed as of the time the bailee receives notice of the transfer. 7. Under subsection (5) documents are never required except where there is an express contract term or it is plainly implicit in the peculiar circumstances of the case or in a usage of trade. Documents may, of course, be authorized although not required, but these cases are not within the scope of this subsection. When documents are required, there are three main requirements of this subsection: (1) All: each required document is essential to a proper tender; (2) Such: the documents must be the ones actually required by the contract in terms of source and substance; (3) Correct form: All documents must be in correct form. These requirements apply to both tangible and electronic documents of title. When tender is made through customary banking channels, a draft may accompany or be associ127

 2-503

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ated with a document of title. The language has been broadened to allow for drafts to be associated with an electronic document of title. Compare Section 2-104(2) denition of nancing agency. When a prescribed document cannot be procured, a question of fact arises under the provision of this Article on substituted performance about whether the agreed manner of delivery is actually commercially impracticable and whether the substitute is commercially reasonable. Cross References: Point 2: Sections 1-303, 2-301, 2-310, 2-507 and 2-513 and Article 7. Point 5: Sections 2-308, 2-310 and 2-509. Point 7: Section 2-614(1). Specic matters involving tender are covered in many additional sections of this Article. See Sections 1-205, 2-301, 2-306 to 2-318, 2-504, 2-507(2), 2-511(1), 2-513, 2-612 and 2-614. Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Conforming. Section 2-106. Contract. Section 1-201. Delivery. Section 2-103. Dishonor. Section 3-502. Document of title. Section 1-201. Draft. Section 3-104(e). Goods. Section 2-103. Notication. Section 1-202. Reasonable time. Section 1-205. Receipt of goods. Section 2-103. Record. Section 2-103. Rights. Section 1-201. Seasonably. Section 1-205. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-504. Shipment by Seller. If the seller is required or authorized to send the goods to the buyer and the contract does not require the seller to deliver them at a particular destination, then unless otherwise agreed the seller must: (a) put conforming goods in the possession of a carrier and make a proper contract for their transportation, having regard to the nature of the goods and other circumstances of the case; (b) obtain and promptly deliver or tender in due form any document necessary to enable the buyer to obtain possession of the goods or otherwise required by the agreement or by usage of trade; and (c) promptly notify the buyer of the shipment. Failure to notify the buyer under paragraph (c) or to make a proper contract under paragraph (a) is a ground for rejection only if material delay or loss ensues. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Section 46, Uniform Sales Act. Changes: Rewritten. 128

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Purposes of Changes: To continue the general policy of the prior uniform statutory provision while incorporating certain modications with respect to the requirement that the contract with the carrier be made expressly on behalf of the buyer and as to the necessity of giving notice of the shipment to the buyer, so that: 1. The section is limited to shipment contracts as contrasted with destination contracts or contracts for delivery at the place where the goods are located. The general principles embodied in this section cover the special cases of F.O.B. point of shipment contracts and C.I.F. and C. & F. contracts. Under the preceding section on manner of tender of delivery, due tender by the seller requires that he comply with the requirements of this section in appropriate cases. 2. The contract to be made with the carrier under paragraph (a) must conform to all express terms of the agreement, subject to any substitution necessary because of failure of agreed facilities as provided in the later provision on substituted performance. However, under the policies of this Article on good faith and commercial standards and on buyer's rights on improper delivery, the requirements of explicit provisions must be read in terms of their commercial and not their literal meaning. This policy is made express with respect to bills of lading in a set in the provision of this Article on form of bills of lading required in overseas shipment. 3. In the absence of agreement, the provision of this Article on options and cooperation respecting performance gives the seller the choice of any reasonable carrier, routing and other arrangements. Whether or not the shipment is at the buyer's expense the seller must see to any arrangements, reasonable in the circumstances, such as refrigeration, watering of live stock, protection against cold, the sending along of any necessary help, selection of specialized cars and the like for paragraph (a) is intended to cover all necessary arrangements whether made by contract with the carrier or otherwise. There is, however, a proper relaxation of such requirements if the buyer is himself in a position to make the appropriate arrangements and the seller gives him reasonable notice of the need to do so. It is an improper contract under paragraph (a) for the seller to agree with the carrier to a limited valuation below the true value and thus cut o the buyer's opportunity to recover from the carrier in the event of loss, when the risk of shipment is placed on the buyer by his contract with the seller. 4. Both the language of paragraph (b) and the nature of the situation it concerns indicate that the requirement that the seller must obtain and deliver promptly to the buyer in due form any document necessary to enable him to obtain possession of the goods is intended to cumulate with the other duties of the seller such as those covered in paragraph (a). In this connection, in the case of pool car shipments a delivery order furnished by the seller on the pool car consignee, or on the carrier for delivery out of a larger quantity, satises the requirements of paragraph (b) unless the contract requires some other form of document. 5. This Article, unlike the prior uniform statutory provision, makes it the seller's duty to notify the buyer of shipment in all cases. The consequences of his failure to do so, however, are limited in that the buyer may reject on this ground only where material delay or loss ensues. A standard and acceptable manner of notication in open credit shipments is the sending of an invoice and in the case of documentary contracts is the prompt forwarding of the documents as under paragraph (b) of this section. It is also usual to send on a straight bill of lading but this is not necessary to the required notication. However, should such a document prove necessary or convenient to the buyer, as in the case of loss and claim against the carrier, good faith would require the seller to send it on request. Frequently the agreement expressly requires prompt notication as by wire or cable. Such a term may be of the essence and the nal clause of paragraph (c) does not prevent the parties from making this a particular ground for rejection. To have this vital and irreparable eect upon the seller's duties, such a term should be part of the dickered terms written in any form, or should otherwise be called seasonably and sharply to the seller's attention. 6. Generally, under the nal sentence of the section, rejection by the buyer is justied only when the seller's dereliction as to any of the requirements of this section in fact is followed by material delay or damage. It rests on the seller, so far as concerns matters not within the peculiar knowledge of the buyer, to establish that his error has not been fol129

 2-504

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lowed by events which justify rejection. Cross References: Point 1: Section 2-503(2). Point 2: Sections 1-203, 2-601 and 2-614. Point 3: Section 2-311(2). Point 5: Section 1-203. Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Conforming. Section 2-106. Contract. Section 1-201. Delivery. Section 2-103. Goods. Section 2-103. Noties. Section 1-202. Seller. Section 2-103. Send. Section 1-201. Usage of trade. Section 1-303.

2-505. Seller's Shipment under Reservation. (1) If the seller has identied goods to the contract by or before shipment: (a) The seller's procurement of a negotiable bill of lading to the seller's own order or otherwise reserves in the seller a security interest in the goods. The seller's procurement of the bill to the order of a nancing agency or of the buyer indicates in addition only the seller's expectation of transferring that interest to the person named. (b) A nonnegotiable bill of lading to the seller or the seller's nominee reserves possession of the goods as security. However, unless a seller has a right to reclaim the goods under Section 2-507(2) a nonnegotiable bill of lading naming the buyer as consignee reserves no security interest even if the seller retains possession or control of the bill of lading. (2) If shipment by the seller with reservation of a security interest is in violation of the contract for sale, it constitutes an improper contract for transportation under Section 2-504 but impairs neither the rights given to the buyer by shipment and identication of the goods to the contract nor the seller's powers as a holder of a negotiable document of title. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. The security interest reserved to the seller under subsection (1) is restricted to securing payment or performance by the buyer and the seller is strictly limited in the seller's disposition and control of the goods as against the buyer and third parties. Under this Article, the provision as to the passing of a property interest expressly applies despite any reservation of security title and also provides that the rights, obligations and remedies of the parties are not altered by the incidence of title generally. The security interest, therefore, must be regarded as a means given to the seller to enforce the seller's rights against the buyer which is unaected by and in turn does not aect the location of title generally. The rules set forth in subsection (1) are not to be altered by any apparent contrary intent of the parties as to passing of title, since the rights and remedies of the parties to the contract of sale, as dened in this Article, rest on the contract and its performance or breach and not on presumptions about the location of title. This Article does not attempt to regulate local procedure for the eective maintenance of the seller's security interest when the action is in replevin by the buyer against the carrier. 2. Every shipment of identied goods under a negotiable bill of lading reserves a security 130

Art. 2

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interest in the seller under subsection (1) paragraph (a). It is frequently convenient for the seller to make the bill of lading to the order of a nominee such as the seller's agent at destination, the nancing agency to which the seller expects to negotiate the document or the bank issuing a credit to the seller. In many instances, also, the buyer is made the order party. This Article does not deal directly with the question as to whether a bill of lading made out by the seller to the order of a nominee gives the carrier notice of any rights which the nominee may have so as to limit the carrier's freedom or obligation to honor the bill of lading in the hands of the seller as the original shipper if the expected negotiation fails. This is dealt with in the Article on Documents of Title (Article 7). 3. A non-negotiable bill of lading taken to a party other than the buyer under subsection (1) paragraph (b) reserves possession of the goods as security in the seller but if the seller seeks to withhold the goods improperly the buyer can tender payment and recover them. 4. In the case of a shipment by non-negotiable bill of lading taken to a buyer, the seller, under subsection (1) retains no security interest or possession as against the buyer and by the shipment the seller de facto loses control as against the carrier except where he rightfully and eectively stops delivery in transit. (Section 2-705) In cases in which the contract gives the seller the right to payment against delivery, the seller, in appropriate cases, has a right to reclaim the goods under Section 2-507(2), although this right is subject to the claims of a good faith purchaser for value under Section 2-403. 5. Under subsection (2) an improper reservation by the seller which would constitute a breach in no way impairs such of the buyer's rights as result from identication of the goods. The security interest reserved by the seller under subsection (1) does not protect the seller from retaining possession or control of the document or the goods for the purpose of extracting more than is due the seller under the contract. Cross References: Point 1: Section 1-201. Point 2: Article 7. Point 3: Sections 2-501(2) and 2-504. Point 4: Sections 2-403, 2-507(2) and 2-705. Point 5: Sections 2-310, 2-501 and 2-502 and Article 7. Denitional Cross References: Bill of lading. Section 1-201. Buyer. Section 2-103. Contract. Section 1-201. Contract for sale. Section 2-106. Delivery. Section 2-103. Financing agency. Section 2-104. Goods. Section 2-103. Holder. Section 1-201. Person. Section 1-201. Security interest. Section 1-201. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-506. Rights of Financing Agency. (1) Except as otherwise provided in Article 5, a nancing agency by paying or purchasing for value a draft that relates to a shipment of goods acquires to the extent of the payment or purchase and in addition to its own rights under the draft and any document of title securing it any rights of the shipper in the goods including the right to stop delivery and the shipper's right to have the draft honored by the buyer. (2) The right to reimbursement of a nancing agency that has in good
131

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faith honored or purchased the draft under commitment to or authority from the buyer is not impaired by subsequent discovery of defects with reference to any relevant document that was apparently regular. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: 1. Financing agency is broadly dened in this Article to cover every normal instance in which a party aids or intervenes in the nancing of a sales transaction. The term as used in subsection (1) is not in any sense intended as a limitation and covers any other appropriate situation which may arise outside the scope of the denition. 2. Paying as used in subsection (1) is typied by the letter of credit, or authority to pay situation in which a banker, by arrangement with the buyer or other consignee, pays on his behalf a draft for the price of the goods. It is immaterial whether the draft is formally drawn on the party paying or his principal, whether it is a sight draft paid in cash or a time draft paid in the rst instance by acceptance, or whether the payment is viewed as absolute or conditional. All of these cases constitute payment under this subsection. Similarly, purchasing for value is used to indicate the whole area of nancing by the seller's banker, and the principle of subsection (1) is applicable without any niceties of distinction between purchase, discount, advance against collection or the like. But it is important to notice that the only right to have the draft honored that is acquired is that against the buyer; if any right against any one else is claimed it will have to be under some separate obligation of that other person. A letter of credit does not necessarily protect purchasers of drafts. See Article 5. And for the relations of the parties to documentary drafts see Part 5 of Article 4. 3. Subsection (1) is made applicable to payments or advances against a draft which relates to a shipment of goods and this has been chosen as a term of maximum breadth. In particular the term is intended to cover the case of a draft against an invoice or against a delivery order. Further, it is unnecessary that there be an explicit assignment of the invoice attached to the draft to bring the transaction within the reason of this subsection. 4. After shipment, the rights of the shipper in the goods are merely security rights and are subject to the buyer's right to force delivery upon tender of the price. The rights acquired by the nancing agency are similarly limited and, moreover, if the agency fails to procure any outstanding negotiable document of title, it may nd its exercise of these rights hampered or even defeated by the seller's disposition of the document to a third party. This section does not attempt to create any new rights in the nancing agency against the carrier which would force the latter to honor a stop order from the agency, a stranger to the shipment, or any new rights against a holder to whom a document of title has been duly negotiated under Article 7. 5. The deletion of the language on its face from subsection (2) is designed to accommodate electronic documents of title without changing the requirement of regularity of the document. Cross References: Point 1: Section 2-104 Point 2: Part 5 of Article 4 and Article 5. Point 4: Sections 2-501 and 2-502 and Article 7. Denitional Cross References: Buyer. Section 2-103. Document of title. Section 1-201. Draft. Section 3-104(e). Financing agency. Section 2-104. Good faith. Section 2-103. Goods. Section 2-103. Purchase. Section 1-201. Rights. Section 1-201. 132

Art. 2
Value. Section 1-204.

Sales

2-507

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-507. Eect of Seller's Tender; Delivery on Condition. (1) Tender of delivery is a condition to the buyer's duty to accept the goods and, unless otherwise agreed, to the buyer's duty to pay for them. Tender entitles the seller to acceptance of the goods and to payment according to the contract. (2) If payment is due and demanded on the delivery to the buyer of goods or documents of title, the seller may reclaim the goods delivered upon a demand made within a reasonable time after the seller discovers or should have discovered that payment was not made. (3) The seller's right to reclaim under subsection (2) is subject to the rights of a buyer in ordinary course of business or other good-faith purchaser for value under Section 2-403. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. The provisions of subsection(1), must be read within the framework of the other sections of this Article which bear upon the question of delivery and payment. 2. The unless otherwise agreed provision of subsection (1) is directed primarily to cases in which payment in advance has been promised or a letter of credit term has been included. Payment according to the contract contemplates immediate payment, payment at the end of an agreed credit term, payment by a time acceptance or the like. Under this Act, contract means the total obligation in law which results from the parties' agreement including the eect of this Article. In this context, therefore, there must be considered the eect in law of provisions such as those on means and manner of payment and on the failure of the agreed means and manner of payment. 3. Subsection (2) provides that the seller has a right to reclamation to recover the goods from the buyer in a cash-sale transaction when the sellers discovers payment has not been made. The phrase due and demanded refers to when the seller takes a check that is later dishonored. See Section 2-511. This subsection, and subsection (3), make the seller's rights parallel in credit-sale and cash-sale transactions. See Section 2-702. 4. Subsection (3) claries the rule that the seller's right to reclaim goods under subsection (2) is subject to the right of the buyer in the ordinary course of business or other good faith purchaser. Cross References: Point 2: Sections 1-201, 2-511 and 2-614. Point 3: Sections 2-310, 2-503, 2-511, 2-601, 2-702 and 2-711 to 2-713. Denitional Cross References: Buyer. Section 2-103. Contract. Section 1-201. Delivery. Section 2-103. Document of title. Section 1-201. Goods. Section 2-103. Good faith. Section 2-103. Reasonable time. Section 1-205. Rights. Section 1-201. Seller. Section 2-103. Value. Section 1-204.

As amended in 2003.
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See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-508. Cure by Seller of Improper Tender or Delivery; Replacement. (1) If the buyer rejects goods or a tender of delivery under Section 2-601 or 2-612 or, except in a consumer contract, justiably revokes acceptance under Section 2-608(1)(b) and the agreed time for performance has not expired, a seller that has performed in good faith, upon seasonable notice to the buyer and at the seller's own expense, may cure the breach of contract by making a conforming tender of delivery within the agreed time. The seller shall compensate the buyer for all of the buyer's reasonable expenses caused by the seller's breach of contract and subsequent cure. (2) If the buyer rejects goods or a tender of delivery under Section 2-601 or 2-612 or, except in a consumer contract, justiably revokes acceptance under Section 2-608(1)(b) and the agreed time for performance has expired, a seller that has performed in good faith, upon seasonable notice to the buyer and at the seller's own expense, may cure the breach of contract, if the cure is appropriate and timely under the circumstances, by making a tender of conforming goods. The seller shall compensate the buyer for all of the buyer's reasonable expenses caused by the seller's breach of contract and subsequent cure. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (1) permits a seller that has made a nonconforming tender in any case to make a conforming tender within the contract time upon seasonable notication to the buyer. It presumes that the buyer has rightfully rejected or justiably revoked acceptance under Section 2-608(1)(b) through timely notication to the seller and has complied with any particularization requirements imposed by Section 2-605(1). This subsection also applies where the seller has taken back the nonconforming goods and refunded the purchase price. The seller may still make a good tender within the contract period. The closer, however, it is to the contract date, the greater is the necessity for extreme promptness on the seller's part in notifying of the intention to cure, if the notication is to be seasonable under this subsection. The rule of this subsection, moreover, is qualied by its underlying reasons. Thus if, after contracting for June delivery, a buyer later makes known to the seller a need for shipment early in the month and the seller ships accordingly, the contract time has been cut down by the supervening modication and the time for cure of tender must reect this modied time term. 2. Cure after a justiable revocation of acceptance is not available as a matter of right in a consumer contract. Furthermore, even in a nonconsumer contract, cure is not available if the revocation is predicated on Section 2-608(1)(a). If the buyer is revoking because of a known defect that the seller has not been willing or able to cure, there is no justication for giving the seller a second chance to cure. 3. Subsection (2) expands the seller's right to cure after the time for performance has expired. As under subsection (1), the buyer's rightful rejection or in a nonconsumer contract justiable revocation of acceptance under Section 2-608(1)(b) trigger the seller's right to cure. Original Section 2-508(2) was designed to prevent surprise rejections by requiring the seller to have reasonable grounds to believe the nonconforming tender was acceptable. Although this test has been abandoned, the requirement that the initial tender be made in good faith prevents a seller from deliberately tendering goods that the seller knows the buyer cannot use in order to save the contract and then, upon rejection, insisting on a 134

Art. 2

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second right to cure. The good faith standard applies under both subsection (1) and subsection (2). 4. The seller's cure under both subsection (1) and subsection (2) must be of conforming goods. Conforming goods includes not only conformity to the contracted-for quality but also as to quantity or assortment or other similar obligations under the contract. Since the time for performance has expired in a case governed by subsection (2), however, the seller's tender of conforming goods required to eect a cure under this section could not conform to the contracted time for performance. Thus, subsection (1) requires that cure be tendered within the agreed time while subsection (2) requires that the tender be appropriate and timely under the circumstances. The requirement that the cure be appropriate and timely under the circumstances provides important protection for the buyer. If the buyer is acquiring inventory on a just-intime basis and needs to procure substitute goods from another supplier to keep the buyer's process moving, the cure would not be timely. If the seller knows from the circumstances that strict compliance with the contract obligations is expected, the seller's cure would not be appropriate. If the seller attempts to cure by repair, the cure would not be appropriate if the attempted cure resulted in goods that did not conform in every respect to the requirements of the contract. The standard for quality on the second tender is governed by Section 2-601. Whether a cure is appropriate and timely is based upon the circumstances and needs of the buyer. A seasonable notice to the buyer and timely cure are predicated on the requirement that the notice and oered cure would be untimely if the buyer has reasonably changed its position in good faith reliance on the nonconforming tender. 5. Cure is at the seller's expense, and the seller is obligated to compensate the buyer for all of the buyer's reasonable expenses caused by the breach and the cure. The term reasonable expenses is not limited to expenses that would qualify as incidental damages. The seller's compensation of the buyer's expenses provided in both subsections (1) and (2) is not controlled by remedy limitations that the parties may have agreed to as provided in Section 2-719. A remedy limitation under Section 2-719 is based upon compensation to the aggrieved party for a breach. The reasonable expenses contemplated under this section are designed to cure the breach in conjunction with the seller's provision of a conforming tender or conforming goods. If the seller is not attempting to cure its breach, a remedy limitation agreed to by the parties under Section 2-719 is an eective way to provide compensation for breach. Cross References: Point 1: Sections 2-605 and 2-608. Point 2: Section 2-608. Point 3: Section 2-608. Point 4: Section 2-511. Point 5: Section 2-719. Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Conforming. Section 2-106. Consumer contract. Section 2-103. Contract. Section 1-201. Delivery. Section 2-103. Goods. Section 2-103. Good faith. Section 2-103. Notice. Section 1-202. Reasonable time. Section 1-205. Seasonable. Section 1-205. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.
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2-509. Risk of Loss in the Absence of Breach. (1) If the contract requires or authorizes the seller to ship the goods by carrier: (a) if it does not require the seller to deliver them at a particular destination, the risk of loss passes to the buyer when the goods are delivered to the carrier even if the shipment is under reservation (Section 2-505); but (b) if it does require the seller to deliver them at a particular destination and the goods are there tendered while in the possession of the carrier, the risk of loss passes to the buyer when the goods are there so tendered as to enable the buyer to take delivery. (2) If the goods are held by a bailee to be delivered without being moved, the risk of loss passes to the buyer: (a) on the buyer's receipt of possession or control of a negotiable document of title covering the goods; (b) on acknowledgment by the bailee to the buyer of the buyer's right to possession of the goods; or (c) after the buyer's receipt of possession or control of a nonnegotiable document of title or other direction to deliver in a record, as provided in Section 2-503(4)(b). (3) In any case not within subsection (1) or (2), the risk of loss passes to the buyer on the buyer's receipt of the goods. (4) The provisions of this section are subject to contrary agreement of the parties and to Sections 2-327 and 2-510. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. The underlying theory of this section on risk of loss is in conformity with common commercial and insurance practice, to base the risk of loss on the physical location of the goods and not by shifting of the risk with the property in the goods. The scope of the section is limited to those cases where there has been no breach by the seller. When there has been a breach by either party, the risk of loss may be shifted to the breaching party under Section 2-510 if the breaching party did not already bear the risk for any reason the party's delivery or tender fails to conform to the contract, the present section does not apply and the situation is governed by the provisions on eect of breach on risk of loss. 2. In a shipment contract, the risk of loss shifts to the buyer when the goods are delivered to the carrier as required by Section 2-504; in a destination contract, the risk of loss shifts when the goods are tendered to the buyer as required by Section 2-503(3). 3. Unlike prior law, subsection (3) makes no distinction between merchant and nonmerchant sellers. In a case not governed by subsection (1) or subsection (2) and not subject to a contrary result under subsection (4), the risk of loss passes to the buyer upon the buyer's receipt of the goods. Receipt requires taking the physical possession of the goods, Section 2-103(1)(l). 4. When the agreement provides for delivery of the goods from seller to the buyer without removal from the physical possession of a bailee, risk of loss passes to the buyer upon receipt of possession or control of the negotiable document of title, acknowledgment made by the bailee of the buyer's right of possession or the buyer's receipt of possession or control of a non-negotiable document of title or other direction to deliver in a record as provided in Section 2-503. See the denition of control in Article 7, 7-106. 5. Subsections (1) through (3) are subject to subsection (4) which provides for a contrary 136

Art. 2

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agreement of the parties. This language is intended as the equivalent of the phrase unless otherwise agreed used more frequently throughout this Act. Contrary is in no way used as a word of limitation, and the buyer and seller are left free to readjust their rights and risks in any manner agreeable to them. Contrary agreement can also be found in the circumstances of the case, a trade usage or practice, or a course of dealing or course of performance. Cross References: Point 1: Section 2-510. Point 2: Sections 2-503 and 2-504. Point 4: Section 2-503. Point 5: Section 2-201. Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Contract. Section 1-201. Delivery. Section 2-103. Document of title. Section 1-201. Goods. Section 2-103. Party. Section 1-201. Receipt of goods. Section 2-103. Sale on approval. Section 2-326. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-510. Eect of Breach on Risk of Loss. (1) If a tender or delivery of goods so fails to conform to the contract as to give a right of rejection, the risk of their loss remains on the seller until cure or acceptance. (2) If the buyer rightfully revokes acceptance, the buyer may to the extent of any deciency in the buyer's eective insurance coverage treat the risk of loss as having rested on the seller from the beginning. (3) If the buyer as to conforming goods already identied to the contract for sale repudiates or is otherwise in breach before risk of their loss has passed to the buyer, the seller may to the extent of any deciency in the seller's eective insurance coverage treat the risk of loss as resting on the buyer for a commercially reasonable time. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: To make clear that: 1. Under subsection (1) the seller by his individual action cannot shift the risk of loss to the buyer unless his action conforms with all the conditions resting on him under the contract. 2. The cure of defective tenders contemplated by subsection (1) applies only to those situations in which the seller makes changes in goods already tendered, such as repair, partial substitution, sorting out from an improper mixture and the like since cure by repossession and new tender has no eect on the risk of loss of the goods originally tendered. The seller's privilege of cure does not shift the risk, however, until the cure is completed. Where defective documents are involved a cure of the defect by the seller or a waiver of the defects by the buyer will operate to shift the risk under this section. However, if the 137

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goods have been destroyed prior to the cure or the buyer is unaware of their destruction at the time he waives the defect in the documents, the risk of the loss must still be borne by the seller, for the risk shifts only at the time of cure, waiver of documentary defects or acceptance of the goods. 3. In cases where there has been a breach of the contract, if the one in control of the goods is the aggrieved party, whatever loss or damage may prove to be uncovered by his insurance falls upon the contract breaker under subsections (2) and (3) rather than upon him. The word eective as applied to insurance coverage in those subsections is used to meet the case of supervening insolvency of the insurer. The deciency referred to in the text means such deciency in the insurance coverage as exists without subrogation. This section merely distributes the risk of loss as stated and is not intended to be disturbed by any subrogation of an insurer. Cross Reference: Section 2-509. Denitional Cross References: Buyer. Section 2-103. Conform. Section 2-106. Contract for sale. Section 2-106. Goods. Section 2-103. Seller. Section 2-103.

2-511. Tender of Payment by Buyer; Payment by Check. (1) Unless otherwise agreed tender of payment is a condition to the seller's duty to tender and complete any delivery. (2) Tender of payment is sucient when made by any means or in any manner current in the ordinary course of business unless the seller demands payment in legal tender and gives any extension of time reasonably necessary to procure it. (3) Subject to the provisions of this Act on the eect of an instrument on an obligation (Section 3-310), payment by check is conditional and is defeated as between the parties by dishonor of the check on due presentment. As amended in 1994.
See Appendix J for material relating to changes made in text in 1994.

Ocial Comment
Prior Uniform Statutory Provision: Section 42, Uniform Sales Act. Changes: Rewritten by this section and Section 2-507. Purposes of Changes: 1. The requirement of payment against delivery in subsection (1) is applicable to noncommercial sales generally and to ordinary sales at retail although it has no application to the great body of commercial contracts which carry credit terms. Subsection (1) applies also to documentary contracts in general and to contracts which look to shipment by the seller but contain no term on time and manner of payment, in which situations the payment may, in proper case, be demanded against delivery of appropriate documents. In the case of specic transactions such as C.O.D. sales or agreements providing for payment against documents, the provisions of this subsection must be considered in conjunction with the special sections of the Article dealing with such terms. The provision that tender of payment is a condition to the seller's duty to tender and complete any delivery integrates this section with the language and policy of the section on delivery in several lots which call for separate payment. Finally, attention should be directed to the provision on right to adequate assurance of performance which recognizes, even before the time for tender, an obligation on the buyer not to impair the seller's expectation of receiving payment in due course. 2. Unless there is agreement otherwise the concurrence of the conditions as to tender of 138

Art. 2

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payment and tender of delivery requires their performance at a single place or time. This Article determines that place and time by determining in various other sections the place and time for tender of delivery under various circumstances and in particular types of transactions. The sections dealing with time and place of delivery together with the section on right to inspection of goods answer the subsidiary question as to when payment may be demanded before inspection by the buyer. 3. The essence of the principle involved in subsection (2) is avoidance of commercial surprise at the time of performance. The section on substituted performance covers the peculiar case in which legal tender is not available to the commercial community. 4. Subsection (3) is concerned with the rights and obligations as between the parties to a sales transaction when payment is made by check. This Article recognizes that the taking of a seemingly solvent party's check is commercially normal and proper and, if due diligence is exercised in collection, is not to be penalized in any way. The conditional character of the payment under this section refers only to the eect of the transaction as between the parties thereto and does not purport to cut into the law of absolute and conditional payment as applied to such other problems as the discharge of sureties or the responsibilities of a drawee bank which is at the same time an agent for collection. The phrase by check includes not only the buyer's own but any check which does not effect a discharge under Article 3 (Section 3-802). Similarly the reason of this subsection should apply and the same result should be reached where the buyer pays by sight draft on a commercial rm which is nancing him. 5. Under subsection (3) payment by check is defeated if it is not honored upon due presentment. This corresponds to the provisions of article on Commercial Paper. (Section 3-802). But if the seller procures certication of the check instead of cashing it, the buyer is discharged. (Section 3-411). 6. Where the instrument oered by the buyer is not a payment but a credit instrument such as a note or a check post-dated by even one day, the seller's acceptance of the instrument insofar as third parties are concerned, amounts to a delivery on credit and his remedies are set forth in the section on buyer's insolvency. As between the buyer and the seller, however, the matter turns on the present subsection and the section on conditional delivery and subsequent dishonor of the instrument gives the seller rights on it as well as for breach of the contract for sale. Cross References: Point 1: Sections 2-307, 2-310, 2-325, 2-503, 2-513 and 2-609. Point 2: Sections 2-307, 2-310, 2-503, 2-504 and 2-513. Point 3: Section 2-614. Point 5: Article 3, esp. Sections 3-802 and 3-411. Point 6: Sections 2-507, 2-702, and Article 3. Denitional Cross References: Buyer. Section 2-103. Check. Section 3-104(f). Dishonor. Section 3-502. Party. Section 1-201. Reasonable time. Section 1-205. Seller. Section 2-103.

2-512. Payment by Buyer Before Inspection. (1) If the contract requires payment before inspection, nonconformity of the goods does not excuse the buyer from so making payment unless: (a) the nonconformity appears without inspection; or (b) despite tender of the required documents the circumstances would justify injunction against honor under this Act (Section 5-109(b)). (2) Payment pursuant to subsection (1) does not constitute an acceptance of goods or impair the buyer's right to inspect or any of the buyer's remedies. As amended in 1995 and 2003.
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See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None, but see Sections 47 and 49, Uniform Sales Act. Purposes: 1. Subsection (1) of the present section recognizes that the essence of a contract providing for payment before inspection is the intention of the parties to shift to the buyer the risks which would usually rest upon the seller. The basic nature of the transaction is thus preserved and the buyer is in most cases required to pay rst and litigate as to any defects later. 2. Inspection under this section is an inspection in a manner reasonable for detecting defects in goods whose surface appearance is satisfactory. 3. Clause (a) of this subsection states an exception to the general rule based on common sense and normal commercial practice. The apparent non-conformity referred to is one which is evident in the mere process of taking delivery. 4. Clause (b) is concerned with contracts for payment against documents and incorporates the general clarication and modication of the case law contained in the section on excuse of a nancing agency. Section 5-114. 5. Subsection (2) makes explicit the general policy of the Uniform Sales Act that the payment required before inspection in no way impairs the buyer's remedies or rights in the event of a default by the seller. The remedies preserved to the buyer are all of his remedies, which include as a matter of reason the remedy for total non-delivery after payment in advance. The provision on performance or acceptance under reservation of rights does not apply to the situations contemplated here in which payment is made in due course under the contract and the buyer need not pay under protest or the like in order to preserve his rights as to defects discovered upon inspection. 6. This section applies to cases in which the contract requires payment before inspection either by the express agreement of the parties or by reason of the eect in law of that contract. The present section must therefore be considered in conjunction with the provision on right to inspection of goods which sets forth the instances in which the buyer is not entitled to inspection before payment. Cross References: Point 4: Article 5. Point 5: Section 1-308. Point 6: Section 2-513(3). Denitional Cross References: Buyer. Section 2-103. Conform. Section 2-106. Contract. Section 1-201. Financing agency. Section 2-104. Goods. Section 2-103. Remedy. Section 1-201. Rights. Section 1-201.

2-513. Buyer's Right to Inspection of Goods. (1) Unless otherwise agreed and subject to subsection (3), if goods are tendered or delivered or identied to the contract for sale, the buyer has a right before payment or acceptance to inspect them at any reasonable place and time and in any reasonable manner. If the seller is required or authorized to send the goods to the buyer, the inspection may be after their arrival. (2) Expenses of inspection must be borne by the buyer but may be recovered from the seller if the goods do not conform and are rejected. (3) Unless otherwise agreed, the buyer is not entitled to inspect the goods before payment of the price if the contract provides:
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(a) for delivery on terms that under applicable course of performance, course of dealing, or usage of trade are interpreted to preclude inspection before payment; or (b) for payment against documents of title, except where the payment is due only after the goods are to become available for inspection. (4) A place, method, or standard of inspection xed by the parties is presumed to be exclusive, but unless otherwise expressly agreed it does not postpone identication or shift the place for delivery or for passing the risk of loss. If compliance becomes impossible, inspection shall be as provided in this section unless the place, method, or standard xed was clearly intended as an indispensable condition failure of which avoids the contract. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provisions: Section 47(2), (3), Uniform Sales Act. Changes: Rewritten, Subsections (2) and (3) being new. Purposes of Changes and New Matter: To correspond in substance with the prior uniform statutory provision and to incorporate in addition some of the results of the better case law so that: 1. The buyer is entitled to inspect goods as provided in subsection (1) unless it has been otherwise agreed by the parties. The phrase unless otherwise agreed is intended principally to cover such situations as those outlined in subsections (3) and (4) and those in which the agreement of the parties negates inspection before tender of delivery. However, no agreement by the parties can displace the entire right of inspection except where the contract is simply for the sale of this thing. Even in a sale of boxed goods as is inspection is a right of the buyer, since if the boxes prove to contain some other merchandise altogether the price can be recovered back; nor do the limitations of the provision on eect of acceptance apply in such a case. 2. The buyer's right of inspection is available to him upon tender, delivery or appropriation of the goods with notice to him. Since inspection is available to him on tender, where payment is due against delivery he may, unless otherwise agreed, make his inspection before payment of the price. It is also available to him after receipt of the goods and so may be postponed after receipt for a reasonable time. Failure to inspect before payment does not impair the right to inspect after receipt of the goods unless the case falls within subsection (4) on agreed and exclusive inspection provisions. The right to inspect goods which have been appropriated with notice to the buyer holds whether or not the sale was by sample. 3. The buyer may exercise his right of inspection at any reasonable time or place and in any reasonable manner. It is not necessary that he select the most appropriate time, place or manner to inspect or that his selection be the customary one in the trade or locality. Any reasonable time, place or manner is available to him and the reasonableness will be determined by trade usages, past practices between the parties and the other circumstances of the case. The last sentence of subsection (1) makes it clear that the place of arrival of shipped goods is a reasonable place for their inspection. 4. Expenses of an inspection made to satisfy the buyer of the seller's performance must be assumed by the buyer in the rst instance. Since the rule provides merely for an allocation of expense there is no policy to prevent the parties from providing otherwise in the agreement. Where the buyer would normally bear the expenses of the inspection but the goods are rightly rejected because of what the inspection reveals, demonstrable and reasonable costs of the inspection are part of his incidental damage caused by the seller's breach. 5. In the case of payment against documents, subsection (3) requires payment before inspection, since shipping documents against which payment is to be made will commonly be tendered while the goods are still in transit. This Article recognizes no exception in any peculiar case in which the goods happen to arrive before the documents are tendered. 141

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However, where by the agreement payment is to await the arrival of the goods, inspection before payment becomes proper since the goods are then available for inspection. Where by the agreement the documents are to be tendered after arrival of the goods, the buyer is entitled to inspect before payment since the goods are then available for inspection. Proof of usage is not necessary to establish this right, but if inspection before payment is disputed the contrary must be established by usage or by an explicit contract term to that eect. For the same reason, that the goods are available for inspection, a term calling for payment against storage documents or a delivery order does not normally bar the buyer's right to inspection before payment under subsection (3)(b). This result is reinforced by the buyer's right under subsection (1) to inspect goods which have been appropriated with notice to him. 6. Under subsection (4) an agreed place, method or standard of inspection is presumed to be intended as exclusive. However, where compliance with an agreed method or standard becomes impossible, the question is basically one of intention. If the parties clearly intend that the method or standard of inspection is a necessary condition without which the entire agreement should fail, the contract is at an end if that method becomes impossible. On the other hand, if the parties merely seek to indicate a convenient and reliable method or standard but do not intend to give up the agreement in the event of the failure, any reasonable method of inspection may be substituted under this Article. Since the purpose of an agreed place of inspection is only to make sure at that point whether or not the goods will be rejected, the exclusive feature of the named place is satised under this Article if the buyer's failure to inspect there is held to be an acceptance with the knowledge of the defects as an inspection would have revealed within the section on waiver of the buyer's objections by failure to particularize. (Section 2-605(1)). 7. Clauses on time of inspection are commonly clauses which limit the time in which the buyer must inspect and give notice of defects. Such clauses are therefore governed by the section of this Article which requires that such a time limitation must be reasonable. 8. Inspection under this Article is not to be regarded as a condition precedent to the passing of title so that risk until inspection remains on the seller. Under subsection (4) such an approach cannot be sustained. Issues between the buyer and seller are settled in this Article almost wholly by special provisions and not by the technical determination of the locus of the title. Thus inspection as a condition to the passing of title becomes a concept almost without meaning. However, in peculiar circumstances inspection may still have some of the consequences hitherto sought and obtained under that concept. 9. Inspection under this section has to do with the buyer's check-up on whether the seller's performance is in accordance with a contract previously made and is not to be confused with the examination of the goods or of a sample or model of them at the time of contracting which may aect the warranties involved in the contract. Cross Reference: Point 1: Section 2-607. Point 2: Sections 2-501 and 2-502. Point 4: Section 2-715. Point 6: Sections 2-605 to 2-608. Point 7: Section 1-204. Point 8: Comment to Section 2-401. Point 9: Section 2-316(b)(2). Denitional Cross References: Buyer. Section 2-103. Conform. Section 2-106. Contract. Section 1-201. Contract for sale. Section 2-106. Course of performance. Section 1-303. Document of title. Section 1-201. Goods. Section 2-103. Party. Section 1-201. Presumed. Section 1-201. Reasonable time. Section 1-205. 142

Art. 2
Rights. Section 1-201. Seller. Section 2-103. Send. Section 1-201. Term. Section 1-201. Usage of trade. Section 1-303.

Sales

2-515

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-514. When Documents Deliverable on Acceptance; When on Payment. Unless otherwise agreed and except as otherwise provided in Article 5, documents against which a draft is drawn are to be delivered to the drawee on acceptance of the draft if it is payable more than three days after presentment; otherwise, only on payment. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
This section, which is consistent with Section 4-503, is subject to Article 5. Under Article 5, because an issuer may have up to seven days to determine compliance of documents (Section 5-108), the delay beyond three days does not necessarily indicate that the draft should be treated as a time draft. Denitional Cross References: Delivery. Section 2-103. Draft. Section 3-104(e).

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-515. Preserving Evidence of Goods in Dispute. In furtherance of the adjustment of any claim or dispute (a) either party on reasonable notication to the other and for the purpose of ascertaining the facts and preserving evidence has the right to inspect, test and sample the goods including such of them as may be in the possession or control of the other; and (b) the parties may agree to a third party inspection or survey to determine the conformity or condition of the goods and may agree that the ndings shall be binding upon them in any subsequent litigation or adjustment. Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: 1. To meet certain serious problems which arise when there is a dispute as to the quality of the goods and thereby perhaps to aid the parties in reaching a settlement, and to further the use of devices which will promote certainty as to the condition of the goods, or at least aid in preserving evidence of their condition. 2. Under paragraph (a), to aord either party an opportunity for preserving evidence, whether or not agreement has been reached, and thereby to reduce uncertainty in any litigation and, in turn perhaps, to promote agreement. Paragraph (a) does not conict with the provisions on the seller's right to resell rejected goods or the buyer's similar right. Apparent conict between these provisions which will be 143

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suggested in certain circumstances is to be resolved by requiring prompt action by the parties. Nor does paragraph (a) impair the eect of a term for payment before inspection. Short of such defects as amount to fraud or substantial failure of consideration, nonconformity is neither an excuse nor a defense to an action for non-acceptance of documents. Normally, therefore, until the buyer has made payment, inspected and rejected the goods, there is no occasion or use for the rights under paragraph (a). 3. Under paragraph (b), to provide for third party inspection upon the agreement of the parties, thereby opening the door to amicable adjustments based upon the ndings of such third parties. The use of the phrase conformity or condition makes it clear that the parties' agreement may range from a complete settlement of all aspects of the dispute by a third party to the use of a third party merely to determine and record the condition of the goods so that they can be resold or used to reduce the stake in controversy. Conformity, at one end of the scale of possible issues, includes the whole question of interpretation of the agreement and its legal eect, the state of the goods in regard to quality and condition, whether any defects are due to factors which operate at the risk of the buyer, and the degree of nonconformity where that may be material. Condition, at the other end of the scale, includes nothing but the degree of damage or deterioration which the goods show. Paragraph (b) is intended to reach any point in the gamut which the parties may agree upon. The principle of the section on reservation of rights reinforces this paragraph in simplifying such adjustments as the parties wish to make in partial settlement while reserving their rights as to any further points. Paragraph (b) also suggests the use of arbitration, where desired, of any points left open, but nothing in this section is intended to repeal or amend any statute governing arbitration. Where any question arises as to the extent of the parties' agreement under the paragraph, the presumption should be that it was meant to extend only to the relation between the contract description and the goods as delivered, since that is what a craftsman in the trade would normally be expected to report upon. Finally, a written and authenticated report of inspection or tests by a third party, whether or not sampling has been practicable, is entitled to be admitted as evidence under this Act, for it is a third party document. Cross References: Point 2: Sections 2-513(3), 2-706 and 2-711(2) and Article 5. Point 3: Sections 1-307 and 1-308. Denitional Cross References: Conform. Section 2-106. Goods. Section 2-103. Notication. Section 1-202. Party. Section 1-201.

PART 6. BREACH, REPUDIATION, AND EXCUSE

2-601. Buyer's Rights on Improper Delivery. Subject to Sections 2-504 and 2-612, and unless otherwise agreed under Sections 2-718 and 2-719, if the goods or the tender of delivery fail in any respect to conform to the contract, the buyer may: (a) reject the whole; (b) accept the whole; or (c) accept any commercial unit or units and reject the rest. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: No one general equivalent provision but numerous provisions, dealing with situations of non-conformity where buyer may accept or reject, including Sections 11, 44 and 69(1), Uniform Sales Act. Changes: Partial acceptance in good faith is recognized and the buyer's remedies on the 144

Art. 2

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contract for breach of warranty and the like, where the buyer has returned the goods after transfer of title, are no longer barred. Purposes of Changes: To make it clear that: 1. A buyer accepting a non-conforming tender is not penalized by the loss of any remedy otherwise open to him. This policy extends to cover and regulate the acceptance of a part of any lot improperly tendered in any case where the price can reasonably be apportioned. Partial acceptance is permitted whether the part of the goods accepted conforms or not. The only limitation on partial acceptance is that good faith and commercial reasonableness must be used to avoid undue impairment of the value of the remaining portion of the goods. This is the reason for the insistence on the commercial unit in paragraph (c). In this respect, the test is not only what unit has been the basis of contract, but whether the partial acceptance produces so materially adverse an eect on the remainder as to constitute bad faith. 2. Acceptance made with the knowledge of the other party is nal. An original refusal to accept may be withdrawn by a later acceptance if the seller has indicated that he is holding the tender open. However, if the buyer attempts to accept, either in whole or in part, after his original rejection has caused the seller to arrange for other disposition of the goods, the buyer must answer for any ensuing damage since the next section provides that any exercise of ownership after rejection is wrongful as against the seller. Further, he is liable even though the seller may choose to treat his action as acceptance rather than conversion, since the damage ows from the misleading notice. Such arrangements for resale or other disposition of the goods by the seller must be viewed as within the normal contemplation of a buyer who has given notice of rejection. However, the buyer's attempts in good faith to dispose of defective goods where the seller has failed to give instructions within a reasonable time are not to be regarded as an acceptance. 3. The right to rejection under this section is subject to the limitations on the right of rejection in installment contracts (Section 2-612) and the standard for rejection in a shipment contract when the seller fails to notify the buyer of the shipment or fails to make a proper contract. (Section 2-504). The right of rejection in this section is also subject to the seller's right to cure (Section 2-508) in appropriate circumstances. Cross References: Point 2: Sections 2-602, 2-612, 2-718 and 2-719. Point 3: Sections 2-504, 2-508 and 2-612. Denitional Cross References: Buyer. Section 2-103. Commercial unit. Section 2-105. Conform. Section 2-106. Contract. Section 1-201. Goods. Section 2-103. Installment contract. Section 2-612. Rights. Section 1-201. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-602. Manner and Eect of Rejection. (1) Rejection of goods must be within a reasonable time after their delivery or tender. It is ineective unless the buyer seasonably noties the seller. (2) Subject to Sections 2-603, 2-604, and Section 2-608(4): (a) after rejection any exercise of ownership by the buyer with respect to any commercial unit is wrongful as against the seller; and (b) if the buyer has before rejection taken physical possession of goods in which the buyer does not have a security interest under Section
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2-711(3), the buyer is under a duty after rejection to hold them with reasonable care at the seller's disposition for a time sucient to permit the seller to remove them; but (c) the buyer has no further obligations with regard to goods rightfully rejected. (3) The seller's rights with respect to goods wrongfully rejected are governed by the provisions of this Article on Seller's remedies in general (Section 2-703). As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Section 50, Uniform Sales Act. Changes: Rewritten. Purposes of Changes: To make it clear that: 1. A tender or delivery of goods made pursuant to a contract of sale, even though wholly non-conforming, requires armative action by the buyer to avoid acceptance. Under subsection (1), therefore, the buyer is given a reasonable time to notify the seller of his rejection, but without such seasonable notication his rejection is ineective. The sections of this Article dealing with inspection of goods must be read in connection with the buyer's reasonable time for action under this subsection. Contract provisions limiting the time for rejection fall within the rule of the section on Time and are eective if the time set gives the buyer a reasonable time for discovery of defects. What constitutes a due notifying of rejection by the buyer to the seller is dened in Section 1-201. 2. Subsection (2) sets forth the duties of the buyer upon rejection. In addition to the duty to hold the goods with reasonable care for the seller's disposition, the buyer also has those duties specied in Sections 2-603, 2-604 and 2-608(4). 3. Elimination of the word rightful in the title makes it clear that a buyer can effectively reject goods even though the rejection is wrongful and constitutes a breach. See Section 2-703(1). The word rightful has also been deleted from the titles to Section 2-603 and 2-604. See Ocial Comments to those sections. 4. The provisions of this section are to be appropriately limited or modied when a negotiation is in process. Cross References: Point 1: Sections 1-201, 1-204(1) and (3), 2-512(2), 2-513(1) and 2-606(1)(b). Point 2: Sections 2-603, 2-604 and 2-608(4). Point 3: Sections 2-603, 2-604 and 2-703. Denitional Cross References: Buyer. Section 2-103. Commercial unit. Section 2-105. Goods. Section 2-103. Noties. Section 1-202. Reasonable time. Section 1-205. Remedy. Section 1-201. Rights. Section 1-201. Seasonable. Section 1-205. Security interest. Section 1-201. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-603. Merchant Buyer's Duties as to Rejected Goods. (1) Subject to any security interest in the buyer under Section 2-711(3),
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if the seller has no agent or place of business at the market of rejection, a merchant buyer is under a duty after rejection of goods in the buyer's possession or control to follow any reasonable instructions received from the seller with respect to the goods and in the absence of such instructions to make reasonable eorts to sell them for the seller's account if they are perishable or threaten to decline in value speedily. In the case of a rightful rejection, instructions are not reasonable if on demand indemnity for expenses is not forthcoming. (2) If the buyer sells goods under subsection (1) following a rightful rejection, the buyer is entitled to reimbursement from the seller or out of the proceeds for reasonable expenses of caring for and selling them, and if the expenses include no selling commission then to such commission as is usual in the trade or if there is none to a reasonable sum not exceeding 10 per cent on the gross proceeds. (3) In complying with this section the buyer is held only to good faith and good-faith conduct under this section is neither acceptance nor conversion nor the basis of an action for damages. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: 1. This section recognizes the duty imposed upon the merchant buyer by good faith and commercial practice to follow any reasonable instructions of the seller as to reshipping, storing, delivery to a third party, reselling or the like. Subsection (1) goes further and extends the duty to include the making of reasonable eorts to eect a salvage sale where the value of the goods is threatened and the seller's instructions do not arrive in time to prevent serious loss. 2. The limitations on the buyer's duty to resell under subsection (1) are to be liberally construed. The buyer's duty to resell under this section arises from commercial necessity and thus is present only when the seller has no agent or place of business at the market of rejection. A nancing agency which is acting in behalf of the seller in handling the documents rejected by the buyer is suciently the seller's agent to lift the burden of salvage resale from the buyer. (See provisions of Sections 4-503 and 5-112 on bank's duties with respect to rejected documents.) The buyer's duty to resell is extended only to goods in his possession or control, but these are intended as words of wide, rather than narrow, import. In eect, the measure of the buyer's control is whether he can practicably eect control without undue commercial burden. 3. The explicit provisions for reimbursement and compensation to the buyer in subsection (2) are applicable and necessary only where he is not acting under instructions from the seller. As provided in subsection (1) the seller's instructions to be reasonable must on demand of the buyer include indemnity for expenses. 4. Since this section makes the resale of perishable goods an armative duty in contrast to a mere right to sell as under the case law, subsection (3) makes it clear that the buyer is liable only for the exercise of good faith in determining whether the value of the goods is suciently threatened to justify a quick resale or whether he has waited a sucient length of time for instructions, or what a reasonable means and place of resale is. 5. A buyer who fails to make a salvage sale when his duty to do so under this section has arisen is subject to damages pursuant to the section on liberal administration of remedies. 6. Except as otherwise stated in this section, its provisions apply to all eective rejections, including rejections that are wrongful. Thus, any merchant buyer whose rejection is eective is subject to the duties set forth in the rst sentence of subsection (1), and a merchant buyer that complies with those duties is entitled to the protection provided by subsection (3). However, the right to indemnity for expenses on demand under the second 147

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sentence of subsection (1) and the right to reimbursement for expenses and a commission under subsection (2) are limited to buyers whose rejections are rightful. Cross References: Point 2: Sections 4-503 and 5-112. Point 5: Section 1-106. Denitional Cross References: Buyer. Section 2-103. Good faith. Section 2-103. Goods. Section 2-103. Merchant. Section 2-104. Security interest. Section 1-201. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-604. Buyer's Options as to Salvage of Rejected Goods. Subject to the provisions of Section 2-603 on perishables, if the seller gives no instructions within a reasonable time after notication of rejection, the buyer may store the rejected goods for the seller's account or reship them to the seller or resell them for the seller's account with reimbursement as provided in Section 2-603. Such action is not acceptance or conversion. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: 1. The basic purpose of this section is twofold: on the one hand it aims at reducing the stake in dispute and on the other at avoiding the pinning of a technical acceptance on a buyer who has taken steps towards realization on or preservation of the goods in good faith. This section is essentially a salvage section and the buyer's right to act under it is conditioned upon (1) non-conformity of the goods, (2) due notication of rejection to the seller under the section on manner of rejection, and (3) the absence of any instructions from the seller which the merchant-buyer has a duty to follow under the preceding section. 2. This section no longer refers to rightful rejections. Accordingly, its provisions apply to any buyer whose rejection is eective. However, this section is subject to Section 2-603, and the provisions of that section dierentiate between rightful and wrongful rejections. Cross References: Point 1: Sections 2-602, and 2-603 and 2-706. Point 2: Section 2-603. Denitional Cross References: Buyer. Section 2-103. Goods. Section 2-103. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-605. Waiver of Buyer's Objections by Failure to Particularize. (1) A buyer's failure to state in connection with rejection a particular defect or in connection with revocation of acceptance a defect that justies
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revocation precludes the buyer from relying on the unstated defect to justify rejection or revocation of acceptance if the defect is ascertainable by reasonable inspection: (a) if the seller had a right to cure the defect and could have cured it if stated seasonably; or (b) between merchants, if the seller has after rejection or revocation of acceptance made a request in a record for a full and nal statement in a record of all defects on which the buyer proposes to rely. (2) A buyer's payment against documents tendered to the buyer made without reservation of rights precludes recovery of the payment for defects apparent in the documents. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. This section rests upon a policy of permitting the buyer to give a quick and informal notice of defects in a tender without penalizing the buyer for omissions, while at the same time protecting a seller that is reasonably misled by the buyer's failure to state curable defects. When the defect in a tender is one which could have been cured by the seller, a buyer that merely rejects the delivery without stating any objections to the tender is probably acting in commercial bad faith and is seeking to get out of a agreement which has become unprotable. Following the general policy of this Article to preserve the deal wherever possible, subsection (1)(a) requires that the seller's right to correct the tender in the circumstances be protected. Subsection (1) as amended makes three substantive changes. First, the failure to particularize aects only the buyer's right to reject or revoke acceptance. It does not aect the buyer's right to establish a breach of the agreement. Waiver of a right to damages for breach because of a failure properly to notify the seller is governed by Section 2-607(3). Second, subsection (1) now requires the seller to have had a right to cure under Section 2-508 in addition to having the ability to cure. This point was perhaps implicit in the original provision, but it is now expressly stated to avoid any question of whether this section creates a seller's right to cure independent of the right enumerated in Section 2-508. Thus, if the defect is one that could be cured under Section 2-508, the buyer will have waived that defect as a basis for rejecting the goods or revoking acceptance if the buyer fails to state the defect with sucient particularity to facilitate the seller's exercise of its right to cure as provided in Section 2-508. Subsection (1) as revised has been extended to include a notice requirement not only as to rejection but also as to revocation of acceptance. This is necessitated by the expansion of the right to cure (Section 2-508) to cover revocation of acceptance in nonconsumer contracts. The application of the subsection to revocation cases is limited in the following ways: 1) because a revocation under Section 2-608(1)(a) does not activate a right to cure under Section 2-508, the revocation does not activate subsection (1); 2) because Section 2-608(1)(b) involves defects that are by denition dicult to discover, there is no waiver under subsection (1) unless the defect justies the revocation and the buyer has notice of it; and 3) because the right to cure following revocation of acceptance is restricted under Section 2-508 to nonconsumer contracts, this notice requirement does not apply to a consumer who is seeking to revoke acceptance. 2. When the time for cure has passed, subsection (1)(b) provides that a merchant seller is entitled upon request to a nal statement of objections by a merchant buyer upon which the seller can rely. What is needed is a clear statement to the buyer of exactly what is being sought. A formal demand will be sucient in the case of a merchant-buyer. 3. Subsection (2) has been amended to make clear that a buyer that makes payment upon presentation of the documents to the buyer may waive defects, but that a person that is not the buyer, such as the issuer of a letter of credit that pays as against documents, is not waiving the buyer's right to assert defects in the documents as against the seller. Subsection (2) applies to documents the same principle contained in Section 2-606(1)(a) 149

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for the acceptance of goods; that is, if the buyer accepts documents that have apparent defects, the buyer is presumed to have waived the defects as a basis for rejecting the documents. Subsection (2) is limited to defects which are apparent in the documents. This rule applies to both tangible and electronic documents of title. When payment is required against documents, the documents must be inspected before the payment, and the payment constitutes acceptance of the documents. When the documents are delivered without requiring a contemporary payment by the buyer, the acceptance of the documents by non-objection is postponed until after a reasonable time for the buyer to inspect the documents. In either situation, however, the buyer waives only what is apparent in the documents. Moreover, in either case, the acceptance of the documents does not constitute an acceptance of the goods and does not impair any options or remedies of the buyer for improper delivery of the goods. See Section 2-512(2). Cross References: Point 1: Sections 2-508, 2-607 and 2-608. Point 3: Sections 2-512, 2-606 and 2-607. Denitional Cross References: Between merchants. Section 2-104. Buyer. Section 2-103. Record. Section 2-103. Seasonably. Section 1-205. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-606. What Constitutes Acceptance of Goods. (1) Acceptance of goods occurs when the buyer: (a) after a reasonable opportunity to inspect the goods signies to the seller that the goods are conforming or that the buyer will take or retain them in spite of their nonconformity; (b) fails to make an eective rejection under Section 2-602(1), but such acceptance does not occur until the buyer has had a reasonable opportunity to inspect them; or (c) Subject to Section 2-608(4), does any act inconsistent with the seller's ownership. (2) Acceptance of a part of any commercial unit is acceptance of that entire unit. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Section 48, Uniform Sales Act. Changes: Rewritten, the qualication in paragraph (c) and subsection (2) being new; otherwise the general policy of the prior legislation is continued. Purposes of Changes and New Matter: To make it clear that: 1. Under this Article acceptance as applied to goods means that the buyer, pursuant to the contract, takes particular goods which have been appropriated to the contract as his own, whether or not he is obligated to do so, and whether he does so by words, action, or silence when it is time to speak. If the goods conform to the contract, acceptance amounts only to the performance by the buyer of one part of his legal obligation. 2. Under this Article acceptance of goods is always acceptance of identied goods which have been appropriated to the contract or are appropriated by the contract. There is no provision for acceptance of title apart from acceptance in general, since acceptance of title is not material under this Article to the detailed rights and duties of the parties. (See Section 150

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2-401). The renements of the older law between acceptance of goods and of title become unnecessary in view of the provisions of the sections on eect and revocation of acceptance, on eects of identication and on risk of loss, and those sections which free the seller's and buyer's remedies from the complications and confusions caused by the question of whether title has or has not passed to the buyer before breach. 3. Under paragraph (a), payment made after tender is always one circumstance tending to signify acceptance of the goods but in itself it can never be more than one circumstance and is not conclusive. Also, a conditional communication of acceptance always remains subject to its expressed conditions. 4. Under paragraph (c), any action taken by the buyer, which is inconsistent with his claim that he has rejected the goods, constitutes an acceptance. However, the provisions of paragraph (c) are subject to the sections dealing with rejection by the buyer which permit the buyer to take certain actions with respect to the goods pursuant to his options and duties imposed by those sections, without eecting an acceptance of the goods. The second clause of paragraph (c) modies some of the prior case law and makes it clear that acceptance in law based on the wrongful act of the acceptor is acceptance only as against the wrongdoer and then only at the option of the party wronged. In the same manner in which a buyer can bind himself, despite his insistence that he is rejecting or has rejected the goods, by an act inconsistent with the seller's ownership under paragraph (c), he can obligate himself by a communication of acceptance despite a prior rejection under paragraph (a). However, the sections on buyer's rights on improper delivery and on the eect of rightful rejection, make it clear that after he once rejects a tender, paragraph (a) does not operate in favor of the buyer unless the seller has re-tendered the goods or has taken armative action indicating that he is holding the tender open. See also Comment 2 to Section 2-601. 5. Subsection (2) supplements the policy of the section on buyer's rights on improper delivery, recognizing the validity of a partial acceptance but insisting that the buyer exercise this right only as to whole commercial units. Cross References: Point 2: Sections 2-401, 2-509, 2-510, 2-607, 2-608 and Part 7. Point 4: Sections 2-601 through 2-604. Point 5: Section 2-601. Denitional Cross References: Buyer. Section 2-103. Commercial unit. Section 2-105. Goods. Section 2-103. Seller. Section 2-103.

2-607. Eect of Acceptance; Notice of Breach; Burden of Establishing Breach after Acceptance; Notice of Claim or Litigation to Person Answerable Over. (1) The buyer must pay at the contract rate for any goods accepted. (2) Acceptance of goods by the buyer precludes rejection of the goods accepted and if made with knowledge of a nonconformity may not be revoked because of it unless the acceptance was on the reasonable assumption that the nonconformity would be seasonably cured, but acceptance does not of itself impair any other remedy provided by this Article for nonconformity. (3) If a tender has been accepted: (a) the buyer must within a reasonable time after the buyer discovers or should have discovered any breach notify the seller, but failure to give timely notice bars the buyer from a remedy only to the extent that the seller is prejudiced by the failure; and (b) if the claim is one for infringement or the like under Section 2-312(2) and the buyer is sued as a result of such a breach, the buyer must so notify the seller within a reasonable time after the buyer receives notice
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of the litigation or be barred from any remedy over for liability established by the litigation. (4) The burden is on the buyer to establish any breach with respect to the goods accepted. (5) If the buyer is sued for indemnity, breach of a warranty, or other obligation for which another party is answerable over: (a) the buyer may give the other party notice of the litigation in a record, and if the notice states that the other party may come in and defend and that if the other party does not do so the other party will be bound in any action against the other party by the buyer by any determination of fact common to the two litigations, then unless the other party after seasonable receipt of the notice does come in and defend the other party is so bound. (b) if the claim is one for infringement or the like under Section 2-312(2), the original seller may demand in a record that its buyer turn over to it control of the litigation including settlement or else be barred from any remedy over and if it also agrees to bear all expense and to satisfy any adverse judgment, the buyer is so barred unless the buyer after seasonable receipt of the demand does turn over control. (6) Subsections (3), (4), and (5) apply to any obligation of a buyer to hold the seller harmless against infringement or the like under Section 2-312(2). As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Under subsection (1), once the buyer accepts a tender the seller acquires a right to its price on the contract terms. In cases of partial acceptance, the price of any part accepted is, if possible, to be reasonably apportioned. Usually this is to be determined in terms of the contract rate, which is the rate determined from the agreement based on the rules and policies of this Article. 2. Under subsection (2) acceptance of goods precludes their subsequent rejection of the goods. Any return of the goods thereafter must be by way of revocation of acceptance under Section 2-608. Revocation is unavailable for a non-conformity known to the buyer at the time of acceptance, except where the buyer has accepted on the reasonable assumption that the non-conformity would be seasonably cured. 3. All other remedies of the buyer remain unimpaired under subsection (2). This is intended to include the buyer's full rights for future installments despite the buyer's acceptance of any earlier non-conforming installment. 4. Subsection (3)(a) provides that the buyer must, within a reasonable time of the discovery, or when the buyer should have discovered any breach, give the seller notication of the breach. A failure to give this notice to the seller bars the buyer from a remedy for breach of contract if the seller suers prejudice due to the failure to notify. See Restatement (Second) of Contracts 229, which provides for an excuse of a condition where the failure is not material and implementation would result in a disproportionate forfeiture. The time of notication is to be determined by applying commercial standards to a merchant buyer. A reasonable time for notication from a retail consumer is to be judged by dierent standards so that in that case it could be extended beyond what would be a commercially reasonable time' in appropriate circumstances because the requirement of notication is meant to defeat commercial bad faith, not to deprive a good faith consumer of a remedy. The content of the notication need merely be sucient to let the seller know that the transaction is still troublesome and must be watched. There is no reason to require that the notication which saves the buyer's rights under this section must include a clear statement of all the objections that will be relied on by the buyer, as is required for state152

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ments of defects upon rejection (Section 2-605). Nor is there reason to require the notication to be a claim for damages or of any threatened litigation or other resort to a remedy. The notication which preserves the buyer's rights under this Article need only be one that informs the seller that the transaction is claimed to involve a breach, and thus opens the way for normal settlement through negotiation. 5. Under this Article various beneciaries are given rights for injuries sustained by them because of the seller's breach of warranty. Such a beneciary does not fall within the reason of the present section in regard to discovery of defects and the giving of notice within a reasonable time after acceptance, since he has nothing to do with acceptance. However, the reason of this section does extend to requiring the beneciary to notify the seller that an injury has occurred. What is said above, with regard to the extended time for reasonable notication from the lay consumer after the injury is also applicable here; but even a beneciary can be properly held to the use of good faith in notifying, once he has had time to become aware of the legal situation. 6. Subsection (4) unambiguously places the burden of proof to establish breach on the buyer after acceptance. However, this rule becomes one purely of procedure when the tender accepted was non-conforming and the buyer has given the seller notice of breach under subsection (3). For subsection (2) makes it clear that acceptance leaves unimpaired the buyer's right to be made whole, and that right can be exercised by the buyer not only by way of cross-claim for damages, but also by way of recoupment in diminution or extinction of the price. 7. The vouching-in procedure in subsection (5) includes indemnity actions, and it includes any other party that is answerable over, not just the immediate seller. Vouching-in does not confer on the notied seller a right to intervene, does not confer jurisdiction of any kind on the court over the seller, and does not create a duty to defend on the part of the seller. Those matters continue to be governed by the applicable rules of civil procedure and substantive law outside this section. Vouching in is based upon the principle that the seller is liable for its contractual obligations for quality or title to the goods which the buyer is being forced to defend. 8. Subsections (3)(b) and (5)(b) give a warrantor against infringement an opportunity to defend or compromise third-party claims or be relieved of liability. Subsection (5)(a) codies for all warranties the practice of voucher to defend. Subsection (6) makes these provisions applicable to the buyer's liability for infringement under Section 2-312. 9. All of the provisions of this section are subject to any explicit reservation of rights. Section 1-308. Cross References: Point 1: Section 1-201. Point 2: Section 2-608. Point 4: Sections 1-204 and 2-605. Point 5: Section 2-318. Point 6: Sections 2-312 and 3-803. Point 8: Section 2-312. Point 9: Section 1-308. Denitional Cross References: Burden of establishing. Section 1-201. Buyer. Section 2-103. Conform. Section 2-106. Contract. Section 1-201. Goods. Section 2-103. Notice. Section 1-202. Reasonable time. Section 1-205. Remedy. Section 1-201. Seasonably. Section 1-205.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.
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2-608. Revocation of Acceptance in Whole or in Part. (1) A buyer may revoke acceptance of a lot or commercial unit whose nonconformity substantially impairs its value to the buyer if the buyer has accepted it: (a) on the reasonable assumption that its nonconformity would be cured and it has not been seasonably cured; or (b) without discovery of the nonconformity if the buyer's acceptance was reasonably induced either by the diculty of discovery before acceptance or by the seller's assurances. (2) Revocation of acceptance must occur within a reasonable time after the buyer discovers or should have discovered the ground for it and before any substantial change in condition of the goods which is not caused by their own defects. The revocation is not eective until the buyer noties the seller of it. (3) A buyer that so revokes has the same rights and duties with regard to the goods involved as if the buyer had rejected them. (4) If a buyer uses the goods after a rightful rejection or justiable revocation of acceptance, the following rules apply: (a) Any use by the buyer that is unreasonable under the circumstances is wrongful as against the seller and is an acceptance only if ratied by the seller. (b) Any use of the goods that is reasonable under the circumstances is not wrongful as against the seller and is not an acceptance, but in an appropriate case the buyer is obligated to the seller for the value of the use to the buyer. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Section 69(1)(d), (3), (4) and (5), Uniform Sales Act. Changes: Rewritten. Purposes of Changes: To make it clear that: 1. Although the prior basic policy is continued, the buyer is no longer required to elect between revocation of acceptance and recovery of damages for breach. Both are now available to him. The non-alternative character of the two remedies is stressed by the terms used in the present section. The section no longer speaks of rescission, a term capable of ambiguous application either to transfer of title to the goods or to the contract of sale and susceptible also of confusion with cancellation for cause of an executed or executory portion of the contract. The remedy under this section is instead referred to simply as revocation of acceptance of goods tendered under a contract for sale and involves no suggestion of election of any sort. 2. Revocation of acceptance is possible only where the non-conformity substantially impairs the value of the goods to the buyer. For this purpose the test is not what the seller had reason to know at the time of contracting; the question is whether the non-conformity is such as will in fact cause a substantial impairment of value to the buyer though the seller had no advance knowledge as to the buyer's particular circumstances. 3. Assurances by the seller under paragraph (b) of subsection (1) can rest as well in the circumstances or in the contract as in explicit language used at the time of delivery. The reason for recognizing such assurances is that they induce the buyer to delay discovery. These are the only assurances involved in paragraph (b). Explicit assurances may be made either in good faith or bad faith. In either case any remedy accorded by this Article is available to the buyer under the section on remedies for fraud. 154

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4. Subsection (2) requires notication of revocation of acceptance within a reasonable time after discovery of the grounds for such revocation. Since this remedy will be generally resorted to only after attempts at adjustment have failed, the reasonable time period should extend in most cases beyond the time in which notication of breach must be given, beyond the time for discovery of non-conformity after acceptance and beyond the time for rejection after tender. The parties may by their agreement limit the time for notication under this section, but the same sanctions and considerations apply to such agreements as are discussed in the comment on manner and eect of rightful rejection. 5. The content of the notice under subsection (2) is to be determined in this case as in others by considerations of good faith, prevention of surprise, and reasonable adjustment. More will generally be necessary than the mere notication of breach required under the preceding section. On the other hand the requirements of the section on waiver of buyer's objections do not apply here. The fact that quick notication of trouble is desirable aords good ground for being slow to bind a buyer by his rst statement. Following the general policy of this Article, the requirements of the content of notication are less stringent in the case of a non-merchant buyer. 6. Under subsection (2) the prior policy is continued of seeking substantial justice in regard to the condition of goods restored to the seller. Thus the buyer may not revoke his acceptance if the goods have materially deteriorated except by reason of their own defects. Worthless goods, however, need not be oered back and minor defects in the articles reoered are to be disregarded. 7. The policy of the section allowing partial acceptance is carried over into the present section and the buyer may revoke his acceptance, in appropriate cases, as to the entire lot or any commercial unit thereof. 8. Subsection (4) deals with the problem of post-rejection or revocation use of the goods. The courts have developed several alternative approaches. Under original Article 2, a buyer's post-rejection or revocation use of the goods could be treated as an acceptance, thus undoing the rejection or revocation, could be a violation of the buyer's obligation of reasonable care, or could be a reasonable use for which the buyer must compensate the seller. Subsection (4) adopts the third approach. In general, a buyer that either rejects or revokes acceptance of the goods should not subsequently use the goods in a manner that is inconsistent with the seller's ownership. In some instances, however, the use may be reasonable. For example, a consumer buyer may have incurred an unavoidable obligation to a third-party nancier and, if the seller fails to refund the price as required by this Article, the buyer may have no reasonable alternative but to use the goods (e.g., a rejected mobile home that provides needed shelter). Another example might involve a commercial buyer that is unable immediately to obtain cover and must use the goods to fulll its obligations to third parties. If circumstances change so that the buyer's use after an eective rejection or a justied revocation of acceptance is no longer reasonable, the continued use of the goods is unreasonable and is wrongful against the seller. This gives the seller the option of ratifying the use, thereby treating it as an acceptance, or pursuing a non-Code remedy for conversion. If the buyer's use is reasonable under the circumstances, the buyer's actions cannot be treated as an acceptance. The buyer must compensate the seller for the value of the use of the goods to the buyer. Determining the appropriate level of compensation requires a consideration of the buyer's particular circumstances and should take into account the defective condition of the goods. There may be circumstances, such as where the use is solely for the purpose of protecting the buyer's security interest in the goods, where no compensation is due the seller under this section. If the seller has a right to compensation under this section that compensation must be netted out against any right of the buyer to damages for the seller's breach of contract. Cross References: Point 3: Section 2-721. Point 4: Sections 1-204, 2-602 and 2-607. Point 5: Sections 2-605 and 2-607. Point 7: Section 2-601. Denitional Cross References: Buyer. Section 2-103. Commercial unit. Section 2-105. 155

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Conform. Section 2-106. Goods. Section 2-103. Noties. Section 1-202. Reasonable time. Section 1-205. Rights. Section 1-201. Seasonably. Section 1-205. Seller. Section 2-103. Value. Section 1-204.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-609. Right to Adequate Assurance of Performance. (1) A contract for sale imposes an obligation on each party that the other's expectation of receiving due performance will not be impaired. If reasonable grounds for insecurity arise with respect to the performance of either party, the other may demand in a record adequate assurance of due performance and until the party receives the assurance may if commercially reasonable suspend any performance for which it has not already received the agreed return. (2) Between merchants, the reasonableness of grounds for insecurity and the adequacy of any assurance oered shall be determined according to commercial standards. (3) Acceptance of any improper delivery or payment does not prejudice the aggrieved party's right to demand adequate assurance of future performance. (4) After receipt of a justied demand, failure to provide within a reasonable time not exceeding 30 days such assurance of due performance as is adequate under the circumstances of the particular case is a repudiation of the contract. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: See Sections 53, 54(1)(b), 55 and 63(2), Uniform Sales Act. Purposes: 1. The section rests on the recognition of the fact that the essential purpose of a contract between commercial men is actual performance and they do not bargain merely for a promise, or for a promise plus the right to win a lawsuit and that a continuing sense of reliance and security that the promised performance will be forthcoming when due, is an important feature of the bargain. If either the willingness or the ability of a party to perform declines materially between the time of contracting and the time for performance, the other party is threatened with the loss of a substantial part of what he has bargained for. A seller needs protection not merely against having to deliver on credit to a shaky buyer, but also against having to procure and manufacture the goods, perhaps turning down other customers. Once he has been given reason to believe that the buyer's performance has become uncertain, it is an undue hardship to force him to continue his own performance. Similarly, a buyer who believes that the seller's deliveries have become uncertain cannot safely wait for the due date of performance when he has been buying to assure himself of materials for his current manufacturing or to replenish his stock of merchandise. 2. Three measures have been adopted to meet the needs of commercial men in such 156

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situations. First, the aggrieved party is permitted to suspend his own performance and any preparation therefor, with excuse for any resulting necessary delay, until the situation has been claried. Suspend performance under this section means to hold up performance pending the outcome of the demand, and includes also the holding up of any preparatory action. This is the same principle which governs the ancient law of stoppage and seller's lien, and also of excuse of a buyer from prepayment if the seller's actions manifest that he cannot or will not perform. (Original Act, Section 63(2).) Secondly, the aggrieved party is given the right to require adequate assurance that the other party's performance will be duly forthcoming. This principle is reected in the familiar clauses permitting the seller to curtail deliveries if the buyer's credit becomes impaired, which when held within the limits of reasonableness and good faith actually express no more than the fair business meaning of any commercial contract. Third, and nally, this section provides the means by which the aggrieved party may treat the contract as broken if his reasonable grounds for insecurity are not cleared up within a reasonable time. This is the principle underlying the law of anticipatory breach, whether by way of defective part performance or by repudiation. The present section merges these three principles of law and commercial practice into a single theory of general application to all sales agreements looking to future performance. 3. Subsection (2) of the present section requires that reasonable grounds and adequate assurance as used in subsection (1) be dened by commercial rather than legal standards. The express reference to commercial standards carries no connotation that the obligation of good faith is not equally applicable here. Under commercial standards and in accord with commercial practice, a ground for insecurity need not arise from or be directly related to the contract in question. The law as to dependence or independence of promises within a single contract does not control the application of the present section. Thus a buyer who falls behind in his account with the seller, even though the items involved have to do with separate and legally distinct contracts, impairs the seller's expectation of due performance. Again, under the same test, a buyer who requires precision parts which he intends to use immediately upon delivery, may have reasonable grounds for insecurity if he discovers that his seller is making defective deliveries of such parts to other buyers with similar needs. Thus, too, in a situation such as arose in Jay Dreher Corporation v. Delco Appliance Corporation, 93 F.2d 275 (C.C.A.2, 1937), where a manufacturer gave a dealer an exclusive franchise for the sale of his product but on two or three occasions breached the exclusive dealing clause, although there was no default in orders, deliveries or payments under the separate sales contract between the parties, the aggrieved dealer would be entitled to suspend his performance of the contract for sale under the present section and to demand assurance that the exclusive dealing contract would be lived up to. There is no need for an explicit clause tying the exclusive franchise into the contract for the sale of goods since the situation itself ties the agreements together. The nature of the sales contract enters also into the question of reasonableness. For example, a report from an apparently trustworthy source that the seller had shipped defective goods or was planning to ship them would normally give the buyer reasonable grounds for insecurity. But when the buyer has assumed the risk of payment before inspection of the goods, as in a sales contract on C.I.F. or similar cash against documents terms, that risk is not to be evaded by a demand for assurance. Therefore no ground for insecurity would exist under this section unless the report went to a ground which would excuse payment by the buyer. 4. What constitutes adequate assurance of due performance is subject to the same test of factual conditions. For example, where the buyer can make use of a defective delivery, a mere promise by a seller of good repute that he is giving the matter his attention and that the defect will not be repeated, is normally sucient. Under the same circumstances, however, a similar statement by a known corner-cutter might well be considered insufcient without the posting of a guaranty or, if so demanded by the buyer, a speedy replacement of the delivery involved. By the same token where a delivery has defects, even though easily curable, which interfere with easy use by the buyer, no verbal assurance can be deemed adequate which is not accompanied by replacement, repair, money-allowance, or other commercially reasonable cure. A fact situation such as arose in Corn Products Rening Co. v. Fasola, 94 N.J.L. 181, 109 157

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A. 505 (1920) oers illustration both of reasonable grounds for insecurity and adequate assurance. In that case a contract for the sale of oils on 30 days' credit, 2% o for payment within 10 days, provided that credit was to be extended to the buyer only if his nancial responsibility was satisfactory to the seller. The buyer had been in the habit of taking advantage of the discount but at the same time that he failed to make his customary 10 day payment, the seller heard rumors, in fact false, that the buyer's nancial condition was shaky. Thereupon, the seller demanded cash before shipment or security satisfactory to him. The buyer sent a good credit report from his banker, expressed willingness to make payments when due on the 30 day terms and insisted on further deliveries under the contract. Under this Article the rumors, although false, were enough to make the buyer's nancial condition unsatisfactory to the seller under the contract clause. Moreover, the buyer's practice of taking the cash discounts is enough, apart from the contract clause, to lay a commercial foundation for suspicion when the practice is suddenly stopped. These matters, however, go only to the justication of the seller's demand for security, or his reasonable grounds for insecurity. The adequacy of the assurance given is not measured as in the type of satisfaction situation aected with intangibles, such as in personal service cases, cases involving a third party's judgment as nal, or cases in which the whole contract is dependent on one party's satisfaction, as in a sale on approval. Here, the seller must exercise good faith and observe commercial standards. This Article thus approves the statement of the court in James B. Berry's Sons Co. of Illinois v. Monark Gasoline & Oil Co., Inc., 32 F.2d 74 (C.C.A.8, 1929), that the seller's satisfaction under such a clause must be based upon reason and must not be arbitrary or capricious; and rejects the purely personal good faith test of the Corn Products Rening Co. case, which held that in the seller's sole judgment, if for any reason he was dissatised, he was entitled to revoke the credit. In the absence of the buyer's failure to take the 2% discount as was his custom, the banker's report given in that case would have been adequate assurance under this Act, regardless of the language of the satisfaction clause. However, the seller is reasonably entitled to feel insecure at a sudden expansion of the buyer's use of a credit term, and should be entitled either to security or to a satisfactory explanation. The entire foregoing discussion as to adequacy of assurance by way of explanation is subject to qualication when repeated occasions for the application of this section arise. This Act recognizes that repeated delinquencies must be viewed as cumulative. On the other hand, commercial sense also requires that if repeated claims for assurance are made under this section, the basis for these claims must be increasingly obvious. 5. A failure to provide adequate assurance of performance and thereby to re-establish the security of expectation, results in a breach only by repudiation under subsection (4). Therefore, the possibility is continued of retraction of the repudiation under the section dealing with that problem, unless the aggrieved party has acted on the breach in some manner. The thirty day limit on the time to provide assurance is laid down to free the question of reasonable time from uncertainty in later litigation. 6. Clauses seeking to give the protected party exceedingly wide powers to cancel or readjust the contract when ground for insecurity arises must be read against the fact that good faith is a part of the obligation of the contract and not subject to modication by agreement and includes, in the case of a merchant, the reasonable observance of commercial standards of fair dealing in the trade. Such clauses can thus be eective to enlarge the protection given by the present section to a certain extent, to x the reasonable time within which requested assurance must be given, or to dene adequacy of the assurance in any commercially reasonable fashion. But any clause seeking to set up arbitrary standards for action is ineective under this Article. Acceleration clauses are treated similarly in the Articles on Commercial Paper and Secured Transactions. Cross References: Point 3: Section 1-203. Point 5: Section 2-611. Point 6: Sections 1-203, 1-309, Articles 3 and 9. Denitional Cross References: Aggrieved party. Section 1-201. Between merchants. Section 2-104. 158

Art. 2
Contract. Section 1-201. Contract for sale. Section 2-106. Party. Section 1-201. Reasonable time. Section 1-205. Record. Section 2-103. Rights. Section 1-201.

Sales

2-610

2-610. Anticipatory Repudiation. (1) If either party repudiates the contract with respect to a performance not yet due the loss of which will substantially impair the value of the contract to the other, the aggrieved party may: (a) for a commercially reasonable time await performance by the repudiating party; or (b) resort to any remedy for breach (Section 2-703 or Section 2-711), even if the aggrieved party has notied the repudiating party that it would await the latter's performance and has urged retraction; and (c) in either case suspend performance or proceed in accordance with the provisions of this Article on the seller's right to identify goods to the contract notwithstanding breach or to salvage unnished goods (Section 2-704). (2) Repudiation includes language that a reasonable person would interpret to mean that the other party will not or cannot make a performance still due under the contract or voluntary, armative conduct that would appear to a reasonable person to make a future performance by the other party impossible. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: See Sections 63(2) and 65, Uniform Sales Act. Purposes: To make it clear that: 1. With the problem of insecurity taken care of by the preceding section and with provision being made in this Article as to the eect of a defective delivery under an installment contract, anticipatory repudiation centers upon an overt communication of intention or an action which renders performance impossible or demonstrates a clear determination not to continue with performance. Under the present section when such a repudiation substantially impairs the value of the contract, the aggrieved party may at any time resort to his remedies for breach, or he may suspend his own performance while he negotiates with, or awaits performance by, the other party. But if he awaits performance beyond a commercially reasonable time he cannot recover resulting damages which he should have avoided. 2. It is not necessary for repudiation that performance be made literally and utterly impossible. Repudiation can result from action which reasonably indicates a rejection of the continuing obligation. And, a repudiation automatically results under the preceding section on insecurity when a party fails to provide adequate assurance of due future performance within thirty days after a justiable demand therefor has been made. Under the language of this section, a demand by one or both parties for more than the contract calls for in the way of counter-performance is not in itself a repudiation nor does it invalidate a plain expression of desire for future performance. However, when under a fair reading it amounts to a statement of intention not to perform except on conditions which go beyond the contract, it becomes a repudiation. 3. The test chosen to justify an aggrieved party's action under this section is the same as that in the section on breach in installment contractsnamely the substantial value of the contract. The most useful test of substantial value is to determine whether material incon159

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venience or injustice will result if the aggrieved party is forced to wait and receive an ultimate tender minus the part or aspect repudiated. 4. After repudiation, the aggrieved party may immediately resort to any remedy he chooses provided he moves in good faith (see Section 1-203). Inaction and silence by the aggrieved party may leave the matter open but it cannot be regarded as misleading the repudiating party. Therefore the aggrieved party is left free to proceed at any time with his options under this section, unless he has taken some positive action which in good faith requires notication to the other party before the remedy is pursued. 5. Subsection (2) provides guidance on when a party can be considered to have repudiated a performance obligation based upon the Restatement (Second) of Contracts 250 and does not purport to be an exclusive statement of when a repudiation has occurred. Repudiation centers upon an overt communication of intention, actions which render performance impossible, or a demonstration of a clear determination not to perform. Failure to provide adequate assurance of due performance under Section 2-609 also operates as a repudiation. Cross References: Point 1: Sections 2-609 and 2-612. Point 2: Section 2-609. Point 3: Section 2-612. Point 4: Section 1-203. Point 5: Section 2-609. Denitional Cross References: Aggrieved party. Section 1-201. Contract. Section 1-201. Party. Section 1-201. Remedy. Section 1-201.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-611. Retraction of Anticipatory Repudiation. (1) Until the repudiating party's next performance is due, that party may retract the repudiation unless the aggrieved party has since the repudiation canceled or materially changed position or otherwise indicated that the repudiation is nal. (2) Retraction may be by any method that clearly indicates to the aggrieved party that the repudiating party intends to perform, but must include any assurance justiably demanded under Section 2-609. (3) Retraction reinstates the repudiating party's rights under the contract with due excuse and allowance to the aggrieved party for any delay occasioned by the repudiation. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: To make it clear that: 1. The repudiating party's right to reinstate the contract is entirely dependent upon the action taken by the aggrieved party. If the latter has cancelled the contract or materially changed his position at any time after the repudiation, there can be no retraction under this section. 2. Under subsection (2) an eective retraction must be accompanied by any assurances demanded under the section dealing with right to adequate assurance. A repudiation is of course sucient to give reasonable ground for insecurity and to warrant a request for assurance as an essential condition of the retraction. However, after a timely and unambigu160

Art. 2

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ous expression of retraction, a reasonable time for the assurance to be worked out should be allowed by the aggrieved party before cancellation. Cross Reference: Point 2: Section 2-609. Denitional Cross References: Aggrieved party. Section 1-201. Cancellation. Section 2-106. Contract. Section 1-201. Party. Section 1-201. Rights. Section 1-201.

2-612. Installment Contract; Breach. (1) An installment contract is one that requires or authorizes the delivery of goods in separate lots to be separately accepted, even if the contract contains a clause each delivery is a separate contract or its equivalent. (2) The buyer may reject any installment that is nonconforming if the nonconformity substantially impairs the value of that installment to the buyer or if nonconformity is a defect in the required documents. However, if the nonconformity does not fall within subsection (3) and the seller gives adequate assurance of its cure the buyer must accept that installment. (3) If nonconformity or default with respect to one or more installments substantially impairs the value of the whole contract, there is a breach of the whole. But the aggrieved party reinstates the contract if the party accepts a nonconforming installment without seasonably notifying of cancellation or if the party brings an action with respect only to past installments or demands performance as to future installments. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comments
Prior Uniform Statutory Provision: Section 45(2), Uniform Sales Act. Changes: Rewritten. Purposes of Changes: To continue prior law but to make explicit the more mercantile interpretation of many of the rules involved, so that: 1. The denition of an installment contract is phrased more broadly in this Article so as to cover installment deliveries tacitly authorized by the circumstances or by the option of either party. 2. In regard to the apportionment of the price for separate payment this Article applies the more liberal test of what can be apportioned rather than the test of what is clearly apportioned by the agreement. This Article also recognizes approximate calculation or apportionment of price subject to subsequent adjustment. A provision for separate payment for each lot delivered ordinarily means that the price is at least roughly calculable by units of quantity, but such a provision is not essential to an installment contract. If separate acceptance of separate deliveries is contemplated, no generalized contrast between wholly entire and wholly divisible contracts has any standing under this Article. 3. This Article rejects any approach which gives clauses such as each delivery is a separate contract their legalistically literal eect. Such contracts nonetheless call for installment deliveries. Even where a clause speaks of a separate contract for all purposes, a commercial reading of the language under the section on good faith and commercial standards requires that the singleness of the document and the negotiation, together with the sense of the situation, prevail over any uncommercial and legalistic interpretation. 4. One of the requirements for rejection under subsection (2) is non-conformity substantially impairing the value of the installment in question. However, an installment 161

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agreement may require accurate conformity in quality as a condition to the right to acceptance if the need for the conformity is made clear either by express provision or by the circumstances. In this case the eect of the agreement is to dene explicitly what amounts to substantial impairment of value. A clause that requires accurate compliance as a condition to the right to acceptance must, however, have some basis in reason, must avoid imposing hardship by surprise, and it is subject to waiver or to displacement by practical construction. 5. Substantial impairment of the value of an installment can turn not only on the quality of the goods but also on such factors as time, quantity, assortment, and the like. It must be judged in terms of the normal or specically known purposes of the contract. The defect in required documents refers to such matters as the absence of insurance documents under a contract that requires these documents, falsity of a bill of lading, or one failing to show shipment within the contract period or to the contract destination. Even in these cases, however, the provisions on cure of tender may apply if appropriate documents are readily procurable. 6. Subsection (3) is designed to further the continuance of the contract in the absence of an overt cancellation. The question arising when an action is brought as to a single installment only is resolved by making such action waive the right to cancellation. This involves merely a defect in one or more installments, as contrasted with the situation where there is a true repudiation within the section on anticipatory repudiation. Whether the nonconformity in any given installment justies cancellation as to the future depends, not on whether such non-conformity indicates an intent or likelihood that the future deliveries will also be defective, but whether the non-conformity substantially impairs the value of the whole contract. If only the seller's security in regard to future installments is impaired, he has the right to demand adequate assurances of proper future performance but has not an immediate right to cancel the entire contract. It is clear under this Article, however, that defects in prior installments are cumulative in eect, so that acceptance does not wash out the defect waived. Prior policy is continued, putting the rule as to buyer's default on the same footing as that in regard to seller's default. 7. Under the requirement of seasonable notication of cancellation under subsection (3), a buyer who accepts a non-conforming installment which substantially impairs the value of the entire contract should properly be permitted to withhold his decision as to whether or not to cancel pending a response from the seller as to his claim for cure or adjustment. Similarly, a seller may withhold a delivery pending payment for prior ones, at the same time delaying his decision as to cancellation. A reasonable time for notifying of cancellation, judged by commercial standard under the section on good faith, extends of course to include the time covered by any reasonable negotiation in good faith. However, during this period the defaulting party is entitled, on request, to know whether the contract is still in eect, before he can be required to perform further. 8. Subsection (2) makes it clear that the buyer's right in the rst instance to reject an installment depends upon whether there has been a substantial impairment of the value of the installment to the buyer and not on the seller's ability to cure the nonconformity. The seller can prevent a rightful rejection by giving adequate assurances of cure. Subsection (2) uses the words to the buyer to clarify that the standard for rejecting an installment consistent is the same standard for revoking acceptance under Section 2-608. Therefore, the test is not what the seller had reason to know at the time of contracting; the question is whether the non-conformity is one that will cause a substantial impairment of value to the buyer even though the seller had no knowledge about the buyer's particular circumstances at the time of contracting. Cross References: Point 2: Sections 2-307 and 2-607. Point 3: Section 1-203. Point 5: Sections 2-208 and 2-609. Point 6: Section 2-610. Point 8: Section 2-608. Denitional Cross References: Action. Section 1-201. Aggrieved party. Section 1-201. Buyer. Section 2-103. 162

Art. 2
Cancellation. Section 2-106. Conform. Section 2-106. Contract. Section 1-201. Lot. Section 2-105. Noties. Section 1-202. Party. Section 1-201. Seasonably. Section 1-205. Seller. Section 2-103.

Sales

2-613

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-613. Casualty to Identied Goods. If the contract requires for its performance goods identied when the contract is made, and the goods suer casualty without fault of either party before the risk of loss passes to the buyer, then: (a) if the loss is total the contract is terminated; and (b) if the loss is partial or the goods have so deteriorated that they no longer conform to the contract, the buyer may nevertheless demand inspection and at the buyer's option either treat the contract as terminated or accept the goods with due allowance from the contract price for the deterioration or the deciency in quantity but without further right against the seller. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Sections 7 and 8, Uniform Sales Act. Changes: Rewritten, the basic policy being continued but the test of a divisible or indivisible sale or contract being abandoned in favor of adjustment in business terms. Purposes of Changes: 1. Where goods whose continued existence is presupposed by the agreement are destroyed without fault of either party, the buyer is relieved from his obligation but may at his option take the surviving goods at a fair adjustment. Fault is intended to include negligence and not merely wilful wrong. The buyer is expressly given the right to inspect the goods in order to determine whether he wishes to avoid the contract entirely or to take the goods with a price adjustment. 2. The section applies whether the goods were already destroyed at the time of contracting without the knowledge of either party or whether they are destroyed subsequently but before the risk of loss passes to the buyer. Where under the agreement, including of course usage of trade, the risk has passed to the buyer before the casualty, the section has no application. Beyond this, the essential question in determining whether the rules of this section are to be applied is whether the seller has or has not undertaken the responsibility for the continued existence of the goods in proper condition through the time of agreed or expected delivery. 3. The use of the word terminated in paragraph (a) claries that pre-termination breaches are preserved. See Section 2-106(3). Cross Reference: Point 4: Section 2-106 Denitional Cross References: Buyer. Section 2-103. Conform. Section 2-106. Contract. Section 1-201. Fault. Section 1-201. 163

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Goods. Section 2-103. Party. Section 1-201. Rights. Section 1-201. Seller. Section 2-103. Terminated. Section 2-106.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-614. Substituted Performance. (1) If without fault of either party the agreed berthing, loading, or unloading facilities fail or an agreed type of carrier becomes unavailable or the agreed manner of performance otherwise becomes commercially impracticable but a commercially reasonable substitute is available, the substitute performance must be tendered and accepted. (2) If the agreed means or manner of payment fails because of domestic or foreign governmental regulation, the seller may withhold or stop delivery unless the buyer provides a means or manner of payment which is commercially a substantial equivalent. If delivery has already been taken, payment by the means or in the manner provided by the regulation discharges the buyer's obligation unless the regulation is discriminatory, oppressive, or predatory. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (1) requires the tender of a commercially reasonable substituted performance where agreed to facilities have failed or have become commercially impracticable. Under this Article, in the absence of a specic agreement, the normal or usual facilities enter into the agreement either through the circumstances of the transaction, a usage of trade or a prior course of dealing between the parties. This section appears between Section 2-613 on casualty to identied goods and Section 2-615 on excuse by failure of presupposed conditions. Those two sections deal with excuse and complete avoidance of the contract when the occurrence or non-occurrence of a contingency which was a basic assumption of the contract makes the expected performance impossible. The distinction between the present section and those sections is whether the failure or impossibility of performance arises in connection with an incidental matter or goes to the very heart of the agreement. The diering lines of solution are contrasted in a comparison of International Paper Co. v. Rockefeller, 161 App.Div. 180, 146 N.Y.S. 371 (1914), and Meyer v. Sullivan, 40 Cal.App. 723, 181 P. 847 (1919). In the former case, a contract for the sale of spruce to be cut from a particular tract of land was involved. When a re destroyed the trees growing on that tract the seller was held excused since performance was impossible. In the latter case, the contract called for delivery of wheat f.o.b. Kosmos Steamer at Seattle. The war led to cancellation of that line's sailing schedule after space had been duly engaged and the buyer was held entitled to demand substituted delivery at the warehouse on the line's loading dock. Under this Article, of course, the seller would also be entitled, had the market gone the other way, to make a substituted tender in that manner. There must, however, be a true commercial impracticability to excuse the agreed to performance and justify a substituted performance. When this is the case, a reasonable substituted performance tendered by either party should excuse that party from strict compliance with the contract terms which do not go to the essence of the agreement. 2. The substitution provided for in this section as between buyer and seller does not carry over into the obligation of a nancing agency under a letter of credit, since the nancing agency is entitled to performance which is plainly adequate on its face and without 164

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need to look into commercial evidence outside of the documents. See Article 5, especially Section 5-108. 3. Under subsection (2), when the contract is still executory on both sides, the seller is permitted to withdraw unless the buyer can provide the seller with a commercially equivalent performance despite the governmental regulation. When, however, only the debt for the price remains, a larger leeway is permitted. The buyer may pay in the manner provided by the regulation, even though this may not be a commercially equivalent performance, provided that the regulation is not discriminatory, oppressive or predatory. Cross Reference: Point 2: Article 5. Denitional Cross References: Buyer. Section 2-103. Delivery. Section 2-103. Fault. Section 1-201. Party. Section 1-201. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-615. Excuse by Failure of Presupposed Conditions. Except to the extent that a seller may have assumed a greater obligation and subject to Section 2-614: (a) Delay in performance or nonperformance in whole or in part by a seller that complies with paragraphs (b) and (c) is not a breach of the seller's duty under a contract for sale if performance as agreed has been made impracticable by the occurrence of a contingency the nonoccurrence of which was a basic assumption on which the contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid. (b) If the causes mentioned in paragraph (a) aect only a part of the seller's capacity to perform, the seller must allocate production and deliveries among its customers but may at its option include regular customers not then under contract as well as its own requirements for further manufacture. The seller may so allocate in any manner that is fair and reasonable. (c) The seller must notify the buyer seasonably that there will be delay or nonperformance and, if allocation is required under paragraph (b), of the estimated quota thus made available for the buyer. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: 1. This section excuses a seller from timely delivery of goods contracted for, where his performance has become commercially impracticable because of unforeseen supervening circumstances not within the contemplation of the parties at the time of contracting. The destruction of specic goods and the problem of the use of substituted performance on points other than delay or quantity, treated elsewhere in this Article, must be distinguished from the matter covered by this section. 2. The present section deliberately refrains from any eort at an exhaustive expression of 165

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contingencies and is to be interpreted in all cases sought to be brought within its scope in terms of its underlying reason and purpose. 3. The rst test for excuse under this Article in terms of basic assumption is a familiar one. The additional test of commercial impracticability (as contrasted with impossibility, frustration of performance or frustration of the venture) has been adopted in order to call attention to the commercial character of the criterion chosen by this Article. 4. Increased cost alone does not excuse performance unless the rise in cost is due to some unforeseen contingency which alters the essential nature of the performance. Neither is a rise or a collapse in the market in itself a justication, for that is exactly the type of business risk which business contracts made at xed prices are intended to cover. But a severe shortage of raw materials or of supplies due to a contingency such as war, embargo, local crop failure, unforeseen shutdown of major sources of supply or the like, which either causes a marked increase in cost or altogether prevents the seller from securing supplies necessary to his performance, is within the contemplation of this section. (See Ford & Sons, Ltd., v. Henry Leetham & Sons, Ltd., 21 Com.Cas. 55 (1915, K.B.D.).) 5. Where a particular source of supply is exclusive under the agreement and fails through casualty, the present section applies rather than the provision on destruction or deterioration of specic goods. The same holds true where a particular source of supply is shown by the circumstances to have been contemplated or assumed by the parties at the time of contracting. (See Davis Co. v. Homann-LaRoche Chemical Works, 178 App.Div. 855, 166 N.Y.S. 179 (1917) and International Paper Co. v. Rockefeller, 161 App.Div. 180, 146 N.Y.S. 371 (1914).) There is no excuse under this section, however, unless the seller has employed all due measures to assure himself that his source will not fail. (See Canadian Industrial Alcohol Co., Ltd., v. Dunbar Molasses Co., 258 N.Y. 194, 179 N.E. 383, 80 A.L.R. 1173 (1932) and Washington Mfg. Co. v. Midland Lumber Co., 113 Wash. 593, 194 P. 777 (1921).) In the case of failure of production by an agreed source for causes beyond the seller's control, the seller should, if possible, be excused since production by an agreed source is without more a basic assumption of the contract. Such excuse should not result in relieving the defaulting supplier from liability nor in dropping into the seller's lap an unearned bonus of damages over. The exible adjustment machinery of this Article provides the solution under the provision on the obligation of good faith. A condition to his making good the claim of excuse is the turning over to the buyer of his rights against the defaulting source of supply to the extent of the buyer's contract in relation to which excuse is being claimed. 6. In situations in which neither sense nor justice is served by either answer when the issue is posed in at terms of excuse or no excuse, adjustment under the various provisions of this Article is necessary, especially the sections on good faith, on insecurity and assurance and on the reading of all provisions in the light of their purposes, and the general policy of this Act to use equitable principles in furtherance of commercial standards and good faith. 7. The failure of conditions which go to convenience or collateral values rather than to the commercial practicability of the main performance does not amount to a complete excuse. However, good faith and the reason of the present section and of the preceding one may properly be held to justify and even to require any needed delay involved in a good faith inquiry seeking a readjustment of the contract terms to meet the new conditions. 8. The provisions of this section are made subject to assumption of greater liability by agreement and such agreement is to be found not only in the expressed terms of the contract but in the circumstances surrounding the contracting, in trade usage and the like. Thus the exemptions of this section do not apply when the contingency in question is sufciently foreshadowed at the time of contracting to be included among the business risks which are fairly to be regarded as part of the dickered terms, either consciously or as a matter of reasonable, commercial interpretation from the circumstances. (See Madeirense Do Brasil, S.A. v. Stulman-Emrick Lumber Co., 147 F.2d 399 (C.C.A., 2 Cir., 1945).) The exemption otherwise present through usage of trade under the present section may also be expressly negated by the language of the agreement. Generally, express agreements as to exemptions designed to enlarge upon or supplant the provisions of this section are to be read in the light of mercantile sense and reason, for this section itself sets up the commercial standard for normal and reasonable interpretation and provides a minimum beyond which agreement may not go. Agreement can also be made in regard to the consequences of exemption as laid down in 166

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paragraphs (b) and (c) and the next section on procedure on notice claiming excuse. 9. The case of a farmer who has contracted to sell crops to be grown on designated land may be regarded as falling either within the section on casualty to identied goods or this section, and he may be excused, when there is a failure of the specic crop, either on the basis of the destruction of identied goods or because of the failure of a basic assumption of the contract. Exemption of the buyer in the case of a requirements contract is covered by the Output and Requirements section both as to assumption and allocation of the relevant risks. But when a contract by a manufacturer to buy fuel or raw material makes no specic reference to a particular venture and no such reference may be drawn from the circumstances, commercial understanding views it as a general deal in the general market and not conditioned on any assumption of the continuing operation of the buyer's plant. Even when notice is given by the buyer that the supplies are needed to ll a specic contract of a normal commercial kind, commercial understanding does not see such a supply contract as conditioned on the continuance of the buyer's further contract for outlet. On the other hand, where the buyer's contract is in reasonable commercial understanding conditioned on a denite and specic venture or assumption as, for instance, a war procurement subcontract known to be based on a prime contract which is subject to termination, or a supply contract for a particular construction venture, the reason of the present section may well apply and entitle the buyer to the exemption. 10. Following its basic policy of using commercial practicability as a test for excuse, this section recognizes as of equal signicance either a foreign or domestic regulation and disregards any technical distinctions between law, regulation, order and the like. Nor does it make the present action of the seller depend upon the eventual judicial determination of the legality of the particular governmental action. The seller's good faith belief in the validity of the regulation is the test under this Article and the best evidence of his good faith is the general commercial acceptance of the regulation. However, governmental interference cannot excuse unless it truly supervenes in such a manner as to be beyond the seller's assumption of risk. And any action by the party claiming excuse which causes or colludes in inducing the governmental action preventing his performance would be in breach of good faith and would destroy his exemption. 11. An excused seller must fulll his contract to the extent which the supervening contingency permits, and if the situation is such that his customers are generally aected he must take account of all in supplying one. Subsections (a) and (b), therefore, explicitly permit in any proration a fair and reasonable attention to the needs of regular customers who are probably relying on spot orders for supplies. Customers at dierent stages of the manufacturing process may be fairly treated by including the seller's manufacturing requirements. A fortiori, the seller may also take account of contracts later in date than the one in question. The fact that such spot orders may be closed at an advanced price causes no diculty, since any allocation which exceeds normal past requirements will not be reasonable. However, good faith requires, when prices have advanced, that the seller exercise real care in making his allocations, and in case of doubt his contract customers should be favored and supplies prorated evenly among them regardless of price. Save for the extra care thus required by changes in the market, this section seeks to leave every reasonable business leeway to the seller. Cross References: Point 1: Sections 2-613 and 2-614. Point 2: Section 1-201. Point 5: Sections 1-203 and 2-316. Point 6: Sections 1-203 and 2-609. Point 7: Section 2-614. Point 8: Sections 1-201, 2-302, and 2-616. Point 9: Sections 1-102, 2-306 and 2-316. Denitional Cross References: Buyer. Section 2-103. Contract. Section 1-201. Contract for sale. Section 2-106. Good faith. Section 2-103. 167

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Noties. Section 1-202. Seasonably. Section 1-205. Seller. Section 2-103.

2-616. Procedure on Notice Claiming Excuse. (1) If a buyer receives notication of a material or indenite delay or an allocation justied under Section 2-615, the buyer may by notication in a record to the seller as to any performance concerned, and if the prospective deciency substantially impairs the value of the whole contract under Section 2-612, then also as to the whole: (a) terminate and thereby discharge any unexecuted portion of the contract; or (b) modify the contract by agreeing to take the buyer's available quota in substitution. (2) If after receipt of notication from the seller the buyer fails to modify the contract within a reasonable time not exceeding 30 days, the contract is terminated with respect to any performance aected. (3) The provisions of this section may not be negated by agreement except in so far as the seller has assumed a greater obligation under Section 2-615. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: 1. This section seeks to establish simple and workable machinery for providing certainty as to when a supervening and excusing contingency excuses the delay, discharges the contract, or may result in a waiver of the delay by the buyer. When the seller noties, in accordance with the preceding section, claiming excuse, the buyer may acquiesce, in which case the contract is so modied. No consideration is necessary in a case of this kind to support such a modication. If the buyer does not elect so to modify the contract, he may terminate it and under subsection (2) his silence after receiving the seller's claim of excuse operates as such a termination. Subsection (3) denies eect to any contract clause made in advance of trouble which would require the buyer to stand ready to take delivery whenever the seller is excused from delivery by unforeseen circumstances. 2. In subsection (2), the term terminated conforms with Section 2-613(a) to clarify that pre-termination breaches are preserved and the term performance conforms with Section 2-615(a) to specify the broad range of obligation that may be included under this provision. Cross References: Point 1: Sections 2-209 and 2-615. Point 2: Sections 2-613 and 2-615. Denitional Cross References: Buyer. Section 2-103. Contract. Section 1-201. Installment contract. Section 2-612. Notication. Section 1-202. Reasonable time. Section 1-205. Record. Section 2-103. Seller. Section 2-103. Termination. Section 2-106.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.
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PART 7. REMEDIES
2-701. Remedies for Breach of Collateral Contracts Not Impaired. Remedies for breach of any obligation or promise collateral or ancillary to a contract for sale are not impaired by the provisions of this Article. Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: Whether a claim for breach of an obligation collateral to the contract for sale requires separate trial to avoid confusion of issues is beyond the scope of this Article; but contractual arrangements which as a business matter enter vitally into the contract should be considered a part thereof in so far as cross-claims or defenses are concerned. Denitional Cross References: Contract for sale. Section 2-106. Remedy. Section 1-201.

2-702. Seller's Remedies on Discovery of Buyer's Insolvency. (1) If the seller discovers that the buyer is insolvent, the seller may refuse delivery except for cash including payment for all goods theretofore delivered under the contract, and stop delivery under Section 2-705. (2) If the seller discovers that the buyer has received goods on credit while insolvent, the seller may reclaim the goods upon demand made within a reasonable time after the buyer's receipt of the goods. Except as provided in this subsection, the seller may not base a right to reclaim goods on the buyer's fraudulent or innocent misrepresentation of solvency or of intent to pay. (3) The seller's right to reclaim under subsection (2) is subject to the rights of a buyer in ordinary course of business or other good-faith purchaser for value under Section 2-403. Successful reclamation of goods excludes all other remedies with respect to them. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. The seller's right to withhold the goods or to stop delivery except for cash when the seller discovers the buyer's insolvency is made explicit in subsection (1) regardless of the passage of title, and the concept of stoppage has been extended to include goods in the possession of any bailee that has not yet attorned to the buyer. 2. Subsection (2) takes as its base line the proposition that any receipt of goods on credit by an insolvent buyer amounts to a tacit business misrepresentation of solvency and therefore is fraudulent as against the particular seller. This section omits the 10-day limitation and the 3-month exception to the 10-day limitation that was in original Article 2. If the buyer is in bankruptcy at the time of reclamation, the seller will have to comply with Section 546(c) of the Bankruptcy Code of 1978, which includes a 10-day limitation. 3. Because the right of the seller to reclaim goods under this section constitutes preferential treatment as against the buyer's other creditors, subsection (3) provides that such reclamation bars all of the seller's other remedies the goods involved. 4. The rights of a seller to reclamation from the buyer under section 2-702 are subordinate to the rights of good faith purchasers from that buyer under Section 2-403. This section takes no position on the seller's claims to proceeds of the goods. Cross References: Point 1: Sections 2-401 and 2-705. 169

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Point 4: Sections 2-403 and 2-702. Denitional Cross References: Buyer. Section 2-103. Buyer in ordinary course of business. Section 1-201. Contract. Section 1-201. Good faith. Section 2-103. Goods. Section 2-103. Insolvent. Section 1-201. Person. Section 1-201. Purchaser. Section 1-201. Reasonable time. Section 1-205. Receipt of goods. Section 2-103. Remedy. Section 1-201. Rights. Section 1-201. Seller. Section 2-103. Tender of delivery. Sections 2-503 and 2-507. Value. Section 1-204.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-703. Seller's Remedies in General. (1) A breach of contract by the buyer includes the buyer's wrongful rejection or wrongful attempt to revoke acceptance of goods, wrongful failure to perform a contractual obligation, failure to make a payment when due, and repudiation. (2) If the buyer is in breach of contract the seller, to the extent provided for by this Act or other law, may: (a) withhold delivery of the goods under Section 2-703(4); (b) stop delivery of the goods under Section 2-705; (c) proceed under Section 2-704 with respect to goods unidentied to the contract or unnished; (d) reclaim the goods under Section 2-507(2) or 2-702(2); (e) require payment directly from the buyer under Section 2-325(c); (f) cancel under Section 2-703(4); (g) resell and recover damages under Section 2-706; (h) recover damages for nonacceptance or repudiation under Section 2-708(1); (i) recover lost prots under Section 2-708(2); (j) recover the price under Section 2-709; (k) obtain specic performance under Section 2-716; (l) recover liquidated damages under Section 2-718; (m) in other cases, recover damages in any manner that is reasonable under the circumstances. (3) If the buyer becomes insolvent, the seller may: (a) withhold delivery under Section 2-702(1); (b) stop delivery of the goods under Section 2-705; (c) reclaim the goods under Section 2-702(2).
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(4) If the buyer wrongfully rejects or revokes acceptance of goods, fails to make a payment when due, or repudiates with respect to a part or the whole, with respect to any goods directly aected and, if the breach is of the whole contract (Section 2-612), with respect to the whole undelivered balance, the aggrieved seller may (a) withhold delivery of such goods; or (b) cancel. As amended in 2003 and 2005.
See Appendix T for material relating to changes made in text in 2003. See Appendix V for material relating to changes made in text in 2005.

Ocial Comment
1. This section is a list of the remedies of the seller available under this Article to remedy any breach by the buyer. It also lists the seller's statutory remedies in the event of the buyer's insolvency. The subsection does not address the extent to which other law provides additional remedies or supplements the statutory remedies in Article 2 (see Section 1-103). The remedies available to the seller enumerated in this section may be modied or limited as provided for in Section 2-719. In addition to the enumerated statutory remedies, the Section also provides for remedies agreed upon by the parties, see subsection (2)(l). This section does not cover the remedies that become available to the parties upon demand for adequate assurance under Section 2-609. This Article rejects any doctrine of election of remedy as a fundamental policy and thus the remedies are essentially cumulative in nature and include all of the available remedies for breach. Whether the pursuit of one remedy bars another depends entirely on the facts of the individual case. 2. The buyer's breach which occasions the use of the remedies under this section may involve only one lot or delivery of goods, or may involve all of the goods which are the subject matter of the particular contract. The right of the seller to pursue a remedy as to all the goods when the breach is as to only one or more lots is covered by the section on breach in installment contracts. The present section deals only with remedies available after the goods involved in the breach have been determined by that section. 3. In addition to the typical case of refusal to pay or default in payment, the language in subsection (1), failure to make a payment when due, is intended to cover the dishonor of a check on due presentment, or the non-acceptance of a draft, and the failure to furnish an agreed letter of credit. 4. It should also be noted that this Act requires its provisions to be liberally administered and provides that any right or obligation which it declares is enforceable by action unless a dierent eect is specically prescribed (Section 1-103). Cross References: Point 2: Section 2-612. Point 3: Section 2-325. Point 4: Section 1-103. Denitional Cross References: Buyer. Section 2-103. Cancel. Section 2-106. Contract. Section 1-201. Delivery. Section 2-103. Goods. Section 2-103. Insolvent. Section 1-201. Remedy. Section 1-201. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.
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2-704. Seller's Right to Identify Goods to the Contract Notwithstanding Breach or to Salvage Unnished Goods. (1) An aggrieved seller may in an appropriate case involving breach by the buyer: (a) identify to the contract conforming goods not already identied if at the time the seller learned of the breach the goods are in the seller's possession or control; (b) treat as the subject of resale goods that have demonstrably been intended for the particular contract even if those goods are unnished. (2) If the goods are unnished, an aggrieved seller may in the exercise of reasonable commercial judgment for the purposes of avoiding loss and of eective realization either complete the manufacture and wholly identify the goods to the contract or cease manufacture and resell for scrap or salvage value or proceed in any other reasonable manner. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Sections 63(3) and 64(4), Uniform Sales Act. Changes: Rewritten, the seller's rights being broadened. Purposes of Changes: 1. This section gives an aggrieved seller the right at the time of breach to identify to the contract any conforming nished goods, regardless of their resalability, and to use reasonable judgment as to completing unnished goods. It thus makes the goods available for resale under the resale section, the seller's primary remedy, and in the special case in which resale is not practicable, allows the action for the price which would then be necessary to give the seller the value of his contract. 2. Under this Article the seller is given express power to complete manufacture or procurement of goods for the contract unless the exercise of reasonable commercial judgment as to the facts as they appear at the time he learns of the breach makes it clear that such action will result in a material increase in damages. The burden is on the buyer to show the commercially unreasonable nature of the seller's action in completing manufacture. Cross References: Sections 2-703 and 2-706. Denitional Cross References: Aggrieved party. Section 1-201. Conforming. Section 2-106. Contract. Section 1-201. Delivery. Section 2-103. Goods. Section 2-103. Rights. Section 1-201. Seller. Section 2-103.

2-705. Seller's Stoppage of Delivery in Transit or Otherwise. (1) A seller may stop delivery of goods in the possession of a carrier or other bailee if the seller discovers the buyer to be insolvent (Section 2-702) or if the buyer repudiates or fails to make a payment due before delivery or if for any other reason the seller has a right to withhold or reclaim the goods. (2) As against such buyer the seller may stop delivery until: (a) receipt of the goods by the buyer;
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(b) acknowledgment to the buyer by any bailee of the goods, except a carrier, that the bailee holds the goods for the buyer; (c) such acknowledgment to the buyer by a carrier by reshipment or as warehouse; or (d) negotiation to the buyer of any negotiable document of title covering the goods. (3) (a) To stop delivery the seller must so notify as to enable the bailee by reasonable diligence to prevent delivery of the goods. (b) After such notication the bailee must hold and deliver the goods according to the directions of the seller but the seller is liable to the bailee for any ensuing charges or damages. (c) If a negotiable document of title has been issued for goods, the bailee is not obliged to obey a notication to stop until surrender of possession or control of the document. (d) A carrier that has issued a nonnegotiable bill of lading is not obliged to obey a notication to stop received from a person other than the consignor. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (1) applies when goods are in the possession of a carrier or other bailee. It applies, in addition to a buyer's insolvency, also to any case where the buyer repudiates or fails to make a payment due before delivery or for any other reason the seller has the right to withhold or reclaim the goods. Where stoppage occurs for insecurity, it is merely a suspension of performance, and if assurances are duly forthcoming from the buyer the seller is not entitled to resell or divert. Improper stoppage is a breach by the seller if it eectively interferes with the buyer's right to due tender under the section on manner of tender of delivery. However, if the bailee obeys an unjustied order to stop the bailee may also be liable to the buyer. The measure of the obligation is dependent on the provisions of the Documents of Title Article (Section 7-303). Subsection 3(b) therefore gives the bailee a right of indemnity as against the seller in this case. 2. Receipt by the buyer includes receipt by the buyer's designated representative, the subpurchaser, when shipment is made direct to the subpurchaser and the buyer never receives the goods. As between the buyer and the seller, the seller's right to stop the goods at any time until they reach the place of nal delivery is recognized by this section. Under subsection (3)(c) and (d), the carrier is under no duty to recognize the stop order of a person who is a stranger to the carrier's contract. But the seller's right as against the buyer to stop delivery remains, whether or not the carrier is obligated to recognize the stop order. If the carrier does obey it, the buyer cannot complain merely because of that circumstance; and the seller becomes obligated under subsection (3)(b) to pay the carrier any ensuing damages or charges. 3. A diversion of a shipment is not a reshipment under subsection (2)(c) when it is merely an incident to the original contract of transportation, nor is the procurement of exchange bills of lading which change only the name of the consignee to that of the buyer's local agent but do not alter the destination of a reshipment. Acknowledgment by the carrier as a warehouse within the meaning of this Article requires a contract of a truly dierent character from the original shipment, a contract not in extension of transit but as a warehouse. 4. Subsection (3)(c) makes the bailee's obedience of a notication to stop conditional upon the surrender of possession or control of any outstanding negotiable document. 5. The seller is responsible for any charges or losses incurred by the carrier in following the seller's orders, whether or not the carrier was obligated to do so. 173

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6. After an eective stoppage under this section the seller's rights in the goods are the same as if the seller had never made a delivery. Cross References: Point 1: Sections 2-503 and 2-609, and Article 7. Point 2: Section 2-103 and Article 7. Denitional Cross References: Bill of lading. Section 1-201. Buyer. Section 2-103. Contract for sale. Section 2-106. Document of title. Section 1-201. Goods. Section 2-103. Insolvent. Section 1-201. Notication. Section 1-202. Receipt of goods. Section 2-103. Rights. Section 1-201.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-706. Seller's Resale Including Contract for Resale. (1) In an appropriate case involving breach by the buyer, the seller may resell the goods concerned or the undelivered balance thereof. If the resale is made in good faith and in a commercially reasonable manner, the seller may recover the dierence between the contract price and the resale price together with any incidental or consequential damages allowed under Section 2-710, but less expenses saved in consequence of the buyer's breach. (2) Except as otherwise provided in subsection (3) or unless otherwise agreed, resale may be at public or private sale including sale by way of one or more contracts to sell or of identication to an existing contract of the seller. Sale may be as a unit or in parcels and at any time and place, and on any terms, but every aspect of the sale including the method, manner, time, place and terms must be commercially reasonable. The resale must be reasonably identied as referring to the broken contract, but it is not necessary that the goods be in existence or that any or all of them have been identied to the contract before the breach. (3) If the resale is at private sale, the seller must give the buyer reasonable notication of an intention to resell. (4) If the resale is at public sale: (a) only identied goods may be sold unless there is a recognized market for a public sale of futures in goods of the kind; (b) it must be made at a usual place or market for public sale if one is reasonably available and except in the case of goods which are perishable or threaten to decline in value speedily the seller must give the buyer reasonable notice of the time and place of the resale; (c) if the goods are not to be within the view of those attending the sale, the notication of sale must state the place where the goods are located and provide for their reasonable inspection by prospective bidders; and (d) the seller may buy.
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(5) A purchaser that buys in good faith at a resale takes the goods free of any rights of the original buyer even if the seller fails to comply with one or more of the requirements of this section. (6) The seller is not accountable to the buyer for any prot made on any resale. A person in the position of a seller (Section 2-707) or a buyer that has rightfully rejected or justiably revoked acceptance must account for any excess over the amount of the buyer's security interest under Section 2-711(3). (7) Failure of a seller to resell under this section does not bar the seller from any other remedy. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Consistent with the revision of Section 2-710, this section now provides for consequential as well as incidental damages. Subsection (7) is new, and parallels the provision for buyer cover in 2-713. Original Section 2-706(1) measured damages by the dierence between the resale price and the contract price; amended subsection (1) reverses these terms (dierence between the contract price and the resale price) because the contract price must be the larger number for there to be direct damages. 2. The right of resale under this section arises when a seller reclaims goods under Section 2-507 or a buyer repudiates or makes a wrongful but eective rejection. In addition, there is a right of resale if the buyer unjustiably attempts to revoke acceptance and the seller takes back the goods. However, the seller may choose to ignore the buyer's unjustiable attempt to revoke acceptance, in which case the appropriate remedy is an action for the price under Section 2-709. Application of the right of resale to cases of buyer repudiation is supplemented by subsection (2), which authorizes a resale of goods which are not in existence or were not identied to the contract before the breach. Subsection (1) allows the seller to resell the goods after a buyer's breach of contract if the seller has possession or control of the goods. The seller may have possession or control of the goods at the time of the breach or may have regained possession of the goods upon the buyer's wrongful rejection. If the seller has regained possession of the goods from the buyer pursuant to Article 9, that Article controls the seller's rights of resale. 3. Under this Article the seller resells by authority of law, on the seller's own behalf, for the seller's own benet and for the purpose of setting the seller's damages. The theory of a seller's agency is therefore rejected. The question of whether the title to the goods has or has not passed to the buyer is not relevant for the operation of this section. 4. To recover the damages prescribed in subsection (1), the seller must act in good faith and in a commercially reasonable manner in making the resale. If the seller complies with the prescribed standards in making the resale, the seller may recover from the buyer the damages provided for in subsection (1). Evidence of market or current prices at any particular time or place is relevant only for the question of whether the seller acted in a commercially reasonable manner in making the resale. 5. Subsection (2) enables the seller to resell in accordance with reasonable commercial practices so as to realize as high a price as possible in the circumstances. A seller may sell at a public sale or a private sale as long as the choice is commercially reasonable. A public sale is one to which members of the public are admitted. A public sale is usually a sale by auction, but all auctions are not public auctions. A private sale may be eected by an auction or by solicitation and negotiation conducted either directly or through a broker. In choosing between a public and private sale, the character of the goods must be considered and relevant trade practices and usages must be observed. A public sale has further requirements stated in subsection (4). The purpose of subsection (2) is to enable the seller to dispose of the goods to the best advantage, and therefore the seller is permitted in making the resale to depart from the terms and conditions of the original contract for sale to any extent commercially reasonable in the circumstances. As for the place for resale, the focus is on the commercial reasonableness of the seller's 175

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choice as to the place for an advantageous resale. This section rejects the theory that the seller should normally resell at the agreed place for delivery and that a resale elsewhere can be permitted only in exceptional cases. The time for resale is a reasonable time after the buyer's breach. What is a reasonable time depends on the nature of the goods, the condition of the market and the other circumstances of the case; its length cannot be measured by any legal yardstick or divided into degrees. When a seller contemplating resale receives a demand from the buyer for inspection under Section 2-515, the time for resale may be appropriately lengthened. 6. The provision of subsection (2) that the goods need not be in existence to be resold applies when the buyer is guilty of anticipatory repudiation of a contract for future goods before the goods or some of the goods have come into existence. In this case, the seller may exercise the right of resale and x the damages by one or more contracts to sell the quantity of conforming future goods aected by the repudiation. The companion provision of subsection (2), that resale may be made although the goods were not identied to the contract prior to the buyer's breach, likewise contemplates an anticipatory repudiation by the buyer, but one occurring after the goods are in existence. The seller may identify goods to the contract after the breach, but must identify the goods being sold as pertaining to the breached contract. If the identied goods conform to the contract, their resale will x the seller's damages as satisfactorily as if the goods had been identied before the breach. 7. If the resale is to be by private sale, subsection (3) requires that reasonable notication of the seller's intention to resell must be given to the buyer. Notication of the time and place of a private resale is not required. 8. Subsection (4) states requirements for a public resale. The requirements of this subsection are in addition to the requirements of subsection (2), which pertain to all resales under this section. Paragraph (a) of subsection (4) qualies the last sentence of subsection (2) with respect to resales of unidentied and future goods at public sale. If conforming goods are in existence the seller may identify them to the contract after the buyer's breach and then resell them at public sale. If the goods have not been identied, however, the seller may resell them at public sale only as future goods and only if there is a recognized market for public sale of futures in goods of the kind. Subsection (4)(b) requires that the seller give the buyer reasonable notice of the time and place of a public resale so that the buyer may have an opportunity to bid or to secure the attendance of other bidders. An exception is made in the case of goods which are perishable or threaten to decline speedily in value. Since there would be no reasonable prospect of competitive bidding elsewhere, subsection (4)(b) requires that a public resale must be made at a usual place or market for public sale if one is reasonably available; i.e., a place or market which prospective bidders may reasonably be expected to attend. The market may still be reasonably available under this subsection, although at a considerable distance from the place where the goods are located. In this case, the expense of transporting the goods for resale is recoverable from the buyer as part of the seller's incidental damages under subsection (1). However, the question of availability is one of commercial reasonableness in the circumstances and if such usual place or market is not reasonably available, a duly advertised public resale may be held at another place if it is one which prospective bidders may reasonably be expected to attend, as distinguished from a place where there is no demand whatsoever for goods of the kind. Subsection (4)(c) is designed to permit intelligent bidding. Subsection (4)(d), which permits the seller to bid and, of course, to become the purchaser, benets the original buyer by tending to increase the resale price and thus decreasing the damages the buyer will have to pay. 9. Subsection (5) allows a purchaser to take the goods free of the rights of the buyer even if the seller has not complied with this section. The policy of resolving any doubts in favor of the resale purchaser operates to the benet of the buyer by increasing the price the purchaser should be willing to pay. 10. Subsection (6) recognizes that when the seller is entitled to resell under this Article, the goods are the seller's goods and the purpose of resale under this section is to set the seller's damages as against the buyer. However, a person in the position of the seller under Section 2-707 or a buyer asserting a security interest in the goods under Section 2-711(3) 176

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has only a limited right in the goods and so must account to the seller for any excess over the limited amount necessary to satisfy that right. 11. Subsection (7) expresses the policy that resale is not a mandatory remedy for the seller. Except as otherwise provided in Section 2-710, the seller is always free to choose between resale and damages for repudiation or nonacceptance under Section 2-708. Subsection (7) parallels the provision in the cover section, Section 2-712. A seller that fails to comply with the requirements of this section may recover damages under Section 2-708(1). In addition, a seller may recover both incidental and consequential damages under Section 2-710 is the seller's damages have not been liquidated under Section 2-718 or limited under Section 2-719. Cross References: Point 1: Section 2-713. Point 2: Section 2-507, 2-709, Article 9. Point 4: Section 1-201. Point 5: Section 2-515. Point 7: Section 2-104. Point 8: Sections 2-104 and 2-710. Point 10: Section 2-707 and 2-711. Point 11: Sections 2-708, 2-710, 2-712, 2-718 and 2-719. Denitional Cross References: Buyer. Section 2-103. Contract. Section 1-201. Contract for sale. Section 2-106. Good faith. Section 2-103. Goods. Section 2-103. Notication. Section 1-202. Person in position of seller. Section 2-707. Purchase. Section 1-201. Rights. Section 1-201. Sale. Section 2-106. Security interest. Section 1-201. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-707. Person in the Position of a Seller. (1) A person in the position of a seller includes as against a principal an agent that has paid or become responsible for the price of goods on behalf of the principal or a person that otherwise holds a security interest or other right in goods similar to that of a seller. (2) A person in the position of a seller has the same remedies as a seller under this Article. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Unlike original Article 2, which gave a limited range of remedies, subsection (2) now provides that a person in the position of a seller has the full range of remedies available to a seller. Denitional Cross References: Goods. Section 2-103. Security interest. Section 1-201. Seller. Section 2-103. 177

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As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-708. Seller's Damages for Nonacceptance or Repudiation. (1) Subject to subsection (2) and to Section 2-723: (a) the measure of damages for nonacceptance by the buyer is the difference between the contract price and the market price at the time and place for tender together with any incidental or consequential damages provided in Section 2-710, but less expenses saved in consequence of the buyer's breach; and (b) the measure of damages for repudiation by the buyer is the dierence between the contract price and the market price at the place for tender at the expiration of a commercially reasonable time after the seller learned of the repudiation, but no later than the time stated in paragraph (a), together with any incidental or consequential damages provided in Section 2-710, less expenses saved in consequence of the buyer's breach. (2) If the measure of damages provided in subsection (1) or in Section 2-706 is inadequate to put the seller in as good a position as performance would have done, the measure of damages is the prot (including reasonable overhead) that the seller would have made from full performance by the buyer, together with any incidental or consequential damages provided in this Article (Section 2-710). As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. This section contains the following changes from original Section 2-708: a) Consistent with the revision of Section 2-710, this section now provides for consequential as well as incidental damages. Subsection (1) has been divided into two paragraphs. The new paragraph claries the measure of damages in anticipatory repudiation. The same approach has taken in Section 2-713 for a buyer's market-based damage claims. b) Original Section 2-708(1) set the measure of damages as the dierence between the market price and the unpaid contract price. The word unpaid has been deleted as superuous and misleading. An aggrieved buyer that has already paid a portion of the price is entitled to recover it in restitution under Section 2-718. c) Original Section 2-708(1) measured damages by the dierence between the market price and the contract price. Subsection (1) reverses the terms (dierence between the contract price and the market price) because the contract price must be the larger number for there to be direct damages. Compare Sections 2-712 and 2-713 on buyer's remedies, where the contract price is listed after the cover or market price. d) Subsection (2) now has the following emphasized language added: provided in subsection (1) or in Section 2-706 is inadequate . . .. Most courts have correctly assumed that original Section 2-708(2) was an alternative to Section 2-706 as well as Section 2-708(1) but still had to ask the question. See, e.g., R.E. Davis Chemical Corp. v. Diasonics, Inc., 826 F.2d 678 (7th Cir. 1987). The change makes this result explicit. e) In subsection (2), the phrases that appeared in original 2-708(2), due allowance for costs reasonably incurred and due credit for payments or proceeds of resale have been deleted. As has been noted repeatedly (see, e.g., Harris, A General Theory for Measuring Seller's Damages for Total Breach of Contract, 60 Mich. L. Rev. 577 (1962)), the due credit language makes no sense for a seller that has lost a sale not because it ceased manufacture on a buyer's breach but because it has resold a nished product (that was 178

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made for its breaching buyer) to one of the seller's existing buyers. When a seller ceases manufacture and resells component parts for scrap or salvage value under Section 2-704(2), a credit for the proceeds is due the buyer to oset the damages under this section. When a seller incurs costs that are not recovered by scrap or salvage, the seller must be given an allowance for those costs to measure its loss accurately. See E. Farnsworth Contracts Section 12.9 (3rd ed. 1999) (general measure of damages = loss in value + other loss-cost avoided-loss avoided). 2. The right to damages under this section arises when a seller reclaims goods under Section 2-507 or a buyer repudiates or makes a wrongful but eective rejection. In addition, there is a right to damages under this Section if the buyer unjustiably attempts to revoke acceptance and the seller takes back the goods. However, if the seller refuses to take the goods back in the face of the buyer's unjustiable attempt to revoke acceptance, the appropriate remedy is an action for the price under Section 2-709. 3. The market price at the time and place for tender is the standard by which damages for nonacceptance are to be determined. The time and place of tender are determined by Section 2-503 on tender of delivery and by the use of common shipping terms. The provisions of Section 2-723 are relevant to determine the market price. In the event that there is no evidence available of the current market price at the time and place of tender, proof of a substitute market may be made as provided for in Section 2-723. Section 2-723, which is consistent with the admissibility of market quotations, is intended to ease materially the problem of providing competent evidence. 4. Subsection (1)(b) addresses the question of when the market price should be measured in the case of an anticipatory repudiation by the buyer. This section provides that the market price should be measured in a case of repudiation at the place of tender under the agreement at a commercially reasonable time after the seller learned of the repudiation, but no later than the time of tender under the agreement. This time approximates the market price at the time the seller would have resold the goods, even though the seller has not done so under Section 2-706. To determine whether the seller has learned of the repudiation, the court should be sensitive to the rights of the aggrieved party when tactical behavior by the buyer has made the determination dicult. See Louisiana Power and Light v. Allegheny Ludlow, 517 F. Supp. 1319 (D.C. La. 1981). 5. Subsection (2) is used in the cases of uncompleted goods, jobbers or middlemen, and other lost-volume sellers. This remedy is an alternative to the remedy under subsection (1) or Section 2-706, and it is available when the damages based upon resale of the goods or market price of the goods do not achieve the goal of full compensation for harm caused by the buyer's breach. No eort has been made to state how lost prots should be calculated because of the variety of situations in which this measurement may be appropriate and the variety of ways in which courts have measured lost prots. This subsection permits the recovery of lost prots in all appropriate cases. Since this section deals with the plainti's lost prot on a particular sale, and not with cases where a plainti is suing for the lost prots from an enterprise as consequential damages, it is not necessary to show a history of earnings; all that is necessary is that the plainti shows a loss of the marginal benet to be gained from performance of the broken contract. To qualify as a lost volume seller, the seller needs to show only that it could have supplied both the breaching purchaser and the resale purchaser with the goods. Islamic Republic of Iran v. Boeing Co., 771 F.2d 1279 (9th Cir. 1985). Where an aggrieved seller has sold goods made for the breaching party to another, courts should consider whether the seller could and would have made a prot on an additional sale in addition to the breached sale. If the seller could not or would not have protably made another sale in the absence of breach, there is no lost volume and the seller would normally be made whole by a recovery of the incidental costs associated with the substitute transaction. 6. Consequential damages are not recoverable under this section unless the seller has made reasonable attempts to minimize the damages in good faith, either by resale under Section 2-706 or by other reasonable means. 7. When an agreement contains provisions for payment of a liquidated sum of money as an alternative to performance, (such as a take-or-pay contract), it must be determined whether the agreement is truly for alternative performances or whether the alternatives are performance or liquidated damages. Recovery under this section is available when a buyer breaches an alternative performance contract. When the alternative is truly liqui179

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dated damages and when that damage provision complies with Section 2-718, recovery is under the liquidated damage clause. See Roye Realty & Developing, Inc. v. Arkla, Inc., 863 P.2d 1150, 1154, 22 U.C.C. Rep Serv. 2d 183 (Okl.1993); 5A Corbin, Corbin on Contracts 1082, at 46364 (1964). Cross References: Point 1: Sections 2-704, 2-710, 2-712, 2-713, 2-718. Point 2: Section 2-507 and 2-709. Point 3: Sections 2-503, and 2-723. Point 4: Section 2-706. Point 5: Section 2-706. Point 6: Section 2-706. Denitional Cross References: Buyer. Section 2-103. Contract. Section 1-201. Reasonable time. Section 1-205. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-709. Action for the Price. (1) If the buyer fails to pay the price as it becomes due, the seller may recover, together with any incidental or consequential damages under Section 2-710, the price: (a) of goods accepted or of conforming goods lost or damaged within a commercially reasonable time after risk of their loss has passed to the buyer; and (b) of goods identied to the contract if the seller is unable after reasonable eort to resell them at a reasonable price or the circumstances reasonably indicate that such eort will be unavailing. (2) If the seller sues for the price, the seller must hold for the buyer any goods that have been identied to the contract and are still in the seller's control. However, if resale becomes possible, the seller may resell them at any time prior to the collection of the judgment. The net proceeds of any such resale must be credited to the buyer, and payment of the judgment entitles the buyer to any goods not resold. (3) After the buyer has wrongfully rejected or revoked acceptance of the goods or has failed to make a payment due or has repudiated (Section 2-610), a seller that is held not entitled to the price under this section shall nevertheless be awarded damages for nonacceptance under Section 2-708. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Section 63, Uniform Sales Act. Changes: Rewritten, important commercially needed changes being incorporated. Purposes of Changes: To make it clear that: 1. Neither the passing of title to the goods nor the appointment of a day certain for payment is now material to a price action. 2. The action for the price is now generally limited to those cases where resale of the goods is impracticable except where the buyer has accepted the goods or where they have 180

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been destroyed after risk of loss has passed to the buyer. 3. This section substitutes an objective test by action for the former not readily resalable standard. An action for the price under subsection (1)(b) can be sustained only after a reasonable eort to resell the goods at reasonable price has actually been made or where the circumstances reasonably indicate that such an eort will be unavailing. 4. If a buyer is in default not with respect to the price, but on an obligation to make an advance, the seller should recover not under this section for the price as such, but for the default in the collateral (though coincident) obligation to nance the seller. If the agreement between the parties contemplates that the buyer will acquire, on making the advance, a security interest in the goods, the buyer on making the advance has such an interest as soon as the seller has rights in the agreed collateral. See Section 9-204. 5. Goods accepted by the buyer under subsection (1)(a) include only goods as to which there has been no justied revocation of acceptance, for such a revocation means that there has been a default by the seller which bars his rights under this section. Goods lost or damaged are covered by the section on risk of loss. Goods identied to the contract under subsection (1)(b) are covered by the section on identication and the section on identication notwithstanding breach. 6. This section is intended to be exhaustive in its enumeration of cases where an action for the price lies. 7. If the action for the price fails, the seller may nonetheless have proved a case entitling him to damages for non-acceptance. In such a situation, subsection (3) permits recovery of those damages in the same action. Cross References: Point 4: Section 1-106. Point 5: Sections 2-501, 2-509, 2-510 and 2-704. Point 7: Section 2-708. Denitional Cross References: Action. Section 1-201. Buyer. Section 2-103. Conforming. Section 2-106. Contract. Section 1-201. Goods. Section 2-103. Reasonable time. Section 1-205. Seller. Section 2-103.

2-710. Seller's Incidental and Consequential Damages. (1) Incidental damages to an aggrieved seller include any commercially reasonable charges, expenses or commissions incurred in stopping delivery, in the transportation, care, and custody of goods after the buyer's breach, in connection with return or resale of the goods or otherwise resulting from the breach. (2) Consequential damages resulting from the buyer's breach include any loss resulting from general or particular requirements and needs of which the buyer at the time of contracting had reason to know and which could not reasonably be prevented by resale or otherwise. (3) In a consumer contract, a seller may not recover consequential damages from a consumer. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (1) provides for reimbursement by the seller for the expenses reasonably incurred as a result of the buyer's breach. The section sets forth as examples the usual and normal types of damages that may arise from the breach but the provision is intended intends to provide for all commercially reasonable expenditures made by the seller. 181

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2. Subsection (2) permits an aggrieved seller to recover consequential damages. Under this section the loss must result from general or particular requirements of the seller of which the buyer had reason to know at the time of contracting. As with Section 2-715, the tacit agreement test is rejected. (See Ocial Comment 2 to Section 2-715). The buyer is not liable for losses that could have been mitigated. Sellers rarely suer compensable consequential damages. A buyer's usual default is failure to pay. In normal circumstances, the disappointed seller will be able to sell to another buyer, borrow to replace the breaching buyer's promised payment, or otherwise adjust the seller's aairs to avoid consequential loss. cf. Afram Export Corp. v. Metallurgiki Halyps, S.A., 772 F.2d 1358, 1368 (7th Cir. 1985). 3. Subsection (3) precludes a seller from recovering consequential damages from a consumer. This is a nonwaivable provision. Cross References: Point 1: Section 2-710, 2-711 and 2-715. Point 2: Section 2-103. Denitional Cross References: Aggrieved party. Section 1-201. Buyer. Section 2-103. Consumer contract. Section 2-103. Delivery. Section 2-103. Goods. Section 2-103. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-711. Buyer's Remedies in General; Buyer's Security Interest in Rejected Goods. (1) A breach of contract by the seller includes the seller's wrongful failure to deliver or to perform a contractual obligation, making of a nonconforming tender of delivery or performance, and repudiation. (2) If the seller is in breach of contract, the buyer, to the extent provided for by this Act or other law, may: (a) in the case of rightful cancellation, rightful rejection, or justiable revocation of acceptance, recover so much of the price as has been paid; (b) deduct damages from any part of the price still due under Section 2-717; (c) cancel under Section 2-711(4); (d) cover and have damages under Section 2-712 as to all goods affected whether or not they have been identied to the contract; (e) recover damages for nondelivery or repudiation under Section 2-713; (f) recover damages for breach with regard to accepted goods or breach with regard to a remedial promise under Section 2-714; (g) recover identied goods under Section 2-502; (h) obtain specic performance or obtain the goods by replevin or similar remedy under Section 2-716; (i) recover liquidated damages under Section 2-718; (j) in other cases, recover damages in any manner that is reasonable under the circumstances. (3) On rightful rejection or justiable revocation of acceptance a buyer has a security interest in goods in the buyer's possession or control for any
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payments made on their price and any expenses reasonably incurred in their inspection, receipt, transportation, care and custody and may hold such goods and resell them in a like manner as an aggrieved seller (Section 2-706). (4) If the seller fails to make delivery or repudiates or the buyer rightfully rejects or justiably revokes acceptance, with respect to any goods involved and with respect to the whole if the breach goes to the whole contract (Section 2-612), the buyer may cancel. As amended in 2003 and 2005.
See Appendix T for material relating to changes made in text in 2003. See Appendix V for material relating to changes made in text in 2005.

Ocial Comment
1. Despite the seller's breach proper re-tender of delivery as a cure under Section 2-508 eectively precludes the buyer's remedies under this section except for damages for any delay. 2. Under subsection (3), the buyer may hold and resell rejected goods if the buyer has paid a part of the price or incurred expenses of the type specied. Paid, as used here, includes acceptance of a draft or other time negotiable instrument or the signing of a negotiable note. The buyer's freedom of resale is coextensive with that of a seller under this Article except that the buyer may not keep any prot resulting from the resale and the buyer is limited to retaining only the amount of the price paid and the costs involved in the inspection and handling of the goods. The buyer's security interest in the goods is intended to be limited to the items listed in subsection (3), and the buyer is not permitted to retain funds that the buyer might believe adequate for the damages. The buyer's right to cover, or to have damages for non-delivery, is not impaired by the buyer's exercise of the right of resale. 3. This Act requires its remedies to be liberally administered and provides that any right or obligation which it declares is enforceable by action unless a dierent eect is specically prescribed (Section 1-103). Cross References: Point 1: Sections 2-502, 2-508, 2-601 and 2-712 through 2-718. Point 2: Section 2-706. Point 3: Section 1-103. Denitional Cross References: Aggrieved party. Section 1-201. Buyer. Section 2-103. Cancellation. Section 2-106. Conforming. Section 2-106. Contract. Section 1-201. Cover. Section 2-712. Delivery. Section 2-103. Goods. Section 2-103. Noties. Section 1-202. Receipt of goods. Section 2-103. Remedial promise. Section 2-103. Remedy. Section 1-201. Security interest. Section 1-201. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-712. Cover; Buyer's Procurement of Substitute Goods. (1) If the seller wrongfully fails to deliver or repudiates or the buyer
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rightfully rejects or justiably revokes acceptance, the buyer may cover by making in good faith and without unreasonable delay any reasonable purchase of or contract to purchase goods in substitution for those due from the seller. (2) A buyer may recover from the seller as damages the dierence between the cost of cover and the contract price together with any incidental or consequential damages under Section 2-715, but less expenses saved in consequence of the seller's breach. (3) Failure of the buyer to eect cover within this section does not bar the buyer from any other remedy. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. The purpose of this section is to provide the buyer with a remedy to enable the buyer to obtain the goods the buyer is entitled to under the contract with the seller. This remedy is the buyer's equivalent of the seller's right to resell. The buyer is entitled to this remedy if the seller wrongfully fails to deliver the goods or repudiates the contract or if the buyer rightfully rejects or justiably revokes acceptance. Cover is not available under this section if the buyer accepts the goods and does not rightfully revoke the acceptance. 2. Subsection (1) claries the circumstances in which a buyer is entitled to cover, prior language referred to breach. The language makes it clear that there is a right to cover [i]f the seller wrongfully fails to deliver or repudiates or the buyer rightfully rejects or justiably revokes acceptance. 3. Subsection (2) allows a buyer that has appropriately covered to measure damages by the dierence between the cover price and the contract price. In addition, the buyer is entitled to incidental damages, and when appropriate, consequential damages under Section 2-715. 4. The denition of cover is necessarily exible, and therefore cover may include a series of contracts or sales as well as a single contract or sale, goods not identical with those involved but commercially usable as reasonable substitutes under the circumstances, and contracts on credit or delivery terms diering from the contract in breach but reasonable under the circumstances. The test of a proper cover is whether at the time and place of cover the buyer acted in good faith and in a reasonable manner. It is immaterial that hindsight may later prove that the method of cover used was not the cheapest or most eective. 5. The requirement in subsection (1) that the buyer must cover without unreasonable delay is not intended to limit the time necessary for the buyer to examine reasonable options and decide how best to eect cover. 6. Subsection (3) expresses the policy that cover is not a mandatory remedy for the buyer. The buyer is always free to choose between cover and damages for nondelivery under Section 2-713. However, this subsection must be read in conjunction with the section 2-715(2)(a), which limits the recovery of consequential damages to those damages that could not reasonably be prevented by cover or otherwise. Moreover, the operation of Section 2-716(3) on replevin and the like must be considered because the inability to cover is made an express condition to the right of the buyer to replevy the goods. Cross References: Point 1: Section 2-706. Point 4: Section 2-104. Point 6: Sections 2-713, 2-715 and 2-716. Denitional Cross References: Buyer. Section 2-103. Contract. Section 1-201. Delivery. Section 2-103. Good faith. Section 2-103. 184

Art. 2
Goods. Section 2-103. Purchase. Section 1-201. Reasonable time. Section 1-205. Remedy. Section 1-201. Seller. Section 2-103.

Sales

2-713

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-713. Buyer's Damages for Nondelivery or Repudiation. (1) Subject to Section 2-723, if the seller wrongfully fails to deliver or repudiates or the buyer rightfully rejects or justiably revokes acceptance: (a) the measure of damages in the case of wrongful failure to deliver by the seller or rightful rejection or justiable revocation of acceptance by the buyer is the dierence between the market price at the time for tender under the contract and the contract price together with any incidental or consequential damages under Section 2-715, but less expenses saved in consequence of the seller's breach; and (b) the measure of damages for repudiation by the seller is the dierence between the market price at the expiration of a commercially reasonable time after the buyer learned of the repudiation, but no later than the time stated in paragraph (a), and the contract price together with any incidental or consequential damages provided in this Article (Section 2-715), less expenses saved in consequence of the seller's breach. (2) Market price is to be determined as of the place for tender or, in cases of rejection after arrival or revocation of acceptance, as of the place of arrival. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. This section provides a rule for anticipatory repudiation cases. This is consistent with the new rule for sellers in Section 2-708(1)(b). In a case not involving repudiation, the buyer's damages will be based on the market price at the time for tender under the agreement. This changes the former rule where the time for measuring damages was at the time the buyer learned of the breach. 2. This section provides for a buyer's expectancy damages when the seller wrongfully fails to deliver the goods or repudiates the contract or the buyer rightfully rejects or justiably revokes acceptance. This section provides an alternative measure of damages to the cover remedy provided for in Section 2-712. 3. Under subsection (1)(a), the measure of damages for a wrongful failure to deliver the goods by the seller or a rightful rejection or justiable revocation of acceptance by the buyer is the dierence between the market price at the time for tender under the agreement and the contract price. 4. Under subsection (1)(b), in the case of an anticipatory repudiation by the seller the market price should be measured at the place where the buyer would have covered at a commercially reasonable time after the buyer learned of the repudiation, but no later than the time of tender under the agreement. This time approximates the market price at the time the buyer would have covered even though the buyer has not done so under Section 2-712. This subsection is designed to put the buyer in the position the buyer would have been in if the seller had performed by approximating the harm the buyer has suered without allowing the buyer an unreasonable time to speculate on the market at the seller's expense. 185

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5. The market price to be used in comparison with the contract price under this section is the price for goods of the same kind and in the same branch of trade. When the market price under this section is dicult to prove, Section 2-723 on the determination and proof of market price is available to permit a showing of a comparable market price. When no market price is available, evidence of spot sale prices may be used to determine damages under this section. When the unavailability of a market price is caused by a scarcity of goods of the type involved, a good case may be made for specic performance under Section 2-716. See the Ocial Comment to that Section. 6. In addition to the damages provides in this section, the buyer is entitled to incidental and consequential damages under Section 2-715. 7. A buyer that has covered under Section 2-712 may not recover the contract price market price dierence under this section, but instead must base the damages on those provided in Section 2-712. To award an additional amount because the buyer could show the market price was higher than the contract price would put the buyer in a better position than performance would have. Of course, the seller would bear the burden of proving that cover had the economic eect of limiting the buyer's actual loss to an amount less than the contract price-market price dierence. An apparent cover, which does not in fact replace the goods contracted for, should not foreclose the use of the contract price-market price measure of damages. If the breaching seller cannot prove that the new purchase is in fact a replacement for the one not delivered under the contract, the cover purchase should not foreclose the buyer's recovery under 2-713 of the market contract dierence. Cross References: Point 2: Section 2-712. Point 4: Section 2-712. Point 5: Sections 1-106, 2-708, 2-716 and 2-723. Point 6: Section 2-715. Point 7: Section 2-708, 2-712 and 2-713. Denitional Cross References: Buyer. Section 2-103. Contract. Section 1-201. Delivery. Section 2-103. Reasonable time. Section 1-205. Seller. Section 2-103.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-714. Buyer's Damages For Breach in Regard to Accepted Goods. (1) If the buyer has accepted goods and given notication pursuant to Section 2-607(3), the buyer may recover as damages for any nonconformity of tender the loss resulting in the ordinary course of events from the seller's breach as determined in any reasonable manner. (2) The measure of damages for breach of warranty is the dierence at the time and place of acceptance between the value of the goods accepted and the value they would have had if they had been as warranted, unless special circumstances show proximate damages of a dierent amount. (3) In a proper case any incidental and consequential damages under Section 2-715 may also be recovered. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: Section 69(6) and (7), Uniform Sales Act. Changes: Rewritten. 186

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Purposes of Changes: 1. This section deals with the remedies available to the buyer after the goods have been accepted and the time for revocation of acceptance has gone by. In general this section adopts the rule of the prior uniform statutory provision for measuring damages where there has been a breach of warranty as to goods accepted, but goes further to lay down an explicit provision as to the time and place for determining the loss. The section on deduction of damages from price provides an additional remedy for a buyer who still owes part of the purchase price, and frequently the two remedies will be available concurrently. The buyer's failure to notify of his claim under the section on eects of acceptance, however, operates to bar his remedies under either that section or the present section. 2. The non-conformity referred to in subsection (1) includes not only breaches of warranties but also any failure of the seller to perform according to his obligations under the contract. In the case of such non-conformity, the buyer is permitted to recover for his loss in any manner which is reasonable. 3. Subsection (2) describes the usual, standard and reasonable method of ascertaining damages in the case of breach of warranty but it is not intended as an exclusive measure. It departs from the measure of damages for non-delivery in utilizing the place of acceptance rather than the place of tender. In some cases the two may coincide, as where the buyer signies his acceptance upon the tender. If, however, the non-conformity is such as would justify revocation of acceptance, the time and place of acceptance under this section is determined as of the buyer's decision not to revoke. 4. The incidental and consequential damages referred to in subsection (3), which will usually accompany an action brought under this section, are discussed in detail in the comment on the next section. Cross References: Point 1: Compare Section 2-711; Sections 2-607 and 2-717. Point 2: Section 2-106. Point 3: Sections 2-608 and 2-713. Point 4: Section 2-715. Denitional Cross References: Buyer. Section 2-103. Conform. Section 2-106. Goods. Section 2-103. Notication. Section 1-202. Seller. Section 2-103.

2-715. Buyer's Incidental and Consequential Damages. (1) Incidental damages resulting from the seller's breach include expenses reasonably incurred in inspection, receipt, transportation and care and custody of goods rightfully rejected, any commercially reasonable charges, expenses or commissions in connection with eecting cover and any other reasonable expense incident to the delay or other breach. (2) Consequential damages resulting from the seller's breach include (a) any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise; and (b) injury to person or property proximately resulting from any breach of warranty. Ocial Comment
Prior Uniform Statutory Provisions: Subsection (2)(b)Sections 69(7) and 70, Uniform Sales Act. Changes: Rewritten. Purposes of Changes and New Matter: 187

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1. Subsection (1) is intended to provide reimbursement for the buyer who incurs reasonable expenses in connection with the handling of rightfully rejected goods or goods whose acceptance may be justiably revoked, or in connection with eecting cover where the breach of the contract lies in non-conformity or non-delivery of the goods. The incidental damages listed are not intended to be exhaustive but are merely illustrative of the typical kinds of incidental damage. 2. Subsection (2) operates to allow the buyer, in an appropriate case, any consequential damages which are the result of the seller's breach. The tacit agreement test for the recovery of consequential damages is rejected. Although the older rule at common law which made the seller liable for all consequential damages of which he had reason to know in advance is followed, the liberality of that rule is modied by refusing to permit recovery unless the buyer could not reasonably have prevented the loss by cover or otherwise. Subparagraph (2) carries forward the provisions of the prior uniform statutory provision as to consequential damages resulting from breach of warranty, but modies the rule by requiring rst that the buyer attempt to minimize his damages in good faith, either by cover or otherwise. 3. In the absence of excuse under the section on merchant's excuse by failure of presupposed conditions, the seller is liable for consequential damages in all cases where he had reason to know of the buyer's general or particular requirements at the time of contracting. It is not necessary that there be a conscious acceptance of an insurer's liability on the seller's part, nor is his obligation for consequential damages limited to cases in which he fails to use due eort in good faith. Particular needs of the buyer must generally be made known to the seller while general needs must rarely be made known to charge the seller with knowledge. Any seller who does not wish to take the risk of consequential damages has available the section on contractual limitation of remedy. 4. The burden of proving the extent of loss incurred by way of consequential damage is on the buyer, but the section on liberal administration of remedies rejects any doctrine of certainty which requires almost mathematical precision in the proof of loss. Loss may be determined in any manner which is reasonable under the circumstances. 5. Subsection (2)(b) states the usual rule as to breach of warranty, allowing recovery for injuries proximately resulting from the breach. Where the injury involved follows the use of goods without discovery of the defect causing the damage, the question of proximate cause turns on whether it was reasonable for the buyer to use the goods without such inspection as would have revealed the defects. If it was not reasonable for him to do so, or if he did in fact discover the defect prior to his use, the injury would not proximately result from the breach of warranty. 6. In the case of sale of wares to one in the business of reselling them, resale is one of the requirements of which the seller has reason to know within the meaning of subsection (2)(a). Cross References: Point 1: Section 2-608. Point 3: Sections 1-203, 2-615 and 2-719. Point 4: Section 1-106. Denitional Cross References: Cover. Section 2-712. Goods. Section 2-103. Person. Section 1-201. Receipt of goods. Section 2-103. Seller. Section 2-103.

2-716. Specic Performance; Buyer's Right to Replevin. (1) Specic performance may be decreed if the goods are unique or in other proper circumstances. In a contract other than a consumer contract, specic performance may be decreed if the parties have agreed to that remedy. However, even if the parties agree to specic performance, specic performance may not be decreed if the breaching party's sole remaining contractual obligation is the payment of money.
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(2) The decree for specic performance may include such terms and conditions as to payment of the price, damages, or other relief as the court may deem just. (3) The buyer has a right of replevin or similar remedy for goods identied to the contract if after reasonable eort the buyer is unable to eect cover for such goods or the circumstances reasonably indicate that such effort will be unavailing or if the goods have been shipped under reservation and satisfaction of the security interest in them has been made or tendered. (4) The buyer's right under subsection (3) vests upon acquisition of a special property, even if the seller had not then repudiated or failed to deliver. As amended in 1999 and 2003.
See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999. See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. This section contains the following changes from original Section 2-716: a) The caption has been amended to make it clear that either party may be entitled to specic performance. b) The second sentence of subsection (1) explicitly permits parties to bind themselves to specic performance even where it would not otherwise be available. c) In subsection (3), the phrase or similar remedy has been added after replevin to reect the fact that under the governing state law the right may be called detinue, sequestration, claim and delivery, or something else. d) Subsection (4) corresponds with Section 2-502(2), which in turn is derived from (but broader than) the conforming amendments to Article 9. It provides a vesting rule for cases in which there is a right of replevin. 2. Uniqueness should be determined in light of the total circumstances surrounding the contract and is not limited to goods identied when the contract is formed. The typical specic performance situation today involves an output or requirements contract rather than a contract for the sale of an heirloom or priceless work of art. A buyer's inability to cover is evidence of other proper circumstances. 3. Subsection (1) provides that a court may decree specic performance if the parties have agreed to that remedy. The parties' agreement to specic performance can be enforced even if legal remedies are entirely adequate. Even in a commercial contract, the third sentence of subsection (1) prevents the aggrieved party from obtaining specic performance if the only obligation of the party in breach is the payment of money. Whether a buyer is obligated to pay the price is determined by Section 2-709, not by this section. Nothing in this section constrains the court's exercise of its equitable discretion to decide whether to enter a decree for specic performance or to determine the conditions or terms of the decree. This section assumes that the decree for specic performance is conditioned on a tender of full performance by the party that seeks the remedy. 4. The legal remedy of replevin or a similar remedy is also available for cases in which cover is unavailable and where the goods have been identied to the contract. This is in addition to the prepaying buyer's right to recover identied goods upon the seller's insolvency or, when the goods have been bought for a consumer purpose, upon the seller's repudiation or failure to deliver (Section 2-502). If a negotiable document of title is outstanding, the buyer's right of replevin relates to the document and does not directly relate to the goods. See Article 7, especially Section 7-602. 5. Subsection (4) provides that a buyer's right to replevin or a similar remedy vests upon the buyer's acquisition of a special property in the goods (Section 2-501) even if the seller has not at that time repudiated or failed to make a required delivery. This vesting rule assumes application of a rst in time priority rule. In other words, if the buyer's rights vest under this rule before a creditor acquires an in rem right to the goods, including an Article 9 security interest and a lien created by levy, the buyer should prevail. 189

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Cross References: Point 1: Section 2-502. Point 3: Section 2-709. Point 4: Section 2-502 and Article 7. Point 5: Section 2-501 and Article 9. Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Consumer contract. Section 2-103. Contract. Section 1-201. Deliver. Section 2-201. Goods. Section 2-103. Party. Section 1-201. Remedy. Section 1-201. Rights. Section 1-201.

As amended in 1999 and 2003.

See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-717. Deduction of Damages from the Price. The buyer on notifying the seller of the intention to do so may deduct all or any part of the damages resulting from any breach of the contract from any part of the price still due under the same contract. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: See Section 69(1)(a), Uniform Sales Act. Purposes: 1. This section permits the buyer to deduct from the price damages resulting from any breach by the seller and does not limit the relief to cases of breach of warranty as did the prior uniform statutory provision. To bring this provision into application the breach involved must be of the same contract under which the price in question is claimed to have been earned. 2. The buyer, however, must give notice of his intention to withhold all or part of the price if he wishes to avoid a default within the meaning of the section on insecurity and right to assurances. In conformity with the general policies of this Article, no formality of notice is required and any language which reasonably indicates the buyer's reason for holding up his payment is sucient. Cross Reference: Point 2: Section 2-609. Denitional Cross References: Buyer. Section 2-103. Contract. Section 1-201. Seller. Section 2-103.

2-718. Liquidation or Limitation of Damages; Deposits. (1) Damages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in the light of the anticipated or actual harm caused by the breach and, in a consumer contract, the diculties of proof of loss, and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy. Section 2-719 determines the enforceability of a term that limits but does not liquidate damages.
190

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(2) If the seller justiably withholds delivery of goods or stops performance because of the buyer's breach or insolvency, the buyer is entitled to restitution of any amount by which the sum of the buyer's payments exceeds the amount to which the seller is entitled by virtue of terms liquidating the seller's damages in accordance with subsection (1). (3) The buyer's right to restitution under subsection (2) is subject to oset to the extent that the seller establishes: (a) a right to recover damages under the provisions of this Article other than subsection (1); and (b) the amount or value of any benets received by the buyer directly or indirectly by reason of the contract. (4) If a seller has received payment in goods, their reasonable value or the proceeds of their resale shall be treated as payments for the purposes of subsection (2). However, if the seller has notice of the buyer's breach before reselling goods received in part performance, the resale is subject to the conditions of this Article on resale by an aggrieved seller (Section 2-706). As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. The last sentence of subsection (1) claries the relationship between this section and Section 2-719. 2. A valid liquidated damages term may liquidate the amount of all damages, including consequential and incidental damages. As under former law, liquidated damages clauses should be enforced if the amount is reasonable in light of the factors provided in subsection (1). This section thus respects the parties' ability to contract for damages while providing some control by requiring that the term be reasonable under the circumstances of the particular case. Under original Section 2-718, a party seeking to enforce a liquidated damages term had to demonstrate the diculty of proving the loss and the inconvenience or nonfeasibility of obtaining an adequate remedy. These requirement have been eliminated in commercial contracts but are retained in consumer contracts. 3. Original Section 2-718(1) stated that an unreasonably large liquidated damage term was void as a penalty. This language has been eliminated as unnecessary and misleading. If the liquidated damages are reasonable in light of the test of subsection (1), the term should be enforced, thereby rendering the penalty language of the former law redundant. The language was also misleading because of its emphasis on unreasonably large damages. A liquidated damages term that provided for damages that are unreasonably small is likewise unenforceable. 4. If a liquidated damages term is unenforceable, the remedies of this Article become available to the aggrieved party. 5. Under subsection (2), only the buyer's payments that are more than the amount of an enforceable liquidated damages term need to be returned to the buyer. If the buyer has made payment by virtue of a trade-in or other goods deposited with the seller, subsection (4) provides that the reasonable value of the goods or the goods' resale price should be used to determine what the buyer has paid, not the value the seller allowed the buyer in the trade-in. To assure that the seller obtains a reasonable price for the goods, the seller must comply with the resale provisions of Section 2-706 if the seller knows of the buyer's breach before the seller has otherwise resold them. Subsection (2) expands the situations in which restitution was available under prior law. Original Section 2-718(2) was limited to circumstances in which the seller justiably withheld delivery because of the buyer's breach. Subsection (2) extends the right to situations where the seller stops performance because of the buyer's breach or insolvency. 6. Subsection (3) continues the rule from the former law without change. If there is no 191

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enforceable liquidated damages term, under subsection (2) the buyer is entitled to restitution subject to a right of set o by the seller for any damages to which the seller is otherwise entitled to under this Article. Cross References: Point 1: Section 2-719. Point 2: Section 2-302. Point 3: Section 2-718. Point 5: Sections 2-706 and 2-718. Denitional Cross References: Aggrieved party. Section 1-201. Agreement. Section 1-201. Buyer. Section 2-103. Consumer contract. Section 2-103. Contract. Section 1-201. Goods. Section 2-103. Insolvent. Section 1-201. Notice. Section 1-202. Party. Section 1-201. Remedy. Section 1-201. Seller. Section 2-103. Term. Section 1-201.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-719. Contractual Modication or Limitation of Remedy. (1) Subject to the provisions of subsections (2) and (3) of this section and of the preceding section on liquidation and limitation of damages, (a) the agreement may provide for remedies in addition to or in substitution for those provided in this Article and may limit or alter the measure of damages recoverable under this Article, as by limiting the buyer's remedies to return of the goods and repayment of the price or to repair and replacement of non-conforming goods or parts; and (b) resort to a remedy as provided is optional unless the remedy is expressly agreed to be exclusive, in which case it is the sole remedy. (2) Where circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as provided in this Act. (3) Consequential damages may be limited or excluded unless the limitation or exclusion is unconscionable. Limitation of consequential damages for injury to the person in the case of consumer goods is prima facie unconscionable but limitation of damages where the loss is commercial is not. Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: 1. Under this section parties are left free to shape their remedies to their particular requirements and reasonable agreements limiting or modifying remedies are to be given eect. However, it is of the very essence of a sales contract that at least minimum adequate remedies be available. If the parties intend to conclude a contract for sale within this Article they must accept the legal consequence that there be at least a fair quantum of remedy for breach of the obligations or duties outlined in the contract. Thus any clause purporting to modify or limit the remedial provisions of this Article in an unconscionable 192

Art. 2

Sales

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manner is subject to deletion and in that event the remedies made available by this Article are applicable as if the stricken clause had never existed. Similarly, under subsection (2), where an apparently fair and reasonable clause because of circumstances fails in its purpose or operates to deprive either party of the substantial value of the bargain, it must give way to the general remedy provisions of this Article. 2. Subsection (1)(b) creates a presumption that clauses prescribing remedies are cumulative rather than exclusive. If the parties intend the term to describe the sole remedy under the contract, this must be clearly expressed. 3. Subsection (3) recognizes the validity of clauses limiting or excluding consequential damages but makes it clear that they may not operate in an unconscionable manner. Actually such terms are merely an allocation of unknown or undeterminable risks. The seller in all cases is free to disclaim warranties in the manner provided in Section 2-316. Cross References: Point 1: Section 2-302. Point 3: Section 2-316. Denitional Cross References: Agreement. Section 1-201. Buyer. Section 2-103. Conforming. Section 2-106. Contract. Section 1-201. Goods. Section 2-103. Remedy. Section 1-201. Seller. Section 2-103.

2-720. Eect of Cancellation or Rescission on Claims for Antecedent Breach. Unless the contrary intention clearly appears, expressions of cancellation or rescission of the contract or the like shall not be construed as a renunciation or discharge of any claim in damages for an antecedent breach. Ocial Comment
Prior Uniform Statutory Provision: None. Purpose: This section is designed to safeguard a person holding a right of action from any unintentional loss of rights by the ill-advised use of such terms as cancellation, rescission, or the like. Once a party's rights have accrued they are not to be lightly impaired by concessions made in business decency and without intention to forego them. Therefore, unless the cancellation of a contract expressly declares that it is without reservation of rights, or the like, it cannot be considered to be a renunciation under this section. Cross Reference: Section 1-107. Denitional Cross References: Cancellation. Section 2-106. Contract. Section 1-201.

2-721. Remedies for Fraud. Remedies for material misrepresentation or fraud include all remedies available under this Article for non-fraudulent breach. Neither rescission or a claim for rescission of the contract for sale nor rejection or return of the goods shall bar or be deemed inconsistent with a claim for damages or other remedy. Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: To correct the situation by which remedies for fraud have been more 193

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circumscribed than the more modern and mercantile remedies for breach of warranty. Thus the remedies for fraud are extended by this section to coincide in scope with those for nonfraudulent breach. This section thus makes it clear that neither rescission of the contract for fraud nor rejection of the goods bars other remedies unless the circumstances of the case make the remedies incompatible. Denitional Cross References: Contract for sale. Section 2-106. Goods. Section 2-103. Remedy. Section 1-201.

2-722. Who May Sue Third Parties for Injury to Goods. If a third party so deals with goods that have been identied to a contract for sale as to cause actionable injury to a party to that contract: (a) a right of action against the third party is in either party to the contract for sale that has title to or a security interest or a special property or an insurable interest in the goods, and if the goods have been destroyed or converted, a right of action is also in the party that either bore the risk of loss under the contract for sale or has since the injury assumed that risk as against the other; (b) if at the time of the injury the party plainti did not bear the risk of loss as against the other party to the contract for sale and there is no arrangement between them for disposition of the recovery, the party plainti's suit or settlement is, subject to its own interest, as a duciary for the other party to the contract; and (c) either party may with the consent of the other sue for the benet of whom it may concern. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: To adopt and extend somewhat the principle of the statutes which provide for suit by the real party in interest. The provisions of this section apply only after identication of the goods. Prior to that time only the seller has a right of action. During the period between identication and nal acceptance (except in the case of revocation of acceptance) it is possible for both parties to have the right of action. Even after nal acceptance both parties may have the right of action if the seller retains possession or otherwise retains an interest. Denitional Cross References: Action. Section 1-201. Buyer. Section 2-103. Contract for sale. Section 2-106. Goods. Section 2-103. Party. Section 1-201. Rights. Section 1-201. Security interest. Section 1-201.

2-723. Proof of Market: Time and Place. (1) If evidence of a price prevailing at the times or places described in this Article is not readily available, the price prevailing within any reasonable time before or after the time described or at any other place that in commercial judgment or under usage of trade would serve as a reasonable substitute for the one described may be used, making any proper allowance for the cost of transporting the goods to or from the other place.
194

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(2) Evidence of a relevant price prevailing at a time or place other than the one described in this Article oered by one party is not admissible unless and until the party has given the other party such notice as the court nds sucient to prevent unfair surprise. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: To eliminate the most obvious diculties arising in connection with the determination of market price, when that is stipulated as a measure of damages by some provision of this Article. Where the appropriate market price is not readily available the court is here granted reasonable leeway in receiving evidence of prices current in other comparable markets or at other times comparable to the one in question. In accordance with the general principle of this Article against surprise, however, a party intending to oer evidence of such a substitute price must give suitable notice to the other party. 1. This section is not intended to exclude the use of any other reasonable method of determining market price or of measuring damages if the circumstances of the case make this necessary. 2. In the case of repudiation Sections 2-708(1)(b) and 2-713(1)(b) provide the rule for the proper measure of damages. Cross Reference: Point 2: Section 2-708 and 2-713. Denitional Cross References: Noties. Section 1-202. Party. Section 1-201. Reasonable time. Section 1-205. Usage of trade. Section 1-303.

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

2-724. Admissibility of Market Quotations. If the prevailing price or value of any goods regularly bought and sold in any established commodity market is in issue, reports in ocial publications or trade journals or in newspapers, periodicals or other means of communication in general circulation published as the reports of the market are admissible in evidence. The circumstances of the preparation of such a report may be shown to aect its weight but not its admissibility. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: To make market quotations admissible in evidence while providing for a challenge of the material by showing the circumstances of its preparation. No explicit provision as to the weight to be given to market quotations is contained in this section, but such quotations, in the absence of compelling challenge, oer an adequate basis for a verdict. Market quotations are made admissible when the price or value of goods traded in any established market is in issue. The reason of the section does not require that the market be closely organized in the manner of a produce exchange. It is sucient if transactions in the commodity are frequent and open enough to make a market established by usage in which one price can be expected to aect another and in which an informed report of the 195

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range and trend of prices can be assumed to be reasonably accurate. This section does not in any way intend to limit or negate the application of similar rules of admissibility to other material, whether by action of the courts or by statute. The purpose of the present section is to assure a minimum of mercantile administration in this important situation and not to limit any liberalizing trend in modern law. Denitional Cross Reference: Goods. Section 2-103.

2-725. Statute of Limitations in Contracts for Sale. (1) Except as otherwise provided in this section, an action for breach of any contract for sale must be commenced within the later of four years after the right of action has accrued under subsection (2) or (3) or one year after the breach was or should have been discovered, but no longer than ve years after the right of action accrued. By the original agreement the parties may reduce the period of limitation to not less than one year but may not extend it. However, in a consumer contract, the period of limitation may not be reduced. (2) Except as otherwise provided in subsection (3), the following rules apply: (a) Except as otherwise provided in this subsection, a right of action for breach of a contract accrues when the breach occurs, even if the aggrieved party did not have knowledge of the breach. (b) For breach of a contract by repudiation, a right of action accrues at the earlier of when the aggrieved party elects to treat the repudiation as a breach or when a commercially reasonable time for awaiting performance has expired. (c) For breach of a remedial promise, a right of action accrues when the remedial promise is not performed when performance is due. (d) In an action by a buyer against a person that is answerable over to the buyer for a claim asserted against the buyer, the buyer's right of action against the person answerable over accrues at the time the claim was originally asserted against the buyer. (3) If a breach of a warranty arising under Section 2-312, 2-313(2), 2-314, or 2-315, or a breach of an obligation, other than a remedial promise, arising under Section 2-313A or 2-313B, is claimed, the following rules apply: (a) Except as otherwise provided in paragraph (c), a right of action for breach of a warranty arising under Section 2-313(2), 2-314, or 2-315 accrues when the seller has tendered delivery to the immediate buyer, as dened in Section 2-313, and has completed performance of any agreed installation or assembly of the goods. (b) Except as otherwise provided in paragraph (c), a right of action for breach of an obligation, other than a remedial promise, arising under Section 2-313A or 2-313B accrues when the remote purchaser, as dened in Section 2-313A or 2-313B, receives the goods. (c) If a warranty arising under Section 2-313(2) or an obligation, other than a remedial promise, arising under Section 2-313A or 2-313B explicitly extends to future performance of the goods and discovery of the breach must await the time for performance, the right of action accrues when the immediate buyer as dened in Section 2-313 or the remote purchaser as dened in Section 2-313A or 2-313B discovers or should have discovered the breach.
196

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(d) A right of action for breach of warranty arising under Section 2-312 accrues when the aggrieved party discovers or should have discovered the breach. However, an action for breach of the warranty of noninfringement may not be commenced more than six years after tender of delivery of the goods to the aggrieved party. (4) If an action commenced within the time limited by subsection (1) is so terminated as to leave available a remedy by another action for the same breach, the other action may be commenced after the expiration of the time limited and within six months after the termination of the rst action unless the termination resulted from voluntary discontinuance or from dismissal for failure or neglect to prosecute. (5) This section does not alter the law on tolling of the statute of limitations nor does it apply to causes of action that accrued before this Act becomes eective. As amended in 2003.
See Appendix T for material relating to changes made in text in 2003.

Ocial Comment
1. Original Section 2-725 has been changed as follows: 1) The basic four-year limitation period in subsection (1) has been supplemented by a discovery rule that permits a cause of action to be brought within one year after the breach was or should have been discovered, although no later than ve years after the time the cause would otherwise have accrued; 2) The applicable limitation period cannot be reduced in a consumer contract (subsection (1)); 3) Subsection (2) contains specic rules for cases of repudiation, breach of a remedial promise, and actions where another person is answerable over; 4) Subsection (3)(a) provides that the limitation period for breach of warranty accrues when tender of delivery has occurred and the seller has completed any agreed installation or assembly of the goods; 5) Subsection (3) contains specic rules for breach of an obligation arising under Section 2-313A or 2-313B, for breach of a warranty arising under Section 2-312, and for breach of a warranty against infringement. 2. Subsection (1) continues the four-year limitation period of original Article 2 but provides for a possible one-year extension to accommodate a discovery of the breach late in the four year period after accrual. The four year period under this Article is shorter than many other statutes of limitation for breach of contract and it provides a period which is appropriate given the nature of the contracts under this Article and modern business practices. As under original Article 2, the period of limitation can be reduced to one year by an agreement in a commercial contract, but the amended section does not permit this reduction in consumer contracts. 3. Subsections (2) and (3) provide rules for accrual of the various types of action that this Article allows. Certainty of commercial relationships is advanced when the rules are clearly set forth. Subsection (2) sets out the accrual rules for actions other than for breach of a warranty, which includes actions based on repudiation or breach of a remedial promise and actions where another person is answerable over. Subsection (3) sets out the accrual rules for the various claims based on a warranty, including a warranty of title and a warranty against infringement, or on an obligation other than a remedial promise arising under Section 2-313A or 2-313B. Subsection (2)(a) states the general rule from prior law that a right of action for breach of contract accrues when the breach occurs without regard to the aggrieved party's knowledge of the breach. This general rule is then subject to the three more explicit rules in subsection (2) and to the rules for breach of warranty stated in subsection (3). Subsection (2)(b) provides an explicit rule for repudiation. In a repudiation, the aggrieved party may await performance for a commercially reasonable time or resort to any remedy for breach. Section 2-610. The accrual rule for breach of contract in a repudiation case is based on the earlier of those two time periods. Subsection (2)(c) provides that a cause of action for breach of a remedial promise accrues when the promise is not performed at the time performance is due. 197

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Subsection (2)(d) addresses the problem that has arisen in the cases when an intermediary party is sued for a breach of obligation for which its seller or another person is answerable over, but the limitations period in the upstream lawsuit has already expired. This subsection allows a party four years, or if reduced in the agreement, not less than one year, from when the claim is originally asserted against the buyer for the buyer to sue the person that is answerable over. Whether a party is in fact answerable over to the buyer is not addressed in this section. 4. Subsection (3) addresses the accrual rules for breach of a warranty arising under Section 2-312, 2-313(2), 2-314 or 2-315, or of an obligation other than a remedial promise arising under Section 2-313A or 2-313B. The subsection does not apply to remedial promises arising under Section 2-313(4); the limitation for all remedial promises are governed by subsection 2(c). The accrual rules explicitly incorporate the denitions of immediate buyer and remote purchaser in Sections 2-313, 2-313A and 2-313B. Any cause of action brought by another person to which the warranty or obligation extends is derivative in nature. Thus, the time period applicable to the immediate buyer or remote purchaser governs even if the action is brought by a person to which the warranty or obligation extends under Section 2-318. Subsection (3)(a) continues the general rule that an action for breach of warranty accrues in the case of an express or implied warranty to an immediate buyer upon completion of tender of delivery of nonconforming goods to the immediate buyer but makes explicit that accrual is deferred until the completion of any installation or assembly that the seller has agreed to undertake. This extension of the time of accrual in the case of installation or assembly applies only in the case of a seller that promises to install or assemble and not in the case of a third party, independent of the seller, undertaking the action. Subsection (3)(b) addresses the accrual of a cause of action for breach of an obligation other than a remedial promise arising under Section 2-313A or 2-313B. In these cases, the cause of action accrues when the remote purchaser (as dened in those sections) receives the goods. This accrual rule balances the rights of the remote buyer or remote lessee to be able to have a cause of action based upon the warranty obligation the seller has created against the rights of the seller to have some limit on the length of time the seller is liable. Both of these accrual rules are subject to the exception in subsection (3)(c) for a warranty or obligation that explicitly extends to the future performance of the goods and discovery of the breach must await the time for performance. In this case, the cause of action does not accrue until the buyer or remote purchaser discovers or should have discovered the breach. For a warranty of title or a warranty of non-infringement under Section 2-312, subsection (3)(d) provides that a cause of action accrues when the aggrieved party discovers or should have discovered the breach. In a typical case, the aggrieved party will not discover the breach until it is sued by a party that asserts title to the goods or that asserts an infringement, either event which could be many years after the buyer acquired the goods. This accrual rule allows the aggrieved party appropriate leeway to then bring a claim against the person that made the warranty. In recognition of a need to have a time of repose in an infringement case, a party may not bring an action based upon a warranty of non-infringement more than six years after tender of delivery. 5. Subsection (4) states the saving provision included in many state statutes and permits an additional short period for bringing new actions where suits begun within the four year period have been terminated so as to leave a remedy still available for the same breach. 6. Subsection (5) makes it clear that this Article does not purport to alter or modify in any respect the law on tolling of the Statute of Limitations as it now prevails in the various jurisdictions. Cross References: Point 1: Sections 2-312, 2-313A, and 2-313B. Point 3: Sections 2-313A, 2-313B, and 2-610. Point 4: Sections 2-312, 2-313,2-313A, 2-313B, 2-314, 2-315 and 2-318. Denitional Cross References: Action. Section 1-201. Aggrieved party. Section 1-201. Agreement. Section 1-201. Buyer. Section 2-103. Consumer contract. Section 2-103. 198

Art. 2
Contract. Section 1-201. Contract for sale. Section 2-106. Delivery. Section 2-103. Goods. Section 2-103. Party. Section 1-201. Reasonable time. Section 1-205. Remedial promise. Section 2-103. Remedy. Section 1-201. Term. Section 1-201. Termination. Section 2-106.

Sales

2-804

As amended in 2003.
See Appendix T for material relating to changes made in Ocial Comment in 2003.

PART 8. TRANSITIONAL PROVISIONS

2-801. Eective Date. This [Act] takes eect on , 20 . As added in 2003. 2-802. Amendment of Existing Article 2. This [Act] amends [insert citation to existing Article 2]. As added in 2003. 2-803. Application to Existing Relations. (1) This [Act] applies to a transaction within its scope that is entered into on or after the eective date of this [Act]. (2) This [Act] does not apply to a transaction that is entered into before the eective date of this [Act] even if the transaction would be subject to this [Act] if it had been entered into after the eective date of this [Act]. (3) This [Act] does not apply to a right of action that accrued before the eective date of this [Act]. (4) Section 2-313B of this [Act] does not apply to an advertisement or similar communication made before the eective date of this [Act]. As added in 2003. 2-804. Savings Clause. A transaction entered into before the eective date of this [Act], and the rights, obligations, and interests owing from that transaction, are governed by any statute or other law amended or repealed by this [Act] as if amendment or repeal had not occurred and may be terminated, completed, consummated, or enforced under that statute or other law. As added in 2003.

199

ARTICLE 2A. LEASES*

PART 1. GENERAL PROVISIONS
2A-101. 2A-102. 2A-103. 2A-104. 2A-105. Short Title. Scope. Denitions and Index of Denitions. Leases Subject to Other Law. Territorial Application of Article to Goods Covered by Certicate of Title. Limitation on Power of Parties to Consumer Lease to Choose Applicable Law and Judicial Forum. Waiver or Renunciation of Claim or Right after Default. Unconscionability. Option to Accelerate at Will.

2A-106. 2A-107. 2A-108. 2A-109.

PART 2. FORMATION AND CONSTRUCTION OF LEASE CONTRACT; ELECTRONIC CONTRACTING

2A-201. 2A-202. 2A-203. 2A-204. 2A-205. 2A-206. 2A-207. 2A-208. 2A-209. 2A-210. 2A-211. 2A-212. 2A-213. 2A-214. 2A-215. 2A-216. 2A-217. 2A-218. 2A-219. 2A-220. 2A-221. 2A-222. 2A-223. Statute of Frauds. Final Expression in a Record: Parol or Extrinsic Evidence. Seals Inoperative. Formation in General. Firm Oers. Oer and Acceptance in Formation of Lease Contract. [Reserved.] [Course of Performance or Practical Construction] Modication, Rescission and Waiver. Lessee under Finance Lease as Beneciary of Supply Contract. Express Warranties. Warranties Against Interference and Against Infringement; Lessee's Obligation Against Infringement. Implied Warranty of Merchantability. Implied Warranty of Fitness for Particular Purpose. Exclusion or Modication of Warranties. Cumulation and Conict of Warranties Express or Implied. Third-party Beneciaries of Express and Implied Warranties. Identication. Insurance and Proceeds. Risk of Loss. Eect of Default on Risk of Loss. Casualty to Identied Goods. Legal Recognition of Electronic Contracts, Records and Signatures. Attribution.
committee members, see Appendix U.

*Article 2A was amended in 2003. For the 2003 Amendments and list of drafting 200

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2A-224. Electronic Communication.

PART 3. EFFECT OF LEASE CONTRACT

2A-301. Enforceability Of Lease Contract. 2A-302. Title to and Possession of Goods. 2A-303. Alienability of Party's Interest under Lease Contract or of Lessor's Residual Interest in Goods; Delegation of Performance; Transfer of Rights. 2A-304. Subsequent Lease of Goods by Lessor. 2A-305. Sale or Sublease of Goods by Lessee. 2A-306. Priority of Certain Liens Arising by Operation of Law. 2A-307. Priority of Liens Arising by Attachment or Levy On, Security Interests In, and Other Claims to Goods. 2A-308. Special Rights of Creditors. 2A-309. Lessor's and Lessee's Rights When Goods Become Fixtures. 2A-310. Lessor's and Lessee's Rights When Goods Become Accessions. 2A-311. Priority Subject to Subordination.

PART 4. PERFORMANCE OF LEASE CONTRACT: REPUDIATED, SUBSTITUTED AND EXCUSED

2A-401. 2A-402. 2A-403. 2A-404. 2A-405. 2A-406. 2A-407. Insecurity: Adequate Assurance of Performance. Anticipatory Repudiation. Retraction of Anticipatory Repudiation. Substituted Performance. Excused Performance. Procedure on Excused Performance. Irrevocable Promises: Finance Leases.

PART 5. DEFAULT
A. IN GENERAL
Default: Procedure. Notice after Default. Modication or Impairment of Rights and Remedies. Liquidation of Damages. Cancellation and Termination and Eect of Cancellation, Termination, Rescission, or Fraud on Rights and Remedies. 2A-506. Statute of Limitations. 2A-507. Proof of Market Rent: Time and Place. 2A-507A. Right to Specic Performance or Replevin or the Like. 2A-501. 2A-502. 2A-503. 2A-504. 2A-505.

B. DEFAULT BY LESSOR
2A-508. 2A-509. 2A-510. 2A-511. 2A-512. 2A-513. 2A-514. Lessee's Remedies. Lessee's Rights on Improper Delivery; Manner and Eect of Rejection. Installment Lease Contracts: Rejection and Default. Merchant Lessee's Duties as to Rejected Goods. Lessee's Duties as to Rejected Goods. Cure by Lessor of Improper Tender or Delivery; Replacement. Waiver of Lessee's Objections.
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2A-515. Acceptance of Goods. 2A-516. Eect of Acceptance of Goods; Notice of Default; Burden of Establishing Default after Acceptance; Notice of Claim or Litigation to Person Answerable Over. 2A-517. Revocation of Acceptance of Goods. 2A-518. Cover; Substitute Goods. 2A-519. Lessee's Damages for Non-delivery, Repudiation, Default, and Breach of Warranty in Regard to Accepted Goods. 2A-520. Lessee's Incidental and Consequential Damages. 2A-521. Reserved. 2A-522. Lessee's Right to Goods on Lessor's Insolvency.

C. DEFAULT BY LESSEE
2A-523. 2A-524. 2A-525. 2A-526. 2A-527. 2A-528. 2A-529. 2A-530. 2A-531. 2A-532. Lessor's Remedies. Lessor's Right to Identify Goods to Lease Contract. Lessor's Right to Possession of Goods. Lessor's Stoppage of Delivery in Transit or Otherwise. Lessor's Rights to Dispose of Goods. Lessor's Damages for Non-acceptance, Failure to Pay, Repudiation, or Other Default. Lessor's Action for the Rent. Lessor's Incidental and Consequential Damages. Standing to Sue Third Parties for Injury to Goods. Lessor's Rights to Residual Interest.

PART 6. TRANSITIONAL PROVISIONS

2A-601. 2A-602. 2A-603. 2A-604. Eective Date. Amendment of Existing Article 2A. Applicability. Savings Clause.

APPENDIX I. CONFORMING AMENDMENT TO ARTICLE 1

PART 1. GENERAL PROVISIONS

2A-101. Short Title. This Article shall be known and may be cited as the Uniform Commercial CodeLeases. Ocial Comment
Rationale for Codication: There are several reasons for codifying the law with respect to leases of goods. An analysis of the case law as it applies to leases of goods suggests at least three signicant issues to be resolved by codication. First, what is a lease? It is necessary to dene lease to determine whether a transaction creates a lease or a security interest disguised as a lease. If the transaction creates a security interest disguised as a lease, the lessor will be required to le a nancing statement or take other action to perfect its interest in the goods against third parties. There is no such requirement with respect to leases. Yet the distinction between a lease and a security interest disguised as a lease is not clear. Second, will the lessor be deemed to have made warranties to the lessee? If the transaction is a sale the 202

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express and implied warranties of Article 2 of the Uniform Commercial Code apply. However, the warranty law with respect to leases is uncertain. Third, what remedies are available to the lessor upon the lessee's default? If the transaction is a security interest disguised as a lease, the answer is stated in Part 5 of the Article on Secured Transactions (Article 9). There is no clear answer with respect to leases. There are reasons to codify the law with respect to leases of goods in addition to those suggested by a review of the reported cases. The answer to this important question should not be limited to the issues raised in these cases. Is it not also proper to determine the remedies available to the lessee upon the lessor's default? It is, but that issue is not reached through a review of the reported cases. This is only one of the many issues presented in structuring, negotiating and documenting a lease of goods. Statutory Analogue: After it was decided to proceed with the codication project, the drafting committee of the National Conference of Commissioners on Uniform State Laws looked for a statutory analogue, gradually narrowing the focus to the Article on Sales (Article 2) and the Article on Secured Transactions (Article 9). A review of the literature with respect to the sale of goods reveals that Article 2 is predicated upon certain assumptions: Parties to the sales transaction frequently are without counsel; the agreement of the parties often is oral or evidenced by scant writings; obligations between the parties are bilateral; applicable law is inuenced by the need to preserve freedom of contract. A review of the literature with respect to personal property security law reveals that Article 9 is predicated upon very dierent assumptions: Parties to a secured transaction regularly are represented by counsel; the agreement of the parties frequently is reduced to a writing, extensive in scope; the obligations between the parties are essentially unilateral; and applicable law seriously limits freedom of contract. The lease is closer in spirit and form to the sale of goods than to the creation of a security interest. While parties to a lease are sometimes represented by counsel and their agreement is often reduced to a writing, the obligations of the parties are bilateral and the common law of leasing is dominated by the need to preserve freedom of contract. Thus the drafting committee concluded that Article 2 was the appropriate statutory analogue. Issues: The drafting committee then identied and resolved several issues critical to codication: Scope: The scope of the Article was limited to leases (Section 2A-102). There was no need to include leases intended as security, i.e., security interests disguised as leases, as they are adequately treated in Article 9. Further, even if leases intended as security were included, the need to preserve the distinction would remain, as policy suggests treatment signicantly dierent from that accorded leases. Denition of Lease: Lease was dened to exclude leases intended as security (Section 2A-103(1)(j)). Given the litigation to date a revised denition of security interest was suggested for inclusion in the Act. (Section 1-201(37)). This revision sharpens the distinction between leases and security interests disguised as leases. Filing: The lessor was not required to le a nancing statement against the lessee or take any other action to protect the lessor's interest in the goods (Section 2A-301). The rened denition of security interest will more clearly signal the need to le to potential lessors of goods. Those lessors who are concerned will le a protective nancing statement (Section 9-408). Warranties: All of the express and implied warranties of the Article on Sales (Article 2) were included (Sections 2A-210 through 2A-216), revised to reect dierences in lease transactions. The lease of goods is suciently similar to the sale of goods to justify this decision. Further, many courts have reached the same decision. Certicate of Title Laws: Many leasing transactions involve goods subject to certicate of title statutes. To avoid conict with those statutes, this Article is subject to them (Section 2A-104(1)(a)). Consumer Leases: Many leasing transactions involve parties subject to consumer protection statutes or decisions. To avoid conict with those laws this Article is subject to them to the extent provided in (Section 2A-104(1)(c) and (2)). Further, certain consumer protections have been incorporated in the Article. 203

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Finance Leases: Certain leasing transactions substitute the supplier of the goods for the lessor as the party responsible to the lessee with respect to warranties and the like. The denition of nance lease (Section 2A-103(1)(g)) was developed to describe these transactions. Various sections of the Article implement the substitution of the supplier for the lessor, including Sections 2A-209 and 2A-407. No attempt was made to fashion a special rule where the nance lessor is an aliate of the supplier of goods; this is to be developed by the courts, case by case. Sale and Leaseback: Sale and leaseback transactions are becoming increasingly common. A number of state statutes treat transactions where possession is retained by the seller as fraudulent per se or prima facie fraudulent. That position is not in accord with modern practice and thus is changed by the Article if the buyer bought for value and in good faith (Section 2A-308(3)). Remedies: The Article has not only provided for lessor's remedies upon default by the lessee (Sections 2A-523 through 2A-531), but also for lessee's remedies upon default by the lessor (Sections 2A-508 through 2A-522). This is a signicant departure from Article 9, which provides remedies only for the secured party upon default by the debtor. This dierence is compelled by the bilateral nature of the obligations between the parties to a lease. Damages: Many leasing transactions are predicated on the parties' ability to stipulate an appropriate measure of damages in the event of default. The rule with respect to sales of goods (Section 2-718) is not suciently exible to accommodate this practice. Consistent with the common law emphasis upon freedom to contract, the Article has created a revised rule that allows greater exibility with respect to leases of goods (Section 2A-504(1)). History: This Article is a revision of the Uniform Personal Property Leasing Act, which was approved by the National Conference of Commissioners on Uniform State Laws in August, 1985. However, it was believed that the subject matter of the Uniform Personal Property Leasing Act would be better treated as an article of this Act. Thus, although the Conference promulgated the Uniform Personal Property Leasing Act as a Uniform Law, activity was held in abeyance to allow time to restate the Uniform Personal Property Leasing Act as Article 2A. In August, 1986 the Conference approved and recommended this Article (including conforming amendments to Article 1 and Article 9) for promulgation as an amendment to this Act. In December, 1986 the Council of the American Law Institute approved and recommended this Article (including conforming amendments to Article 1 and Article 9), with ocial comments, for promulgation as an amendment to this Act. In March, 1987 the Permanent Editorial Board for the Uniform Commercial Code approved and recommended this Article (including conforming amendments to Article 1 and Article 9), with ocial comments, for promulgation as an amendment to this Act. In May, 1987 the American Law Institute approved and recommended this Article (including conforming amendments to Article 1 and Article 9), with ocial comments, for promulgation as an amendment to this Act. In August, 1987 the Conference conrmed its approval of the nal text of this Article. Upon its initial promulgation, Article 2A was rapidly enacted in several states, was introduced in a number of other states, and underwent bar association, law revision commission and legislative study in still further states. In that process debate emerged, principally sparked by the study of Article 2A by the California Bar Association, California's non-uniform amendments to Article 2A, and articles appearing in a symposium on Article 2A published after its promulgation in the Alabama Law Review. The debate chiey centered on whether Article 2A had struck the proper balance or was clear enough concerning the ability of a lessor to grant a security interest in its leasehold interest and in the residual, priority between a secured party and the lessee, and the lessor's remedy structure under Article 2A. This debate over issues on which reasonable minds could and did dier began to aect the enactment eort for Article 2A in a deleterious manner. Consequently, the Standby Committee for Article 2A, composed predominantly of the former members of the drafting committee, reviewed the legislative actions and studies in the various states, and opened a dialogue with the principal proponents of the non-uniform amendments. Negotiations were conducted in conjunction with, and were facilitated by, a study of the uniform Article and 204

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the non-uniform Amendments by the New York Law Revision Commission. Ultimately, a consensus was reached, which has been approved by the membership of the Conference, the Permanent Editorial Board, and the Council of the Institute. Rapid and uniform enactment of Article 2A is expected as a result of the completed amendments. The Article 2A experience rearms the essential viability of the procedures of the Conference and the Institute for creating and updating uniform state law in the commercial law area. Relationship of Article 2A to Other Articles: The Article on Sales provided a useful point of reference for codifying the law of leases. Many of the provisions of that Article were carried over, changed to reect dierences in style, leasing terminology or leasing practices. Thus, the ocial comments to those sections of Article 2 whose provisions were carried over are incorporated by reference in Article 2A, as well; further, any case law interpreting those provisions should be viewed as persuasive but not binding on a court when deciding a similar issue with respect to leases. Any change in the sequence that has been made when carrying over a provision from Article 2 should be viewed as a matter of style, not substance. This is not to suggest that in other instances Article 2A did not also incorporate substantially revised provisions of Article 2, Article 9 or otherwise where the revision was driven by a concern over the substance; but for the lack of a mandate, the drafting committee might well have made the same or a similar change in the statutory analogue. Those sections in Article 2A include Sections 2A-104, 2A-105, 2A-106, 2A-108(2) and (4), 2A-109(2), 2A-208, 2A-214(2) and (3)(a), 2A-216, 2A-303, 2A-306, 2A-503, 2A-504(3)(b), 2A-506(2), and 2A-515. For lack of relevance or signicance not all of the provisions of Article 2 were incorporated in Article 2A. This codication was greatly inuenced by the fundamental tenet of the common law as it has developed with respect to leases of goods: freedom of the parties to contract. Note that, like all other Articles of this Act, the principles of construction and interpretation contained in Article 1 are applicable throughout Article 2A (Section 2A-103(4)). These principles include the ability of the parties to vary the eect of the provisions of Article 2A, subject to certain limitations including those that relate to the obligations of good faith, diligence, reasonableness and care (Section 1-102(3)). Consistent with those principles no negative inference is to be drawn by the episodic use of the phrase unless otherwise agreed in certain provisions of Article 2A. Section 1-102(4). Indeed, the contrary is true, as the general rule in the Act, including this Article, is that the eect of the Act's provisions may be varied by agreement. Section 1-102(3). This conclusion follows even where the statutory analogue contains the phrase and the correlative provision in Article 2A does not. 2003 AMENDMENTS TO UNIFORM COMMERCIAL CODE ARTICLE 2ALEASES The Drafting Committee was charged with making changes to Article 2A where appropriate to incorporate amendments to Article 2, also being considered at this time, and also with making changes to the Article necessitated by the recent revision of Article 9. It is anticipated that the amendments to Articles 2 and 2A will be presented to the state legislatures as a single package. As with original Article 2A, these amendments are intended to reect the distinctive nature of leasing as a commercial transaction. Therefore the following principles should be considered in applying this Article: Leasing is Distinctive From Other Commercial Transactions Leasing is a distinct commercial transaction which is dierent in many respects from either the sale or the secured nancing of goods. A true lease of goods involves the payment for the temporary possession, use and enjoyment of goods, and a lease is entered into with an expectation that the goods will be returned to the owner at the end of the lease term. In contrast, a sale of goods involves a transfer of title for a price, and a security interest involves an interest in the goods that is limited to the remaining secured debt. The separation of ownership and possession in a lease of goods as well as other considerations can result in many dierences between the law of leases and the law for the sale of goods. These dierences include remedies and, to some extent, contract formation and warranties. Lease Contract Formation Leases often involve complex, on-going, multi-faceted obligations. Ownership of the residual remains with the lessor, and for that reason the lessor has a continuing economic interest in the goods that is not present in a sale. Therefore, lease contracts commonly 205

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cover many matters other than the lessor's duty to provide the goods and the lessee's duty to pay rent. These include where and when the goods will be returned to the lessor; options to renew the lease or purchase the goods; maintenance and repairs; restrictions on use of the goods; taxes, insurance; and record keeping. For these reasons, leasing custom and practice favors formal, structured rules of contract formation and greater usage, particularly in commercial leases, of a record of the parties' agreement embodying their understanding. Warranties Because of the manner in which leased goods are promoted and distributed-for example, lessors generally do not engage in mass-market advertising aimed at, or make representations in materials to be delivered to, remote lessees-amended Article 2A does not contain provisions analogous to Sections 2-313A and 2-313B of amended Article 2. Though nothing in this Article precludes, in an appropriate case, the application of the principles contained in those sections to a lease transaction, a lessor is responsible only for the lessor's representations and those of the lessor's agents and the lessor is not for the representations made by a third party, such as the supplier or manufacturer of the goods. In addition, a lessee may have the right as a remote purchaser under Article 2 to assert claims under Sections 2-313A and 2-313B directly against a manufacturer or supplier that has engaged in advertising. Damages The typical measure of damages for breach of a lease diers from that applied in the law that governs the sale of goods in that, for breach of a lease contract by the lessee, the present value of an ongoing stream of rental payments normally must be taken into consideration as well as the lessor's rights to return of the goods with a certain residual value. As a result, if the goods are sold following a default by the lessee, in calculating the lessee's deciency, the value of the lessor's residual interest should be excluded from the disposition proceeds that are credited to the lessee.

As amended in 1990, 2003 and 2005.

See Appendix F for material relating to changes in Ocial Comment in 1990. See Appendix U for material relating to changes made in Ocial Comment in 2003. See Appendix V for material relating to changes made in Ocial Comment in 2005.

2A-102. Scope. This Article applies to any transaction, regardless of form, that creates a lease. Ocial Comment
Uniform Statutory Source: Section 9-102(1). Throughout this Article, unless otherwise stated, references to Section are to other sections of this Act. Changes: Substantially revised. Purposes: This Article governs transactions as diverse as the lease of a hand tool to an individual for a few hours and the leveraged lease of a complex line of industrial equipment to a multi-national organization for a number of years. To achieve that end it was necessary to provide that this Article applies to any transaction, regardless of form, that creates a lease. Since lease is dened as a transfer of an interest in goods (Section 2A-103(1)(j)) and goods is dened to include xtures (Section 2A103(1)(h)), application is limited to the extent the transaction relates to goods, including xtures. Further, since the denition of lease does not include a sale (Section 2-106(1)) or retention or creation of a security interest (Section 1-201(37)), application is further limited; sales and security interests are governed by other Articles of this Act. Finally, in recognition of the diversity of the transactions to be governed, the sophistication of many of the parties to these transactions, and the common law tradition as it applies to the bailment for hire or lease, freedom of contract has been preserved. DeKoven, Proceedings After Default by the Lessee Under a True Lease of Equipment, in 1C P. Coogan, W. Hogan, D. Vagts, Secured Transactions Under the Uniform Commercial Code, 206

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29B.02[2] (1986). Thus, despite the extensive regulatory scheme established by this Article, the parties to a lease will be able to create private rules to govern their transaction. Sections 2A-103(4) and 1-102(3). However, there are special rules in this Article governing consumer leases, as well as other state and federal statutes, that may further limit freedom of contract with respect to consumer leases. A court may apply this Article by analogy to any transaction, regardless of form, that creates a lease of personal property other than goods, taking into account the expressed intentions of the parties to the transaction and any dierences between a lease of goods and a lease of other property. Such application has precedent as the provisions of the Article on Sales (Article 2) have been applied by analogy to leases of goods. E.g., Hawkland, The Impact of the Uniform Commercial Code on Equipment Leasing, 1972 Ill.L.F. 446; Murray, Under the Spreading Analogy of Article 2 of the Uniform Commercial Code, 39 Fordham L.Rev. 447 (1971). Whether such application would be appropriate for other bailments of personal property, gratuitous or for hire, should be determined by the facts of each case. See Mieske v. Bartell Drug Co., 92 Wash.2d 40, 4648, 593 P.2d 1308, 1312 (1979). Further, parties to a transaction creating a lease of personal property other than goods, or a bailment of personal property may provide by agreement that this Article applies. Upholding the parties' choice is consistent with the spirit of this Article. Denitional Cross Reference: Lease. Section 2A-103(1)(p).

2A-103. Denitions and Index of Denitions. (1) In this Article, unless the context otherwise requires: (a) Cancellation occurs when either party puts an end to the lease contract for default by the other party. (b) Commercial unit means such a unit of goods as by commercial usage is a single whole for purposes of lease and division of which materially impairs its character or value on the market or in use. A commercial unit may be a single article, as a machine, or a set of articles, as a suite of furniture or a line of machinery, or a quantity, as a gross or carload, or any other unit treated in use or in the relevant market as a single whole. (c) Conforming goods or performance under a lease contract means goods or performance that are in accordance with the obligations under the lease contract. (d) Conspicuous, with reference to a term, means so written, displayed, or presented that a reasonable person against which it is to operate ought to have noticed it. A term in an electronic record intended to evoke a response by an electronic agent is conspicuous if it is presented in a form that would enable a reasonably congured electronic agent to take it into account or react to it without review of the record by an individual. Whether a term is conspicuous or not is a decision for the court. Conspicuous terms include the following: (i) for a person: (A) a heading in capitals equal to or greater in size than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same or lesser size; and (B) language in the body of a record or display in larger type than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same size, or set o from surrounding text of the same size by symbols or other marks that call attention to the language; and
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(ii) for a person or an electronic agent, a term that is so placed in a record or display that the person or electronic agent cannot proceed without taking action with respect to the particular term. (e) Consumer means an individual who leases or contracts to lease goods that, at the time of contracting, are intended by the individual to be used primarily for personal, family, or household purposes. (f) Consumer lease means a lease that a lessor regularly engaged in the business of leasing or selling makes to a consumer.
Legislative Note: Present Article 2A has a bracketed provision allowing States to insert a dollar cap on leases designated as consumer leases, amended Article 2 denes consumer contract and does not include a dollar cap in the denition. Some States have not included a dollar cap in present Article 2A and States which have adopted a dollar cap have stated varying amounts. If a State wishes to include a dollar cap, the cap should be inserted here. Any cap probably should be set high enough to bring within the denition most automobile leasing transactions for personal, family, or household use.

(g) Delivery means the voluntary transfer of physical possession or control of goods. (h) Electronic means relating to technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities. (i) Electronic agent means a computer program or an electronic or other automated means used independently to initiate an action or respond to electronic records or performances in whole or in part, without review or action by an individual. (j) Electronic record means a record created, generated, sent, communicated, received, or stored by electronic means. (k) Fault means wrongful act, omission, breach, or default. (l) Finance lease means a lease with respect to which: (i) the lessor does not select, manufacture, or supply the goods; (ii) the lessor acquires the goods or the right to possession and use of the goods in connection with the lease or, in the case of goods that have been leased previously by the lessor and are not being leased to a consumer, in connection with another lease; and (iii) one of the following occurs: (A) the lessee receives a copy of the agreement by which the lessor acquired, or proposes to acquire, the goods or the right to possession and use of the goods before signing the lease agreement; (B) the lessee's approval of the agreement or of the general contractual terms under which the lessor acquired or proposes to acquire the goods or the right to possession and use of the goods is a condition to the eectiveness of the lease contract; (C) the lessee, before signing the lease agreement, receives an accurate and complete statement designating the promises and warranties, and any disclaimers of warranties, limitations or modications of remedies, or liquidated damages, including those of a third party, such as the manufacturer of the goods, provided to the lessor by the person supplying the goods in connection with or as part of the contract by which the lessor acquired the goods or the right to possession and use of the goods; or (D) if the lease is not a consumer lease, before the lessee signs the lease agreement, the lessor informs the lessee in a record:
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(I) of the identity of the person supplying the goods to the lessor, unless the lessee has selected that person and directed the lessor to acquire the goods or the right to possession and use of the goods from that person; (II) that the lessee is entitled under this article to the promises and warranties, including those of any third party, provided to the lessor by the person supplying the goods in connection with or as part of the contract by which the lessor acquired the goods or the right to possession and use of the goods; and (III) that the lessee may communicate with the person supplying the goods to the lessor and receive an accurate and complete statement of those promises and warranties, including any disclaimers and limitations of them, or a statement of remedies. (m) Good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing.
Legislative Note: Denition (m) should not be adopted if the jurisdiction has enacted the equivalent provision in the 2001 Revised Article 1.

(n) Goods means all things that are movable at the time of identication to a lease contract or that are xtures (Section 2A-309). The term includes future goods, specially manufactured goods, and the unborn young of animals. The term does not include information, the money in which the price is to be paid, investment securities under Article 8, or choses in action. (o) Installment lease contract means a lease contract that authorizes or requires the delivery of goods in separate lots to be separately accepted, even though the lease contract contains a clause each delivery is a separate lease or its equivalent. (p) Lease means a transfer of the right to possession and use of goods for a period in return for consideration, but a sale, including a sale on approval or a sale or return, retention or creation of a security interest, or license of information is not a lease. Unless the context clearly indicates otherwise, the term includes a sublease. (q) Lease agreement, as distinguished from lease contract, means the bargain, with respect to the lease, of the lessor and the lessee in fact as found in their language or inferred from other circumstances including course of performance, course of dealing, or usage of trade as provided in Section 1-303. Unless the context clearly indicates otherwise, the term includes a sublease agreement. (r) Lease contract, as distinguished from lease agreement, means the total legal obligation that results from the lease agreement as determined by the [Uniform Commercial Code] as supplemented by any other applicable rules of law. Unless the context clearly indicates otherwise, the term includes a sublease contract. (s) Leasehold interest means the interest of the lessor or the lessee under a lease contract. (t) Lessee means a person that acquires the right to possession and use of goods under a lease. Unless the context clearly indicates otherwise, the term includes a sublessee. (u) Lessee in ordinary course of business means a person that leases
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goods in good faith, without knowledge that the lease violates the rights of another person, and in the ordinary course from a person, other than a pawnbroker, in the business of selling or leasing goods of that kind. A person leases in ordinary course if the lease to the person comports with the usual or customary practices in the kind of business in which the lessor is engaged or with the lessor's own usual or customary practices. A lessee in ordinary course of business may lease for cash, by exchange of other property, or on secured or unsecured credit, and may acquire goods or documents of title under a preexisting lease contract. Only a lessee that takes possession of the goods or has a right to recover the goods from the lessor under this article may be a lessee in ordinary course of business. A person that acquires goods in a transfer in bulk or as security for or in total or partial satisfaction of a money debt is not a lessee in ordinary course of business. (v) Lessor means a person that transfers the right to possession and use of goods under a lease. Unless the context clearly indicates otherwise, the term includes a sublessor. (w) Lessor's residual interest means the lessor's interest in the goods after expiration, termination, or cancellation of the lease contract. (x) Lien means a charge against or interest in goods to secure payment of a debt or performance of an obligation. The term does not include a security interest. (y) Lot means a parcel or a single article that is the subject matter of a separate lease or delivery, whether or not it is sucient to perform the lease contract. (z) Merchant lessee means a lessee that is a merchant with respect to goods of the kind subject to the lease. (aa) Present value means the amount as of a date certain of one or more sums payable in the future, discounted to the date certain by use of either an interest rate specied by the parties if that rate is not manifestly unreasonable at the time the transaction is entered into or, if an interest rate is not so specied, a commercially reasonable rate that takes into account the facts and circumstances at the time the transaction is entered into.
Legislative Note: Denition (aa) should not be adopted if the jurisdiction has enacted the equivalent provision in the 2001 Revised Article 1.

(bb) Purchase includes taking by sale, lease, mortgage, security interest, pledge, gift, or any other voluntary transaction creating an interest in goods.
Legislative Note: Denition (bb) should not be adopted if the jurisdiction has enacted the equivalent provision in the 2001 Revised Article 1.

(cc) Record means information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.
Legislative Note: Denition (cc) should not be adopted if the jurisdiction has enacted the equivalent provision in the 2001 Revised Article 1.

(dd) Sign means, with present intent to authenticate or adopt a record, (i) to execute or adopt a tangible symbol; or
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(ii) to attach to or logically associate with the record an electronic sound, symbol, or process. (ee) Sublease means a lease of goods the right to possession and use of which was acquired by the lessor as a lessee under an existing lease. () Supplier means a person from which a lessor buys or leases goods to be leased under a nance lease. (gg) Supply contract means a contract under which a lessor buys or leases goods to be leased. (hh) Termination occurs when either party pursuant to a power created by agreement or law puts an end to the lease contract otherwise than for default. (2) Other denitions applying to this Article and the sections in which they appear are: Accessions. Section 2A-310(1). Construction mortgage. Section 2A-309(1)(d). Encumbrance. Section 2A-309(1)(e). Fixtures. Section 2A-309(1)(a). Fixture ling. Section 2A-309(1)(b). Purchase money lease. Section 2A-309(1)(c). (3) The following denitions in other Articles apply to this Article: Between merchants. Section 2-104(3). Buyer. Section 2-103(1)(a). Consumer goods. Section 9-109(1). Entrusting. Section 2-403(3). Letter of credit. Section 5-102(a)(10). Merchant. Section 2-104(1). Receipt of goods. Section 2-103(1)(c). Sale. Section 2-106(1). Sale on approval. Section 2-326. Sale or return. Section 2-326. Seller. Section 2-103(1)(n). (4) In addition Article 1 contains general denitions and principles of construction and interpretation applicable throughout this Article. As amended in 1990, 1999, 2001 and 2003.
See Appendix F for material relating to changes made in text in 1990. See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999. See Appendix I contained within revised Article 1 for material relating to changes made in text in 2001. See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
(a) The denition of Buyer in ordinary course of business is in Article 1 (Section 1-201(9)). It was amended as part of the Article 9 revision process, and revised Article 1 is consistent with the Article 9 amendment. (b) Cancellation. Section 2-106(4). The eect of a cancellation is provided in Section 2A505(1). 211

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(c) Commercial unit. Section 2-105(6). (d) Conforming. Section 2-106(2). (e) Consumer lease. New. This Article includes a subset of rules that applies only to consumer leases. Sections 2A-106, 2A-108(2), 2A-108(4), 2A-109(2), 2A-221, 2A-309, 2A-406, 2A-407, 2A-504(3)(b), and 2A-516(3)(b). For a transaction to qualify as a consumer lease it must rst qualify as a lease. Section 2A-103(1)(j). Note that this Article regulates the transactional elements of a lease, including a consumer lease; consumer protection statutes, present and future, and existing consumer protection decisions are unaected by this Article. Section 2A-104(1)(c) and (2). Of course, Article 2A as state law also is subject to federal consumer protection law. This denition is modeled after the denition of consumer lease in the Consumer Leasing Act, 15 U.S.C. 1667 (1982), and in the Unif. Consumer Credit Code 1.301(14), 7A U.L.A. 43 (1974). However, this denition of consumer lease diers from its models in several respects: the lessor can be a person regularly engaged either in the business of leasing or of selling goods, the lease need not be for a term exceeding four months, a lease primarily for an agricultural purpose is not covered, and whether there should be a limitation by dollar amount and its amount is left up to the individual states. This denition focuses on the parties as well as the transaction. If a lease is within this denition, the lessor must be regularly engaged in the business of leasing or selling, and the lessee must be an individual, not an organization; note that a lease to two or more individuals having a common interest through marriage or the like is not excluded as a lease to an organization under Section 1-201(28). The lessee must take the interest primarily for a personal, family or household purpose. If required by the enacting state, total payments under the lease contract, excluding payments for options to renew or buy, cannot exceed the gure designated. (f) Fault. Section 1-201(16). (g) For a transaction to qualify as a nance lease it must rst qualify as a lease. Unless the lessor is comfortable that the transaction will qualify as a nance lease, the lease agreement should include provisions giving the lessor the benets created by the subset of rules applicable to the transaction that qualies as a nance lease under this Article. A nance lease is the product of a three party transaction. The supplier manufactures or supplies the goods pursuant to the lessee's specication, perhaps even pursuant to a purchase order, sales agreement or lease agreement between the supplier and the lessee. After the prospective nance lease is negotiated, a purchase order, sales agreement, or lease agreement is entered into by the lessor (as buyer or prime lessee) or an existing order, agreement or lease is assigned by the lessee to the lessor, and the lessor and the lessee then enter into a lease or sublease of the goods. Due to the limited function usually performed by the lessor, the lessee looks almost entirely to the supplier for representations, covenants and warranties. If a manufacturer's warranty carries through, the lessee may also look to that. Yet, this denition does not restrict the lessor's function solely to the supply of funds; if the lessor undertakes or performs other functions, express warranties, covenants and the common law will protect the lessee. This denition focuses on the transaction, not the status of the parties; to avoid confusion it is important to note that in other contexts, e.g., tax and accounting, the term nance lease has been used to connote dierent types of lease transactions, including leases that are disguised secured transactions. M. Rice, Equipment Financing, 6271 (1981). A lessor who is a merchant with respect to goods of the kind subject to the lease may be a lessor under a nance lease. Many leases that are leases back to the seller of goods (Section 2A308(3)) will be nance leases. This conclusion is easily demonstrated by a hypothetical. Assume that B has bought goods from C pursuant to a sales contract. After delivery to and acceptance of the goods by B, B negotiates to sell the goods to A and simultaneously to lease the goods back from A, on terms and conditions that, we assume, will qualify the transaction as a lease. In documenting the sale and lease back, B assigns the original sales contract between B, as buyer, and C, as seller, to A. A review of these facts leads to the conclusion that the lease from A to B qualies as a nance lease, as all three conditions of the denition are satised. Subparagraph (i) is satised as A, the lessor, had nothing to do with the selection, manufacture, or supply of the equipment. Subparagraph (ii) is satised as A, the lessor, bought the equipment at the same time that A leased the equipment to B, which certainly is in connection with the lease. Finally, subparagraph (iii)(A) is satised as 212

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A entered into the sales contract with B at the same time that A leased the equipment back to B. B, the lessee, will have received a copy of the sales contract in a timely fashion. Subparagraph (i) requires the lessor to remain outside the selection, manufacture and supply of the goods; that is the rationale for releasing the lessor from most of its traditional liability. The lessor is not prohibited from possession, maintenance or operation of the goods, as policy does not require such prohibition. To insure the lessee's reliance on the supplier, and not on the lessor, subparagraph (ii) requires that the goods (where the lessor is the buyer of the goods) or that the right to possession and use of the goods (where the lessor is the prime lessee and the sublessor of the goods) be acquired in connection with the lease (or sublease) to qualify as a nance lease. The scope of the phrase in connection with is to be developed by the courts, case by case. Finally, as the lessee generally relies almost entirely upon the supplier for representations and covenants, and upon the supplier or a manufacturer, or both, for warranties with respect to the goods, subparagraph (iii) requires that one of the following occur: (A) the lessee receive a copy of the supply contract before signing the lease contract; (B) the lessee's approval of the supply contract is a condition to the eectiveness of the lease contract; (C) the lessee receive a statement describing the promises and warranties and any limitations relevant to the lessee before signing the lease contract; or (D) before signing the lease contract and except in a consumer lease, the lessee receive a writing identifying the supplier (unless the supplier was selected and required by the lessee) and the rights of the lessee under Section 2A-303, and advising the lessee a statement of promises and warranties is available from the supplier. Thus, even where oral supply orders or computer placed supply orders are compelled by custom and usage the transaction may still qualify as a nance lease if the lessee approves the supply contract before the lease contract is eective and such approval was a condition to the effectiveness of the lease contract. Moreover, where the lessor does not want the lessee to see the entire supply contract, including price information, the lessee may be provided with a separate statement of the terms of the supply contract relevant to the lessee; promises between the supplier and the lessor that do not aect the lessee need not be included. The statement can be a restatement of those terms or a copy of portions of the supply contract with the relevant terms clearly designated. Any implied warranties need not be designated, but a disclaimer or modication of remedy must be designated. A copy of any manufacturer's warranty is sucient if that is the warranty provided. However, a copy of any Regulation M disclosure given pursuant to 12 C.F.R. 213.4(g) concerning warranties in itself is not sucient since those disclosures need only briey identify express warranties and need not include any disclaimer of warranty. Under subparagraphs (ii) and (iii), except when the new lease is to a consumer lessee, a nance lessor can have that status on re-leasing the property after it is returned from an original lease. However, in that case, the other elements required for the lease to be a nance lessee must be complied with. If a transaction does not qualify as a nance lease, the parties may achieve the same result by agreement; no negative implications are to be drawn if the transaction does not qualify. Further, absent the application of special rules (fraud, duress, and the like), a lease that qualies as a nance lease and is assigned by the lessor or the lessee to a third party does not lose its status as a nance lease under this Article. Finally, this Article creates no special rule where the lessor is an aliate of the supplier; whether the transaction qualies as a nance lease will be determined by the facts of each case. (h) Goods. Section 9-105(1)(h). See Section 2A-103(3) for reference to the denition of Account, Chattel paper, Document, General intangibles and Instrument. See Section 2A-217 for determination of the time and manner of identication. (i) Installment lease contract. Section 2-612(1). (j) Lease. New. There are several reasons to codify the law with respect to leases of goods. An analysis of the case law as it applies to leases of goods suggests at least several signicant issues to be resolved by codication. First and foremost is the denition of a lease. It is necessary to dene lease to determine whether a transaction creates a lease or a security interest disguised as a lease. If the transaction creates a security interest disguised as a lease, the transaction will be governed by the Article on Secured Transactions (Article 9) and the lessor will be required to le a nancing statement or take other action to perfect its interest in the goods against third parties. There is no such requirement with respect to leases under the common law and, except with respect to leases of xtures (Section 2A-309), this Article imposes no such requirement. Yet the distinction between a lease and 213

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a security interest disguised as a lease is not clear from the case law at the time of the promulgation of this Article. DeKoven, Leases of Equipment: Puritan Leasing Company v. August, A Dangerous Decision, 12 U.S.F. L.Rev. 257 (1978). At common law a lease of personal property is a bailment for hire. While there are several denitions of bailment for hire, all require a thing to be let and a price for the letting. Thus, in modern terms and as provided in this denition, a lease is created when the lessee agrees to furnish consideration for the right to the possession and use of goods over a specied period of time. Mooney, Personal Property Leasing: A Challenge, 36 Bus.Law. 1605, 1607 (1981). Further, a lease is neither a sale (Section 2-106(1)) nor a retention or creation of a security interest (Section 1-201(37)). Due to extensive litigation to distinguish true leases from security interests, an amendment to Section 1-201(37) has been promulgated with this Article to create a sharper distinction. This section as well as Section 1-201(37) must be examined to determine whether the transaction in question creates a lease or a security interest. The following hypotheticals indicate the perimeters of the issue. Assume that A has purchased a number of copying machines, new, for $1,000 each; the machines have an estimated useful economic life of three years. A advertises that the machines are available to rent for a minimum of one month and that the monthly rental is $100.00. A intends to enter into leases where A provides all maintenance, without charge to the lessee. Further, the lessee will rent the machine, month to month, with no obligation to renew. At the end of the lease term the lessee will be obligated to return the machine to A's place of business. This transaction qualies as a lease under the rst half of the denition, for the transaction includes a transfer by A to a prospective lessee of possession and use of the machine for a stated term, month to month. The machines are goods (Section 2A-103(1)(h)). The lessee is obligated to pay consideration in return, $100.00 for each month of the term. However, the second half of the denition provides that a sale or a security interest is not a lease. Since there is no passing of title, there is no sale. Sections 2A-103(3) and 2-106(1). Under pre-Act security law this transaction would have created a bailment for hire or a true lease and not a conditional sale. Da Rocha v. Macomber, 330 Mass. 611, 61415, 116 N.E.2d 139, 142 (1953). Under Section 1-201(37), as amended with the promulgation of this Article, the same result would follow. While the lessee is obligated to pay rent for the one month term of the lease, one of the other four conditions of the second paragraph of Section 1-201(37) must be met and none is. The term of the lease is one month and the economic life of the machine is 36 months; thus, subparagraph (a) of Section 1-201(37) is not now satised. Considering the amount of the monthly rent, absent economic duress or coercion, the lessee is not bound either to renew the lease for the remaining economic life of the goods or to become the owner. If the lessee did lease the machine for 36 months, the lessee would have paid the lessor $3,600 for a machine that could have been purchased for $1,000; thus, subparagraph (b) of Section 1-201(37) is not satised. Finally, there are no options; thus, subparagraphs (c) and (d) of Section 1-201(37) are not satised. This transaction creates a lease, not a security interest. However, with each renewal of the lease the facts and circumstances at the time of each renewal must be examined to determine if that conclusion remains accurate, as it is possible that a transaction that rst creates a lease, later creates a security interest. Assume that the facts are changed and that A requires each lessee to lease the goods for 36 months, with no right to terminate. Under pre-Act security law this transaction would have created a conditional sale, and not a bailment for hire or true lease. Hervey v. Rhode Island Locomotive Works, 93 U.S. 664, 67273 (1876). Under this subsection, and Section 1-201(37), as amended with the inclusion of this Article in the Act, the same result would follow. The lessee's obligation for the term is not subject to termination by the lessee and the term is equal to the economic life of the machine. Between these extremes there are many transactions that can be created. Some of the transactions have not been properly categorized by the courts in applying the 1978 and earlier Ocial Texts of Section 1-201(37). This subsection, together with Section 1-201(37), as amended with the promulgation of this Article, draws a brighter line, which should create a clearer signal to the professional lessor and lessee. (k) Lease agreement. This denition is derived from the rst sentence of Section 1-201(3). Because the denition of lease is broad enough to cover future transfers, lease agreement includes an agreement contemplating a current or subsequent transfer. Thus it was not necessary to make an express reference to an agreement for the future lease of 214

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goods (Section 2-106(1)). This concept is also incorporated in the denition of lease contract. Note that the denition of lease does not include transactions in ordinary building materials that are incorporated into an improvement on land. Section 2A-309(2). The provisions of this Article, if applicable, determine whether a lease agreement has legal consequences; otherwise the law of bailments and other applicable law determine the same. Sections 2A-103(4) and 1-103. (l) Lease contract. This denition is derived from the denition of contract in Section 1-201(11). Note that a lease contract may be for the future lease of goods, since this notion is included in the denition of lease. (m) Leasehold interest. New. (n) Lessee. New. (o) The denition of Lessee in ordinary course of business conforms with amendments to Section 1-201(9) (buyer in ordinary course of business) that were part of the Article 9 revision process (with the omission of the reference to sales of minerals). (p) Lessor. New. (q) Lessor's residual interest. New. (r) Lien. New. This term is used in Section 2A-307 (Priority of Liens Arising by Attachment or Levy on, Security Interests in, and Other Claims to Goods). (s) Lot. Section 2-105(5). (t) Merchant lessee. New. This term is used in Section 2A-511 (Merchant Lessee's Duties as to Rightfully Rejected Goods). A person may satisfy the requirement of dealing in goods of the kind subject to the lease as lessor, lessee, seller, or buyer. (u) Present value. New. Authorities agree that present value should be used to determine fairly the damages payable by the lessor or the lessee on default. E.g., Taylor v. Commercial Credit Equip. Corp., 170 Ga.App. 322, 316 S.E.2d 788 (1984). Present value is dened to mean an amount that represents the discounted value as of a date certain of one or more sums payable in the future. This is a function of the economic principle that a dollar today is more valuable to the holder than a dollar payable in two years. While there is no question as to the principle, reasonable people would dier as to the rate of discount to apply in determining the value of that future dollar today. To minimize litigation, this Article allows the parties to specify the discount or interest rate, if the rate was not manifestly unreasonable at the time the transaction was entered into. In all other cases, the interest rate will be a commercially reasonable rate that takes into account the facts and circumstances of each case, as of the time the transaction was entered into. (v) Purchase. Section 1-201(32). This denition omits the reference to lien contained in the denition of purchase in Article 1 (Section 1-201(32)). This should not be construed to exclude consensual liens from the denition of purchase in this Article; the exclusion was mandated by the scope of the denition of lien in Section 2A-103(1)(r). Further, the denition of purchaser in this Article adds a reference to lease; as purchase is dened in Section 1-201(32) to include any other voluntary transaction creating an interest in property, this addition is not substantive. (w) Sublease. New. (x) Supplier. New. (y) Supply contract. New. (z) Termination. Section 2-106(3). The eect of a termination is provided in Section 2A505(2).

As amended in 2001, 2003 and 2005.

See Appendix I contained within revised Article 1 for material relating to changes made in Ocial Comment in 2001. See Appendix U for material relating to changes made in Ocial Comment in 2003. See Appendix V for material relating to changes made in Ocial Comment in 2005.

2A-104. Leases Subject to Other Law. (1) A lease subject to this Article, is also subject to any applicable:
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(a) [list any certicate of title statutes covering automobiles, trailers, mobile homes, boats, farm tractors, or the like;] (b) certicate of title statute of another jurisdiction (Section 2A-105); or (c) rule of law that establishes a dierent rule for consumers. (2) To the extent there is a conict between this Article, other than Sections 2A-105, 2A-304(3), and 2A-305(3), and a law referred to in subsection (1), that law governs. (3) For purposes of this Article, failure to comply with a law referred to in subsection (1) has only the eect specied in that law. (4) This article modies, limits, and supersedes the federal Electronic Signatures in Global and National Commerce Act, 15 U.S.C. Section 7001 et seq., except that nothing in this article modies, limits, or supersedes Section 7001(c) of that Act or authorizes electronic delivery of any of the notices described in Section 7003(b) of that Act. As amended in 1990 and 2003.
See Appendix F for material relating to changes made in text in 1990. See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Sections 9-203(4) and 9-302(3)(b) and (c). Changes: Substantially revised. Purposes: 1. This Article creates a comprehensive scheme for the regulation of transactions that create leases. Section 2A-102. Thus, the Article supersedes all prior legislation dealing with leases, except to the extent set forth in this Section. 2. Subsection (1) states the general rule that a lease, although governed by the scheme of this Article, also may be governed by certain other applicable laws. This may occur in the case of a consumer lease. Section 2A-103(1)(e). Those laws may be state statutes existing prior to enactment of Article 2A or passed afterward. In this case, it is desirable for this Article to specify which statute controls. Or the law may be a pre-existing consumer protection decision. This Article preserves such decisions. Or the law may be a statute of the United States. Such a law controls without any statement in this Article under applicable principles of preemption. An illustration of a statute of the United States that governs consumer leases is the Consumer Leasing Act, 15 U.S.C. 1667-1667(e) (1982) and its implementing regulation, Regulation M, 12 C.F.R. 213 (1986); the statute mandates disclosures of certain lease terms, delimits the liability of a lessee in leasing personal property, and regulates the advertising of lease terms. An illustration of a state statute that governs consumer leases and which if adopted in the enacting state prevails over this Article is the Unif. Consumer Credit Code, which includes many provisions similar to those of the Consumer Leasing Act, e.g. Unif. Consumer Credit Code 3.202, 3.209, 3.401, 7A U.L.A. 10809, 115, 125 (1974), as well as provisions in addition to those of the Consumer Leasing Act, e.g., Unif. Consumer Credit Code 5.109.111, 7A U.L.A. 17176 (1974) (the right to cure a default). Such statutes may dene consumer lease so as to govern transactions within and without the denition of consumer lease under this Article. 3. Under subsection (2), subject to certain limited exclusions, in case of conict a statute or a decision described in subsection (1) prevails over this Article. For example, a provision like Unif. Consumer Credit Code 5.112, 7A U.L.A. 176 (1974), limiting self-help repossession, prevails over Section 2A-525(3). A consumer protection decision rendered after the effective date of this Article may supplement its provisions. For example, in relation to Article 9 a court might conclude that an acceleration clause may not be enforced against an individual debtor after late payments have been accepted unless a prior notice of default is given. To the extent the decision establishes a general principle applicable to transactions other than secured transactions, it may supplement Section 2A-502. 216

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4. Consumer protection in lease transactions is primarily left to other law. However, several provisions of this Article do contain special rules that may not be varied by agreement in the case of a consumer lease. E.g., Sections 2A-106, 2A-108, and 2A-109(2). Were that not so, the ability of the parties to govern their relationship by agreement together with the position of the lessor in a consumer lease too often could result in a one-sided lease agreement. 5. In construing this provision the reference to statute should be deemed to include applicable regulations. A consumer protection decision is nal on the eective date of this Article if it is not subject to appeal on that date or, if subject to appeal, is not later reversed on appeal. Of course, such a decision can be overruled by a later decision or superseded by a later statute. 6. Subsection (4) takes advantage of a provision of the federal Electronic Signatures in Global and National Commerce Act (E-Sign). E-Sign permits state law to modify, limit or supersede its provisions if the state law is consistent with Titles I and II of E-Sign, gives no special legal eect or validity to and does not require the implementation or application of specic technologies or technical specications, and if enacted subsequent to E-Sign makes specic reference to E-Sign. Subsection (4) does not apply to section 101(c) of E-Sign, nor does it authorize electronic delivery of the notices described in section 103(b) of E-Sign. Cross References: Point 3: Section 2A-525. Point 4: Sections 2A-106, 2A-108 and 2A-109. Denitional Cross Reference: Lease. Section 2A-103(1)(p).

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-105. Territorial Application of Article to Goods Covered by Certicate of Title. (1) This section applies to goods covered by a certicate of title, even if there is no other relationship between the jurisdiction under whose certicate of title the goods are covered and the goods or the lessee or lessor. (2) Goods become covered by a certicate of title when a valid application for the certicate of title and the application fee are delivered to the appropriate authority. Goods cease to be covered by a certicate of title at the earlier of the time the certicate of title ceases to be eective under the law of the issuing jurisdiction or the time the goods become covered subsequently by a certicate of title issued by another jurisdiction. (3) Subject to Sections 2A-304(3) and 2A-305(3), with respect to goods covered by a certicate of title under a statute of this State or of another jurisdiction, compliance and the eect of compliance or noncompliance with the certicate-of-title statute are governed by the local law of the jurisdiction whose certicate of title covers the goods from the time the goods become covered by the certicate until the goods cease to be covered by the certicate of title. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Former Section 9-103(2)(a) and (b) (now codied as Sections 9-303 and 9-316). Changes: Substantially revised. The provisions of the last sentence of former Section 9-103(2)(b) were not incorporated as they are superuous in this context. The provisions of former Section 9-103(2)(d) were not incorporated because the problems dealt with are 217

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adequately addressed by this section and Sections 2A-304(3) and 305(3). Purposes: The new certicate referred to in (2) must be permanent, not temporary. Generally, the lessor or creditor whose interest is indicated on the most recently issued certicate of title will prevail over interests indicated on certicates issued previously by other jurisdictions. This provision reects a policy that it is reasonable to require holders of interests in goods covered by a certicate of title to police the goods or risk losing their interests when a new certicate of title is issued by another jurisdiction. Cross References: Sections 2A-304(3), 2A-305(3), and Sections 9-303, 9-316 and 9-337. Denitional Cross Reference: Goods. Section 2A-103(1)(n).

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-106. Limitation on Power of Parties to Consumer Lease to Choose Applicable Law and Judicial Forum. (1) If the law chosen by the parties to a consumer lease is that of a jurisdiction other than a jurisdiction in which the lessee resides at the time the lease agreement becomes enforceable or within 30 days thereafter or in which the goods are to be used, the choice is not enforceable. (2) If the judicial forum chosen by the parties to a consumer lease is a forum that would not otherwise have jurisdiction over the lessee, the choice is not enforceable. Ocial Comment
Uniform Statutory Source: Uniform Consumer Credit Code 1.201(8). 1974. Changes: Substantially Revised. Purposes: There is a real danger that a lessor may induce a consumer lessee to agree that the applicable law will be a jurisdiction that has little eective consumer protection, or to agree that the applicable forum will be a forum that is inconvenient for the lessee in the event of litigation. As a result, this section invalidates these choice of law or forum clauses, except where the law chosen is that of the state of the consumer's residence or where the goods will be kept, or the forum chosen is one that otherwise would have jurisdiction over the lessee. However, the jurisdiction in which the goods are to be used may include the jurisdiction in which they are physically delivered to the lessee. Thus, a term selecting the law of the jurisdiction of delivery normally is enforceable under this section. Subsection (1) limits potentially abusive choice of law clauses in consumer leases. This section has no eect on choice of law clauses in leases that are not consumer leases and those clauses would be governed by other law. Subsection (2) prevents enforcement of potentially abusive jurisdictional consent clauses in consumer leases. By using the term judicial forum, this section does not limit selection of a nonjudicial forum, such as arbitration. This section has no eect on choice of forum clauses in leases that are not consumer leases; such clauses are, as a matter of current law, prima facie valid. The Bremen v. Zapata O-Shore Co., 407 U.S. 1, 10 (1972) and these clauses would be governed by other law. Cross Reference: Section 9-103(1)(c). Denitional Cross References: Consumer lease. Section 2A-103(1)(f). Lease agreement. Section 2A-103(1)(k). Lessee. Section 2A-103(1)(t). Goods. Section 2A-103(1)(n). Party. Section 1-201.

As amended in 2003.
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See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-107. Waiver or Renunciation of Claim or Right after Default. A claim or right arising out of an alleged default or breach of warranty may be discharged in whole or in part without consideration by the aggrieved party in a signed record. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 1-107. Changes: Revised to reect leasing practices and terminology. This clause is used throughout the ocial comments to this Article to indicate the scope of change in the provisions of the Uniform Statutory Source included in the section; these changes range from one extreme, e.g., a signicant dierence in practice (a warranty as to merchantability is not implied in a nance lease (Section 2A-212)) to the other extreme, e.g., a modest dierence in style or terminology (the transaction governed is a lease not a sale (Section 2A103)). Denitional Cross References: Record. Section 2A-103(1)(p). Signed. Section 2A-103(1)(dd).

2A-108. Unconscionability. (1) If the court as a matter of law nds a lease contract or any clause of a lease contract to have been unconscionable at the time it was made the court may refuse to enforce the lease contract, or it may enforce the remainder of the lease contract without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result. (2) With respect to a consumer lease, if the court as a matter of law nds that a lease contract or any clause of a lease contract has been induced by unconscionable conduct or that unconscionable conduct has occurred in the collection of a claim arising from a lease contract, the court may grant appropriate relief. (3) Before making a nding of unconscionability under subsection (1) or (2), the court, on its own motion or that of a party, shall aord the parties a reasonable opportunity to present evidence as to the setting, purpose, and eect of the lease contract or clause thereof, or of the conduct. (4) In an action in which the lessee claims unconscionability with respect to a consumer lease: (a) If the court nds unconscionability under subsection (1) or (2), the court shall award reasonable attorney's fees to the lessee. (b) If the court does not nd unconscionability and the lessee claiming unconscionability has brought or maintained an action the lessee knew to be groundless, the court shall award reasonable attorney's fees to the party against which the claim is made. (c) In determining attorney's fees, the amount of the recovery on behalf of the claimant under subsections (1) and (2) is not controlling. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.
219

 2A-108

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Ocial Comment
Uniform Statutory Source: Section 2-302 and Uniform Consumer Credit Code 5.108. Changes: Subsection (1) is taken almost verbatim from the provisions of Section 2-302(1). Subsection (2) is suggested by the provisions of Uniform Consumer Credit Code 5.108(1), (2). Subsection (3), taken from the provisions of Section 2-302(2), has been expanded to cover unconscionable conduct. Uniform Consumer Credit Code 5.108(3). The provision for the award of attorney's fees to consumers, subsection (4), covers unconscionability under subsection (1) as well as (2). Subsection (4) is modeled on the provisions of Uniform Consumer Credit Code 5.108(6). Purposes: Subsections (1) and (3) of this section apply the concept of unconscionability reected in the provisions of Section 2-302 to leases. See Dillman & Assocs. v. Capitol Leasing Co., 110 Ill.App.3d 335, 342, 442 N.E.2d 311, 316 (App.Ct.1982). Subsection (3) omits the adjective commercial found in subsection 2-302(2) because subsection (3) is concerned with all leases and the relevant standard of conduct is determined by the context. The balance of the section is modeled on the provisions of Uniform Consumer Credit Code 5.108. Thus subsection (2) recognizes that a consumer lease or a clause in a consumer lease may not itself be unconscionable but that the agreement would never have been entered into if unconscionable means had not been employed to induce the consumer to agree. To make a statement to induce the consumer to lease the goods, in the expectation of invoking an integration clause in the lease to exclude the statement's admissibility in a subsequent dispute, may be unconscionable. Subsection (2) also provides a consumer remedy for unconscionable conduct, such as using or threatening to use force or violence, in the collection of a claim arising from a lease contract. These provisions are not exclusive. The remedies of this section are in addition to remedies otherwise available for the same conduct under other law, for example, an action in tort for abusive debt collection or under another statute of this State for such conduct. The reference to appropriate relief in subsection (2) is intended to foster liberal administration of this remedy. Sections 2A-103(4) and 1-106(1). Subsection (4) authorizes an award of reasonable attorney's fees if the court nds unconscionability with respect to a consumer lease under subsection (1) or (2). Provision is also made for recovery by the party against whom the claim was made if the court does not nd unconscionability and does nd that the consumer knew the action to be groundless. Further, subsection (4)(b) is independent of, and thus will not override, a term in the lease agreement that provides for the payment of attorney's fees. Cross References: Section 1-106(1), Section 2-302 and Section 2A-103(4). Denitional Cross References: Action. Section 1-201. Consumer lease. Section 2A-103(1)(f). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Party. Section 1-201.

2A-109. Option to Accelerate at Will. (1) A term providing that one party or that party's successor in interest may accelerate payment or performance or require collateral or additional collateral at will or when the party deems itself insecure or words of similar import means that the party has power to do so only if that party in good faith believes that the prospect of payment or performance is impaired. (2) With respect to a consumer lease, the burden of establishing good faith under subsection (1) is on the party that has exercised the power; otherwise the burden of establishing lack of good faith is on the party against which the power has been exercised. As amended in 2003.
220

Art. 2A

Leases

2A-201

See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 1-208 and Uniform Consumer Credit Code 5.109(2). Purposes: Subsection (1) reects modest changes in style to the provisions of the rst sentence of Section 1-208. Subsection (2), however, reects a signicant change in the provisions of the second sentence of Section 1-208 by creating a new rule with respect to a consumer lease. A lease provision allowing acceleration at the will of the lessor or when the lessor deems itself insecure is of critical importance to the lessee. In a consumer lease it is a provision that is not usually agreed to by the parties but is usually mandated by the lessor. Therefore, where its invocation depends not on specic criteria but on the discretion of the lessor, its use should be regulated to prevent abuse. Subsection (1) imposes a duty of good faith upon its exercise. Subsection (2) shifts the burden of establishing good faith to the lessor in the case of a consumer lease, but not otherwise. Cross Reference: Section 1-208. Denitional Cross References: Burden of establishing. Section 1-201. Consumer lease. Section 2A-103(1)(f). Good faith. Sections 2A-103(1)(m). Party. Section 1-201. Term. Section 1-201.

PART 2. FORMATION AND CONSTRUCTION OF LEASE CONTRACT; ELECTRONIC CONTRACTING

2A-201. Statute of Frauds. (1) A lease contract is not enforceable by way of action or defense unless: (a) the total payments to be made under the lease contract, excluding payments for options to renew or buy, are less than $1,000; or (b) there is a record, signed by the party against which enforcement is sought or by that party's authorized agent, sucient to indicate that a lease contract has been made between the parties and to describe the goods leased and the lease term. (2) Any description of leased goods or of the lease term is sucient and satises subsection (1)(b), whether or not it is specic, if it reasonably identies what is described. (3) A record is not insucient because it omits or incorrectly states a term agreed upon, but the lease contract is not enforceable under subsection (1)(b) beyond the lease term and the quantity of goods shown in the record. (4) A lease contract that does not satisfy the requirements of subsection (1), but which is valid in other respects, is enforceable: (a) if the goods are to be specially manufactured or obtained for the lessee and are not suitable for lease or sale to others in the ordinary course of the lessor's business, and the lessor, before notice of repudiation is received and under circumstances that reasonably indicate that the goods are for the lessee, has made either a substantial beginning of their manufacture or commitments for their procurement; (b) if the party against which enforcement is sought admits in the party's pleading, or in the party's testimony or otherwise under oath
221

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Art. 2A

that a lease contract was made, but the lease contract is not enforceable under this paragraph beyond the quantity of goods admitted; or (c) with respect to goods that have been received and accepted by the lessee. (5) The lease term under a lease contract referred to in subsection (4) is: (a) if there is a record signed by the party against which enforcement is sought or by that party's authorized agent specifying the lease term, the term so specied; (b) if the party against which enforcement is sought admits in the party's pleading, or in the party's testimony or otherwise under oath a lease term, the term so admitted; or (c) a reasonable lease term. (6) A lease contract that is enforceable under this section is not unenforceable merely because it is not capable of being performed within one year or any other period after its making. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
1. This section, although closely parallel to Article 2-201, conforms to custom and usage in lease transactions. Section 2-201(2), which has a special rule for sales between merchants, is not included in this section as the number of those transactions that involve leases, as opposed to sales, is modest. Subsection (4) creates no exception for transactions where payment has been made and accepted. This is a departure from Section 2-201(3)(c). The reason for the departure is grounded in the distinction between sales and leases. Unlike a buyer in a sales transaction, the lessee does not tender payment in full for goods delivered, but only payment of rent for one or more months. Therefore, as a matter of policy, this act of payment is not a sucient substitute for the required memorandum. 2. Amended Article 2A retains the requirements of original Article 2A that lease contracts for $1,000 or more must satisfy the requirements of this section. Leases often involve a complex, on-going relationship between the lessor and lessee, and it is often important that there be a record that aords a basis to believe that the proered evidence rests on a real transaction unless, as in Article 2, a substitute for a record described in subsection (4) fullls the same function. 3. Subsection (5) establishes the criteria for supplying the lease term if it is omitted, as the lease contract may still be enforceable under subsection (4). 4. Subsection (6), which was not in prior versions of this Article, repeals the one year provision of the Statute of Frauds for contracts for the lease of goods. The phrase any other applicable period recognizes that some state statutes apply to periods longer than one year. The confused and contradictory interpretations under the so-called one year clause are illustrated in C.R. Klewin, Inc. v. Flagship Properties, Inc., 600 A.2d 772 (Conn. 1991). Cross References: Point 1: Sections 2-201, 9-110 and 9-203(1)(a). Denitional Cross References: Action. Section 1-201. Agreed. Section 1-201. Buying. Section 2A-103(1)(a). Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Notice. Section 1-202. 222

Art. 2A
Party. Section 1-201. Record. Section 2A-201(1)(cc). Sale. Section 2-106(1). Signed. Section 2A-103(1)(dd). Term. Section 1-201.

Leases

2A-203

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-202. Final Expression in a Record: Parol or Extrinsic Evidence. (1) Terms with respect to which the conrmatory memoranda of the parties agree or which are otherwise set forth in a record intended by the parties as a nal expression of their agreement with respect to such terms as are included therein may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be supplemented by evidence of: (a) course of performance, course of dealing, or usage of trade (Section 1-303); and (b) consistent additional terms unless the court nds the record to have been intended also as a complete and exclusive statement of the terms of the agreement. (2) Terms in a record may be explained by evidence of course of performance, course of dealing, or usage of trade without a preliminary determination by the court that the language used is ambiguous. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-202. This section is based on and conforms to amended Article 2, Section 2-202. The ocial commentary to that Section may be of aid in the interpretation of this section. Cross Reference: Section 2-202 Denitional Cross References: Agreement. Section 1-201. Course of dealing. Section 1-303. Party. Section 1-201. Term. Section 1-201. Record. Section 2A-103(1)(cc). Usage of trade. Section 1-303.

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-203. Seals Inoperative. The axing of a seal to a record evidencing a lease contract or an oer to enter into a lease contract does not render the record a sealed instrument and the law with respect to sealed instruments does not apply to the lease contract or oer. As amended in 2003.
223

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See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-203. Changes: Revised to reect leasing practices and terminology. Denitional Cross References: Lease contract. Section 2A-103(1)(r). Record. Section 2A-103(1)(cc).

2A-204. Formation in General. (1) A lease contract may be made in any manner sucient to show agreement, including oer and acceptance, conduct by both parties which recognizes the existence of a lease contract, the interaction of electronic agents, and the interaction of an electronic agent and an individual. (2) An agreement sucient to constitute a lease contract may be found although the moment of its making is undetermined. (3) Even if one or more terms are left open, a lease contract does not fail for indeniteness if the parties have intended to make a lease contract and there is a reasonably certain basis for giving an appropriate remedy. (4) Except as otherwise provided in Sections 2A-222 through 2A-224, the following rules apply: (a) A lease contract may be formed by the interaction of electronic agents of the parties, even if no individual was aware of or reviewed the electronic agents' actions or the resulting terms and agreements. (b) A lease contract may be formed by the interaction of an electronic agent and an individual acting on the individual's own behalf or for another person. A lease contract is formed if the individual takes actions that the individual is free to refuse to take or makes a statement, and the individual has reason to know that the actions or statement will: (i) cause the electronic agent to complete the transaction or performance; or (ii) indicate acceptance of an oer, regardless of other expressions or actions by the individual to which the electronic agent cannot react. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-204. Changes: Revised to reect leasing practices and terminology. This section is based on and conforms to amended Article 2, Section 2-204. The ocial commentary to that Section may be of aid in the interpretation of this section. Cross Reference: Section 2-204. Denitional Cross References: Agreement. Section 1-201. Electronic Section 2A-103(1)(h). Electronic Agent. Section 2A-103(1)(i). Electronic Record. Section 2A-103(1)(j). Lease contract. Section 2A-103(1)(r). Party. Section 1-201. Record. Section 2A-103(1)(cc). Remedy. Section 1-201. 224

Art. 2A
Term. Section 1-201.

Leases

2A-207

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-205. Firm Oers. An oer by a merchant to lease goods to or from another person in a signed record that by its terms gives assurance it will be held open is not revocable, for lack of consideration, during the time stated or, if no time is stated, for a reasonable time, but in no event may the period of irrevocability exceed three months. Any such term of assurance in a form supplied by the oeree must be separately signed by the oeror. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-205. Changes: Revised to reect leasing practices and terminology. Denitional Cross References: Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Merchant. Section 2-104(1). Person. Section 1-201. Reasonable time. Section 1-205. Record. Section 2A-103(1)(cc). Signed. Section 2A-103(1)(dd). Term. Section 1-201.

2A-206. Oer and Acceptance in Formation of Lease Contract. (1) Unless otherwise unambiguously indicated by the language or circumstances, an oer to make a lease contract must be construed as inviting acceptance in any manner and by any medium reasonable in the circumstances. (2) If the beginning of a requested performance is a reasonable mode of acceptance, an oeror who is not notied of acceptance within a reasonable time may treat the oer as having lapsed before acceptance. Ocial Comment
Uniform Statutory Source: Section 2-206(1)(a) and (2). Changes: Revised to reect leasing practices and terminology. Denitional Cross References: Lease contract. Section 2A-103(1)(r). Noties. Section 1-201. Reasonable time. Section 1-205.

2A-207. [Reserved.] [Course of Performance or Practical Construction] [(1) If a lease contract involves repeated occasions for performance by either party with knowledge of the nature of the performance and opportunity for objection to it by the other, any course of performance accepted or acquiesced in without objection is relevant to determine the meaning of the lease agreement.
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(2) The express terms of a lease agreement and any course of performance, as well as any course of dealing and usage of trade, must be construed whenever reasonable as consistent with each other; but if that construction is unreasonable, express terms control course of performance, course of performance controls both course of dealing and usage of trade, and course of dealing controls usage of trade. (3) Subject to the provisions of Section 2A-208 on modication and waiver, course of performance is relevant to show a waiver or modication of any term inconsistent with the course of performance.]
Legislative Note: Section 2A-207 should not be repealed if a jurisdiction has not enacted the 2001 Revised Article 1.

Ocial Comment
Uniform Statutory Source: Sections 2-208 and 1-205(4). Changes: Revised to reect leasing practices and terminology, except that subsection (2) was further revised to make the subsection parallel the provisions of Section 1-205(4) by adding that course of dealing controls usage of trade. Purposes: The section should be read in conjunction with Section 2A-208. In particular, although a specic term may control over course of performance as a matter of lease construction under subsection (2), subsection (3) allows the same course of dealing to show a waiver or modication, if Section 2A-208 is satised.

2A-208. Modication, Rescission and Waiver. (1) An agreement modifying a lease contract needs no consideration to be binding. (2) A signed lease agreement that excludes modication or rescission except by a signed record may not be otherwise modied or rescinded, but, except as between merchants, such a requirement in a form supplied by a merchant must be separately signed by the other party. (3) Although an attempt at modication or rescission does not satisfy the requirements of subsection (2), it may operate as a waiver. (4) A party that has made a waiver aecting an executory portion of a lease contract may retract the waiver by reasonable notication received by the other party that strict performance will be required of any term waived, unless the retraction would be unjust in view of a material change of position in reliance on the waiver. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-209. Changes: Revised to reect leasing practices and terminology, except that the provisions of subsection 2-209(3) were omitted. Purposes: Section 2-209(3) provides that the requirements of the statute of frauds section of this Article (Section 2-201) must be satised if the contract as modied is within its provisions. This provision was not incorporated as it is unfair to allow an oral modication to make the entire lease contract unenforceable, e.g. if the modication takes it a few dollars over the dollar limit. At the same time, the problem could not be solved by providing that the lease contract would still be enforceable in its pre-modication state (if it then satised the statute of frauds) since in some cases that might be worse than no enforcement at all. Resolution of the issue is left to the courts based on the facts of each case. Cross References: Sections 2-201 and 2-209. 226

Art. 2A

Leases

2A-209

Denitional Cross References: Agreement. Section 1-201. Between merchants. Section 2-104(3). Lease agreement. Section 2A-103(1)(k). Lease contract. Section 2A-103(1)(r). Merchant. Section 2-104(1). Notication. Section 1-202. Party. Section 1-201. Record. Section 2A-103(1)(cc). Signed. Section 2A-103(1)(dd). Term. Section 1-201.

2A-209. Lessee under Finance Lease as Beneciary of Supply Contract. (1) The benet of a supplier's promises to the lessor under the supply contract and of all warranties, whether express or implied, including those of any third party provided in connection with or as part of the supply contract, extends to the lessee to the extent of the lessee's leasehold interest under a nance lease related to the supply contract, but is subject to the terms of the warranty and of the supply contract and all defenses or claims arising therefrom. (2) The extension of the benet of a supplier's promises and of warranties to the lessee (Section 2A-209(1)) does not: (i) modify the rights and obligations of the parties to the supply contract, whether arising therefrom or otherwise, or (ii) impose any duty or liability under the supply contract on the lessee. (3) Any modication or rescission of the supply contract by the supplier and the lessor is eective between the supplier and the lessee unless, before the modication or rescission, the supplier has received notice that the lessee has entered into a nance lease related to the supply contract. If the modication or rescission is eective between the supplier and the lessee, the lessor is deemed to have assumed, in addition to the obligations of the lessor to the lessee under the lease contract, promises of the supplier to the lessor and warranties that were so modied or rescinded as they existed and were available to the lessee before modication or rescission. (4) In addition to the extension of the benet of the supplier's promises and of warranties to the lessee under subsection (1), the lessee retains all rights that the lessee may have against the supplier which arise from an agreement between the lessee and the supplier or under other law. As amended in 1990.
See Appendix F for material relating to changes made in text in 1990.

Ocial Comment
Uniform Statutory Source: None. Changes: This section is modeled on Section 9-318, the Restatement (Second) of Contracts 302315 (1981), and leasing practices. See Earman Oil Co. v. Burroughs Corp., 625 F.2d 1291, 129697 (5th Cir.1980). Purposes: 1. The function performed by the lessor in a nance lease is extremely limited. Section 2A-103(1)(g). The lessee looks to the supplier of the goods for warranties and the like or, in some cases as to warranties, to the manufacturer if a warranty made by that person is passed on. That expectation is reected in subsection (1), which is self-executing. As a mat227

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ter of policy, the operation of this provision may not be excluded, modied or limited; however, an exclusion, modication, or limitation of any term of the supply contract or warranty, including any with respect to rights and remedies, and any defense or claim such as a statute of limitations, eective against the lessor as the acquiring party under the supply contract, is also eective against the lessee as the beneciary designated under this provision. For example, the supplier is not precluded from excluding or modifying an express or implied warranty under a supply contract. Sections 2-312(2) and 2-316, or Section 2A-214. Further, the supplier is not precluded from limiting the rights and remedies of the lessor and from liquidating damages. Sections 2-718 and 2-719 or Sections 2A-503 and 2A-504. If the supply contract excludes or modies warranties, limits remedies, or liquidates damages with respect to the lessor, such provisions are enforceable against the lessee as beneciary. Thus, only selective discrimination against the beneciaries designated under this section is precluded, i.e., exclusion of the supplier's liability to the lessee with respect to warranties made to the lessor. This section does not aect the development of other law with respect to products liability. 2. Enforcement of this benet is by action. Sections 2A-103(4) and 1-106(2). 3. The benet extended by these provisions is not without a price, as this Article also provides in the case of a nance lease that is not a consumer lease that the lessee's promises to the lessor under the lease contract become irrevocable and independent upon the lessee's acceptance of the goods. Section 2A-407. 4. Subsection (2) limits the eect of subsection (1) on the supplier and the lessor by preserving, notwithstanding the transfer of the benets of the supply contract to the lessee, all of the supplier's and the lessor's rights and obligations with respect to each other and others; it further absolves the lessee of any duties with respect to the supply contract that might have been inferred from the extension of the benets thereof. 5. Subsections (2) and (3) also deal with dicult issues related to modication or rescission of the supply contract. Subsection (2) states a rule that determines the impact of the statutory extension of benet contained in subsection (1) upon the relationship of the parties to the supply contract and, in a limited respect, upon the lessee. This statutory extension of benet, like that contained in Sections 2A-216 and 2-318, is not a modication of the supply contract by the parties. Thus, subsection (3) states the rules that apply to a modication or rescission of the supply contract by the parties. Subsection (3) provides that a modication or rescission is not eective between the supplier and the lessee if, before the modication or rescission occurs, the supplier received notice that the lessee has entered into the nance lease. On the other hand, if the modication or rescission is eective, then to the extent of the modication or rescission of the benet or warranty, the lessor by statutory dictate assumes an obligation to provide to the lessee that which the lessee would otherwise lose. For example, assume a reduction in an express warranty from four years to one year. No prejudice to the lessee may occur if the goods perform as agreed. If, however, there is a breach of the express warranty after one year and before four years pass, the lessor is liable. A remedy for any prejudice to the lessee because of the bifurcation of the lessee's recourse resulting from the action of the supplier and the lessor is left to resolution by the courts based on the facts of each case. 6. Subsection (4) makes it clear that the rights granted to the lessee by this section do not displace any rights the lessee otherwise may have against the supplier. Cross References: Point 1: Sections 2-313, 2-316, 2-718, and 2-719 and Sections 2A-103(1)(g), 2A-214, 2A-503, and 2A-504. Point 2: Section 1-106 and Sections 2A-103. Point 3: Section 2A-407 Point 5: Section 2-318 and Section 2A-216. Denitional Cross References: Action. Section 1-201. Finance lease. Section 2A-103(1)(l). Leasehold interest. Section 2A-103(1)(s). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Notice. Section 1-202. 228

Art. 2A

Leases

2A-211

Party. Section 1-201. Rights. Section 1-201. Supplier. Section 2A-103(1)(). Supply contract. Section 2A-103(1)(gg). Term. Section 1-201.

2A-210. Express Warranties. (1) Express warranties by the lessor are created as follows: (a) Any armation of fact or promise made by the lessor to the lessee which relates to the goods and becomes part of the basis of the bargain creates an express warranty that the goods will conform to the armation or promise. (b) Any description of the goods which is made part of the basis of the bargain creates an express warranty that the goods will conform to the description. (c) Any sample or model that is made part of the basis of the bargain creates an express warranty that the whole of the goods will conform to the sample or model. (2) It is not necessary to the creation of an express warranty that the lessor use formal words, such as warrant or guarantee, or that the lessor have a specic intention to make a warranty, but an armation merely of the value of the goods or a statement purporting to be merely the lessor's opinion or commendation of the goods does not create a warranty. Ocial Comment
Uniform Statutory Source: Section 2-313. Changes: Revised to reect leasing practices and terminology. Purposes: All of the express and implied warranties of the Article on Sales (Article 2) are included in this Article, revised to reect the dierences between a sale of goods and a lease of goods. Sections 2A-210 through 2A-216. The lease of goods is suciently similar to the sale of goods to justify this decision. Hawkland, The Impact of the Uniform Commercial Code on Equipment Leasing, 1972 Ill.L.F. 446, 45960. Many state and federal courts have reached the same conclusion. Value of the goods, as used in subsection (2), includes rental value. Cross References: Section 2-313, and Sections 2A-210 through 2A-216. Denitional Cross References: Conforming. Section 2A-103(1)(c). Goods. Section 2A-103(1)(n). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Value. Section 1-204.

2A-211. Warranties Against Interference and Against Infringement; Lessee's Obligation Against Infringement. (1) Except in a nance lease, a lessor in a lease contract warrants that, except for claims by any person by way of infringement or the like, for the duration of the lease no person holds: (a) a claim to or interest in the goods not attributable to the lessee's own act or omission which will interfere with the lessee's enjoyment of its leasehold interest; or (b) a colorable claim to or interest in the goods which will unreasonably expose the lessee to litigation.
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(2) A nance lessor warrants that, except for claims by way of infringement or the like, for the duration of the lease no person holds: (a) a claim or interest in the goods that arose from an act or omission of the lessor which will interfere with the lessee's enjoyment of its leasehold interest; or (b) a colorable claim to or interest in the goods that arose from an act or omission of the lessor which will unreasonably expose the lessee to litigation. (3) Except in a nance lease, a lessor that is a merchant regularly dealing in goods of the kind warrants that the goods will be delivered free of the rightful claim of a third party by way of infringement or the like. However, a lessee that furnishes specications to a lessor or a supplier holds the lessor and the supplier harmless against any claim of infringement or the like that arises out of compliance with the specications. (4) A warranty under this section may be excluded or modied only by specic language that is conspicuous and contained in a record, or by circumstances, including course of performance, course of dealing, or usage of trade, that give the lessee reason to know that the lessor is leasing the goods subject to a claim or interest of any person, or that it is leasing subject to any claims of infringement or the like. As amended in 2003 and 2005.
See Appendix U for material relating to changes made in text in 2003. See Appendix V for material relating to changes made in text in 2005.

Ocial Comment
1. Scope of warranty of title. Unlike other warranties in Part 5, the warranty made by a lessor in subsections (1), (2), and (3) is standardized but can be disclaimed or modied under subsection (4). The lessor, other than a nance lessor, warrants that (1) that no person holds an interest that interfere with the lessee's enjoyment of its leasehold, (a warranty of quite enjoyment) and (2) the transfer does not unreasonably expose the lessee to litigation. An unreasonable exposure to litigation occurs when a third person has or asserts a colorable claim to or interest in the goods. The following cases illustrate the concept of colorable claims: Frank Arnold KRS, Inc. v. L.S. Meier Auction Co., Inc., 806 F.2d 462 (3d Cir. 1986) (two law suits contest title); Jeanneret v. Vichey, 693 F.2d 259 (2d Cir. 1982) (export restrictions in country from which painting was taken aect value); Colton v. Decker, 540 N.W.2d 172 (S.D. 1995) (conicting vehicle identication numbers). As one court put it, there need not be an actual encumbrance of the purchaser's title or actual disturbance of possession to permit a purchaser to recover for a breach of warranty of title when he demonstrates the existence of a cloud on his title, regardless of whether it eventually develops that a third party's title is superior. The policy is that a purchaser should not be required to engage in a contest over the validity of his ownership. Maroon Chevrolet, Inc. v. Nordstrom, 587 So.2d 514, 518 (Fla.App. 1991) (conicting vehicle identication numbers). Amended Article 2A follows this principle. 2. A nance lessor is essentially a middle-man between a supplier and the lessee. The lessee, therefore, looks to the supplier (seller or lessor) for warranty protection, including warranties of title. Section 2A-209. Therefore, a nance lessor warrants only against its own acts. Subsection (2). 3. Unlike the warranty of title, for the warranty against infringement the lessor must be a merchant who regularly deals in goods of the kind sold. The warranty can be disclaimed or modied under subsection (4). See Bonneau Co. v. AG Industries, Inc., 116 F.3d 155 (5th Cir. 1997), which holds that if the buyer furnishes specications to a seller who follows them, there is no warranty against infringement under Section 2-312(3). Moreover, al230

Art. 2A

Leases

2A-212

though a lessor warrants against claims or interests, the lessor is not responsible for safeguarding the lessee against claims or encumbrances that might arise because of the lessee's own acts (e.g., an act that would be a default under the lease) or omissions (e.g., a city impounds a leased car and refuses to release it until the lessee pays delinquent parking nes). 4. Disclaimers. Subsection (4), which has been moved from original 2A-214(4), deals with the disclaimer or modication of the warranty of title or against infringement, and it states the general standard that must be met to disclaim or modify against an immediate lessee. The language needs to be conspicuous and in a record. Cross References: Point 2: Section 2A-209 Point 3: Section 2-312 and Section 2A-211. Point 4: Section 2A-414. Denitional Cross References: Delivery. Section 2A-103(1)(g). Finance lease. Section 2A-103(1)(l). Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease contract. Section 2A-103(1)(r). Leasehold interest. Section 2A-103(1)(s). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Merchant. Section 2-104(1). Person. Section 1-201. Record. Section 2A-103(1)(cc). Supplier. Section 2A-103(1)().

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-212. Implied Warranty of Merchantability. (1) Except in a nance lease, a warranty that the goods will be merchantable is implied in a lease contract if the lessor is a merchant with respect to goods of that kind. (2) Goods to be merchantable must be at least such as (a) pass without objection in the trade under the description in the lease agreement; (b) in the case of fungible goods, are of fair average quality within the description; (c) are t for the ordinary purposes for which goods of that description are used; (d) run, within the variation permitted by the lease agreement, of even kind, quality, and quantity within each unit and among all units involved; (e) are adequately contained, packaged, and labeled as the lease agreement may require; and (f) conform to any promises or armations of fact made on the container or label. (3) Other implied warranties may arise from course of dealing or usage of trade. As amended in 2003.
231

 2A-212

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Art. 2A

See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
1. The question when the warranty is imposed turns basically on the meaning of the terms of the agreement as recognized in the trade. Goods delivered under an agreement made by a merchant in a given line of trade must be of a quality comparable to that generally acceptable in that line of trade under the description or other designation of the goods used in the agreement. The responsibility imposed rests on any merchant-lessor. 2. If an unmerchantable good causes personal injury to the lessee who is injured while using the good, the lessee can sue the lessor for breach of the implied warranty of merchantability and recover for injury to person proximately resulting from the breach. Section 2A520(2)(b). Because the lessee has an action for breach of warranty and probably an action in tort as well, there is a tension between warranty law and tort law where goods cause personal injury or property damage. The primary source of that tension comes from the disagreement over whether the concept of defect in tort and the concept of merchantability in Article 2A are coextensive when a personal injury is caused by the defective good: i.e., if goods are merchantable under warranty law can they still be defective under tort law, and if goods are not defective under tort law can they be unmerchantable under warranty law? The answer to both questions should be no, and the tension between merchantability in warranty and defect in tort where personal injury or property damage is involved should be resolved as follows:
When recovery is sought for injury to person or property, whether goods are merchantable is to be determined by applicable state products liability law. When, however, a claim for injury to person or property is based on an implied warranty of tness under Section 2A-213 or an express warranty under Section 2A-210 this Article determines whether an implied warranty of tness or an express warranty was made and breached, as well as what damages are recoverable under Section 2A-530.

Thus, if a lessor makes a representation about the safety of a product that becomes part of the basis of the lessee's bargain and the lessee is injured by the product, the product without the representation is not defective under applicable tort law, it is not unmerchantable under this section. On the other hand, if the product did not conform to the representation about safety, then the lessor made and breached an express warranty and the lessee may recover under Article 2A. 3. Subsection (2) does not purport to exhaust the meaning of merchantable nor to negate any of its attributes not specically mentioned in the text of the statute but that arise by usage of trade or through case law. The language used is must be at least such as . . . , and the intention is to leave open other possible attributes of merchantability. 4. Paragraphs (a) and (b) of subsection (2) are to be read together. Both refer to the standards of that line of the trade which ts the transaction and the lessor's business. Fair average is a term directly appropriate to agricultural bulk products and means goods centering around the middle belt of quality, not the least or the worst that can be understood in the particular trade by the designation, but such as can pass without objection. Of course a fair percentage of the least is permissible but the goods are not fair average if they are all of the least or worst quality possible under the description. In cases of doubt about what quality is intended, the price at which a merchant closes a contract is an excellent indication of the nature and scope of the merchant's obligation under the present section. 5. Fitness for the ordinary purposes for which goods of the type are used is a fundamental concept of the present section and is covered in paragraph (2)(c). The phrase goods of that description rather than the language from the original Article 2A for which goods of that type are used is used in subsection (2)(c). This change emphasizes the importance of the agreed description to determine tness for ordinary purposes. 6. Paragraph (2)(d) on evenness of kind, quality and quantity follows case law. But precautionary language has been added as a reminder of the frequent usages of trade which permit substantial variations both with and without an allowance or an obligation to replace the varying units. 7. Paragraph (2)(e) applies only where the nature of the goods and of the transaction require a certain type of container, package or label. Paragraph (2)(f) applies, on the other hand, wherever there is a label or container on which representations are made, even though the original contract, either by express terms or usage of trade, may not have 232

Art. 2A

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required either the labeling or the representation. This follows from the general obligation of good faith which requires that a lessee should not be placed in the position of using goods delivered under false representations that appear on the package or container. No problem of extra consideration arises in this connection since, under this Article, an obligation is imposed by the original contract not to deliver mislabeled articles, and the obligation is imposed where mercantile good faith requires and without reference to the doctrine of consideration. 8. Exclusion or modication of the warranty of merchantability, or of any part of it, is dealt with in Section 2A-214. That section must be read with particular reference to its subsection (6) on limitation of remedies. The warranty of merchantability, wherever it is normal, is so commonly taken for granted that its exclusion from the contract is a matter threatening surprise and therefore requiring special precaution. 9. Subsection (3) makes explicit that usage of trade and course of dealing can create warranties, and that they are implied rather than express warranties, and thus subject to exclusion or modication under Section 2A-214. 10. In an action based on breach of warranty, it is of course necessary to show not only the existence of the warranty but the fact that the warranty was broken and that the breach of the warranty was the proximate cause of the loss sustained. An armative showing by the lessor that the loss resulted from some action or event following the lessor's delivery of the goods can operate as a defense. Equally, evidence that indicates that the lessor exercised care in the manufacture, processing or selection of the goods is relevant to the issue of whether the warranty was in fact broken. An action by the lessee following an examination of the goods which ought to have indicated the defect complained of can be shown as matter bearing on whether the breach itself was the cause of the injury. Cross References: Point 2: Sections 2A-210, 2A-520 and 2A-530. Point 8: Section 2A-214. Point 9: Section 2A-214. Denitional Cross References: Conforming. Section 2A-103(1)(c). Course of dealing. Section 1-303. Finance lease. Section 2A-103(1)(l). Fungible. Section 1-201. Goods. Section 2A-103(1)(n). Lease agreement. Section 2A-103(1)(k). Lease contract. Section 2A-103(1)(r). Lessor. Section 2A-103(1)(v). Merchant. Section 2-104(1). Usage of trade. Section 1-303.

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-213. Implied Warranty of Fitness for Particular Purpose. Except in a nance lease, if the lessor at the time the lease contract is made has reason to know of any particular purpose for which the goods are required and that the lessee is relying on the lessor's skill or judgment to select or furnish suitable goods, there is in the lease contract an implied warranty that the goods will be t for that purpose. Ocial Comment
Uniform Statutory Source: Section 2-315. Changes: Revised to reect leasing practices and terminology. E.g., All-States Leasing Co. v. Bass, 96 Idaho 873, 879, 538 P.2d 1177, 1183 (1975) (implied warranty of tness for a particular purpose (Article 2) extends to lease transactions). Denitional Cross References: 233

 2A-213

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Finance lease. Section 2A-103(1)(l). Goods. Section 2A-103(1)(n). Knows. Section 1-201. Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v).

2A-214. Exclusion or Modication of Warranties. (1) Words or conduct relevant to the creation of an express warranty and words or conduct tending to negate or limit a warranty must be construed wherever reasonable as consistent with each other; but, subject to Section 2A-202, negation or limitation is inoperative to the extent that the construction is unreasonable. (2) Subject to subsection (3), to exclude or modify the implied warranty of merchantability or any part of it the language must be in a record and be conspicuous. In a consumer lease the language must state The lessor undertakes no responsibility for the quality of the goods except as otherwise provided in this contract, and in any other contract the language must mention merchantability. Subject to subsection (3), to exclude or modify the implied warranty of tness the exclusion must be in a record and be conspicuous. Language to exclude all implied warranties of tness in a consumer lease must state The lessor assumes no responsibility that the goods will be t for any particular purpose for which you may be leasing these goods, except as otherwise provided in the contract, and in any other contract the language is sucient if it states, for example, that There are no warranties that extend beyond the description on the face hereof. Language that satises the requirements of this subsection for a consumer lease also satises its requirements for any other lease contract. (3) Notwithstanding subsection (2): (a) unless the circumstances indicate otherwise, all implied warranties are excluded by expressions like as is, with all faults, or other language that in common understanding calls the lessee's attention to the exclusion of warranties and makes plain that there is no implied warranty, if in a record and conspicuous; (b) if the lessee before entering into the lease contract has examined the goods or the sample or model as fully as desired or has refused to examine the goods, after a demand by the lessor there is no implied warranty with regard to defects that an examination ought in the circumstances to have revealed to the lessee; and (c) an implied warranty may also be excluded or modied by course of dealing, or course of performance, or usage of trade. (4) Remedies for breach of warranty can be limited in accordance with Section 2A-503 and 2A-504. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
The changes conform to amended Article 2. Former subsection (4) has been moved to Section 2-211. 234

Art. 2A

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1. Subsection (1) deals with clauses in lease contracts that seek to exclude all warranties, express or implied. This section protects a lessee from unexpected and unbargained language of disclaimer by denying eect to this language when it is inconsistent with language of express warranty, and permits the exclusion of implied warranties only by language or other circumstances which protect the lessee from surprise. The lessor is protected against false allegations of oral warranties by this Article's provisions on parol and extrinsic evidence and against unauthorized representations by the customary lack of authority clauses. This Article treats the limitation or avoidance of consequential damages as a matter of limiting remedies for breach, separate from the matter of creation of liability under a warranty. If no warranty exists, there is of course no problem of limiting remedies for breach of warranty. Under subsection (4), the question of limitation of remedy is governed by the sections referred to rather than by this section. 2. The general test for disclaimers of implied warranties remains in subsection (3)(a), and the more specic tests are in subsection (2). A disclaimer that satises the requirements of subsection (3)(a) need not also satisfy any of the requirements of subsection (2). 3. Subsection (2) distinguishes between commercial and consumer leases. However, unlike the parallel provision in Article 2 (Section 2-316), under this section all exclusions under subsection (2) must be in a record and the language must be conspicuous, unlike Article 2 which only makes this mandatory for consumer contracts. Thus in both commercial and consumer leases, language that disclaims the implied warranty of merchantability must be in a record, and must be conspicuous. Subsection (2) presupposes that the implied warranty in question exists unless excluded or modied. 4. Subsection (3)(a) deals with general terms such as as is, as they stand, with all faults, and the like. These terms in ordinary commercial usage are understood to mean that the lessee takes the entire risk as to the quality of the goods involved. The terms covered by the subsection are in fact merely a particularization of subsection (3)(c), which provides for exclusion or modication of implied warranties by usage of trade. Nothing in subsection (3)(a) prevents a term such as there are no implied warranties from being effective in appropriate circumstances, as when the term is a negotiated term between commercial parties. Satisfaction of subsection (3)(a) requires that the language be set forth in a record and the language must be conspicuous. This is a variance with the parallel provision in Article 2 that makes these requirements mandatory only in consumer contracts. 5. The exceptions to the general rule set forth in subsections (3)(b) and (3)(c) are common factual situations in which the circumstances surrounding the transaction are in themselves sucient to call the lessee's attention to the fact that no implied warranties are made or that a certain implied warranty is being excluded. Under subsection (3)(b), warranties may be excluded or modied by the circumstances when the lessee examines the goods or a sample or model of them before entering into the contract. Examination as used in this paragraph is not synonymous with inspection before acceptance or at any other time after the lease has been made. Of course if the lessee discovers the defect and uses the goods anyway, or if the lessee unreasonably fails to examine the goods before using them, the resulting injuries may be found to have resulted from the lessee's own action rather than have been proximately caused by a breach of warranty. To bring the transaction within the scope of refused to examine in subsection (3)(a), it is not sucient that the goods are available for inspection. There must in addition be an actual examination by the lessee or a demand by the lessor that the lessee examine the goods fully. The lessor's demand must place the lessee on notice that the lessee is assuming the risk of defects which the examination ought to reveal. The particular lessee's skill and the normal method of examining goods in the circumstances determine what defects are excluded by the examination. A failure to notice defects which are obvious cannot excuse the lessee because of the lack of notice. However, an examination under circumstances which do not permit chemical or other testing of the goods does not exclude defects which could be ascertained only by testing. Nor can latent defects be excluded by a simple examination. A professional lessee examining a product in the lessee's eld will be held to have assumed the risk for all defects which a professional in the eld ought to observe, while a nonprofessional lessee will be held to have assumed the risk only for the defects as a layperson might be expected to observe. 235

 2A-214

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Denitional Cross References: Conspicuous. Section 2A-103(1)(d). Course of dealing. Section 1-303. Fault. Section 2A-103(1)(k). Goods. Section 2A-103(1)(n). Knows. Section 1-201. Lease. Section 2A-103(1)(p). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Person. Section 1-201. Record. Section 2A-103(1)(cc). Usage of trade. Section 1-303.

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-215. Cumulation and Conict of Warranties Express or Implied. Warranties, whether express or implied, must be construed as consistent with each other and as cumulative, but if that construction is unreasonable, the intention of the parties determines which warranty is dominant. In ascertaining that intention the following rules apply: (a) Exact or technical specications displace an inconsistent sample or model or general language of description. (b) A sample from an existing bulk displaces inconsistent general language of description. (c) Express warranties displace inconsistent implied warranties other than an implied warranty of tness for a particular purpose. Ocial Comment
Uniform Statutory Source: Section 2-317. Denitional Cross Reference: Party. Section 1-201.

2A-216. Third-party Beneciaries of Express and Implied Warranties.

ALTERNATIVE A

A warranty to or for the benet of a lessee under this Article, whether express or implied, extends to any natural person who is in the family or household of the lessee or who is a guest in the lessee's home if it is reasonable to expect that such person may use, consume, or be aected by the goods and who is injured in person by breach of the warranty. This section does not displace principles of law and equity that extend a warranty to or for the benet of a lessee to other persons. The operation of this section may not be excluded, modied, or limited, but an exclusion, modication, or limitation of the warranty, including any with respect to rights and remedies, eective against the lessee is also eective against any beneciary designated under this section.
ALTERNATIVE B

A warranty to or for the benet of a lessee under this Article, whether

236

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express or implied, extends to any natural person who may reasonably be expected to use, consume, or be aected by the goods and who is injured in person by breach of the warranty. This section does not displace principles of law and equity that extend a warranty to or for the benet of a lessee to other persons. The operation of this section may not be excluded, modied, or limited, but an exclusion, modication, or limitation of the warranty, including any with respect to rights and remedies, eective against the lessee is also eective against the beneciary designated under this section.
ALTERNATIVE C

A warranty to or for the benet of a lessee under this Article, whether express or implied, extends to any person who may reasonably be expected to use, consume, or be aected by the goods and who is injured by breach of the warranty. The operation of this section may not be excluded, modied, or limited with respect to injury to the person of an individual to whom the warranty extends, but an exclusion, modication, or limitation of the warranty, including any with respect to rights and remedies, eective against the lessee is also eective against the beneciary designated under this section. Ocial Comment
Uniform Statutory Source: Section 2-318. Changes: The provisions of Section 2-318 have been included in this section, modied in two respects: rst, to reect leasing practice, including the special practices of the lessor under a nance lease; second, to reect and thus codify elements of the ocial comment to Section 2-318 with respect to the eect of disclaimers and limitations of remedies against third parties. Purposes: Alternative A is based on the 1962 version of Section 2-318 and is least favorable to the injured person as the doctrine of privity imposed by other law is abrogated to only a limited extent. Alternatives B and C are based on later additions to Section 2-318 and are more favorable to the injured person. In determining which alternative to select, the state legislature should consider making its choice parallel to the choice it made with respect to Section 2-318, as interpreted by the courts. The last sentence of each of Alternatives A, B and C does not preclude the lessor from excluding or modifying an express or implied warranty under a lease. Section 2A-214. Further, that sentence does not preclude the lessor from limiting the rights and remedies of the lessee and from liquidating damages. Sections 2A-503 and 2A-504. If the lease excludes or modies warranties, limits remedies for breach, or liquidates damages with respect to the lessee, such provisions are enforceable against the beneciaries designated under this section. However, this last sentence forbids selective discrimination against the beneciaries designated under this section, i.e., exclusion of the lessor's liability to the beneciaries with respect to warranties made by the lessor to the lessee. Other law, including the Article on Sales (Article 2), may apply in determining the extent to which a warranty to or for the benet of the lessor extends to the lessee and third parties. This is in part a function of whether the lessor has bought or leased the goods. This Article does not purport to change the development of the relationship of the common law, with respect to products liability, including strict liability in tort (as restated in Restatement (Second) of Torts, 402A (1965)), to the provisions of this Act. Compare Cline v. Prowler Indus. of Maryland, 418 A.2d 968 (Del.1980) and Hawkins Constr. Co. v. Matthews Co., 190 Neb. 546, 209 N.W.2d 643 (1973) with Dippel v. Sciano, 37 Wis.2d 443, 155 N.W.2d 55 (1967). Cross References: Section 2-318, and Sections 2A-214, 2A-503 and 2A-504. Denitional Cross References: Goods. Section 2A-103(1)(n). Lessee. Section 2A-103(1)(t). 237

 2A-216
Person. Section 1-201. Remedy. Section 1-201. Rights. Section 1-201.

Uniform Commercial Code

Art. 2A

2A-217. Identication. Identication of goods as goods to which a lease contract refers may be made at any time and in any manner explicitly agreed to by the parties. In the absence of explicit agreement, identication occurs: (a) when the lease contract is made if the lease contract is for a lease of goods that are existing and identied; (b) when the goods are shipped, marked, or otherwise designated by the lessor as goods to which the lease contract refers, if the lease contract is for a lease of goods that are not existing and identied; or (c) when the young are conceived, if the lease contract is for a lease of unborn young of animals. Ocial Comment
Uniform Statutory Source: Section 2-501. Changes: This section, together with Section 2A-218, is derived from the provisions of Section 2-501, with changes to reect lease terminology; however, this section omits as irrelevant to leasing practice the treatment of special property. Purposes: With respect to subsection (b) there is a certain amount of ambiguity in the reference to when goods are designated, e.g., when the lessor is both selling and leasing goods to the same lessee/buyer and has marked goods for delivery but has not distinguished between those related to the lease contract and those related to the sales contract. As in Section 2-501(1)(b), this issue has been left to be resolved by the courts, case by case. Cross References: Section 2-501 and Section 2A-218. Denitional Cross References: Agreement. Section 1-201. Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease contract. Section 2A-103(1)(r). Lessor. Section 2A-103(1)(v). Party. Section 1-201.

2A-218. Insurance and Proceeds. (1) A lessee obtains an insurable interest when existing goods are identied to the lease contract even though the goods identied are nonconforming and the lessee has an option to reject them. (2) If a lessee has an insurable interest only by reason of the lessor's identication of the goods, the lessor, until default or insolvency or notication to the lessee that identication is nal, may substitute other goods for those identied. (3) Notwithstanding a lessee's insurable interest under subsections (1) and (2), the lessor retains an insurable interest until an option to buy has been exercised by the lessee and risk of loss has passed to the lessee. (4) Nothing in this section impairs any insurable interest recognized under any other statute or rule of law. (5) The parties by agreement may determine that one or more parties have an obligation to obtain and pay for insurance covering the goods and by agreement may determine the beneciary of the proceeds of the insurance.
238

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Ocial Comment
Uniform Statutory Source: Section 2-501. Changes: This section, together with Section 2A-217, is derived from the provisions of Section 2-501, with changes and additions to reect leasing practices and terminology. Purposes: Subsection (2) states a rule allowing substitution of goods by the lessor under certain circumstances, until default or insolvency of the lessor, or until notication to the lessee that identication is nal. Subsection (3) states a rule regarding the lessor's insurable interest that, by virtue of the dierence between a sale and a lease, necessarily is different from the rule stated in Section 2-501(2) regarding the seller's insurable interest. For this purpose the option to buy shall be deemed to have been exercised by the lessee when the resulting sale is closed, not when the lessee gives notice to the lessor. Further, subsection (5) is new and reects the common practice of shifting the responsibility and cost of insuring the goods between the parties to the lease transaction. Cross References: Sections 2-501, 2-501(2) and Section 2A-217. Denitional Cross References: Agreement. Section 1-201. Buying. Section 2A-103(1)(a). Conforming. Section 2A-103(1)(c). Goods. Section 2A-103(1)(n). Insolvent. Section 1-201. Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Notication. Section 1-202. Party. Section 1-201.

2A-219. Risk of Loss. (1) Except in the case of a nance lease, risk of loss is retained by the lessor and does not pass to the lessee. In the case of a nance lease, risk of loss passes to the lessee. (2) Subject to Section 2A-220, if risk of loss is to pass to the lessee and the time of passage is not stated, the following rules apply: (a) If the lease contract requires or authorizes the goods to be shipped by carrier (i) and it does not require delivery at a particular destination, the risk of loss passes to the lessee when the goods are delivered to the carrier; but (ii) if it does require delivery at a particular destination and the goods are there tendered while in the possession of the carrier, the risk of loss passes to the lessee when the goods are there so tendered as to enable the lessee to take delivery. (b) If the goods are held by a bailee to be delivered without being moved, the risk of loss passes to the lessee on acknowledgment by the bailee to the lessee of the lessee's right to possession of the goods. (c) In any case not within subsection (a) or (b), the risk of loss passes to the lessee on the lessee's receipt of the goods. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-509(1) through (3). Changes: Subsection (1) is new. The introduction to subsection (2) is new, but 239

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subparagraph (a) incorporates the provisions of Section 2-509(1); subparagraph (b) incorporates the provisions of Section 2-509(2) only in part, reecting current practice in lease transactions. Purposes: Subsection (1) states rules related to retention or passage of risk of loss consistent with current practice in lease transactions. The provisions of subsection (4) of Section 2-509 are not incorporated as they are not necessary. This section does not deal with responsibility for loss caused by the wrongful act of either the lessor or the lessee. Cross References: Sections 2-509(1), 2-509(2) and 2-509(4). Denitional Cross References: Delivery. Section 2A-103(1)(g). Finance lease. Section 2A-103(1)(l). Goods. Section 2A-103(1)(n). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Merchant. Section 2-104(1). Receipt. Section 2-103(1)(c). Rights. Section 1-201. Supplier. Section 2A-103(1)().

2A-220. Eect of Default on Risk of Loss. (1) Where risk of loss is to pass to the lessee and the time of passage is not stated: (a) If a tender or delivery of goods so fails to conform to the lease contract as to give a right of rejection, the risk of their loss remains with the lessor, or, in the case of a nance lease, the supplier, until cure or acceptance. (b) If the lessee rightfully revokes acceptance, the lessee, to the extent of any deciency in its eective insurance coverage, may treat the risk of loss as having remained with the lessor from the beginning. (2) Whether or not risk of loss is to pass to the lessee, if the lessee as to conforming goods already identied to a lease contract repudiates or is otherwise in default under the lease contract, the lessor, or, in the case of a nance lease, the supplier, to the extent of any deciency in its eective insurance coverage may treat the risk of loss as resting on the lessee for a commercially reasonable time. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-510. Changes: Revised to reect leasing practices and terminology. The rule in Section (1)(b) does not allow the lessee under a nance lease to treat the risk of loss as having remained with the supplier from the beginning. This is appropriate given the limited circumstances under which the lessee under a nance lease is allowed to revoke acceptance. Section 2A-517 and Section 2A-516 ocial comment. Cross Reference Section 2A-516 and 2A-517. Denitional Cross References: Conforming. Section 2A-103(1)(c). Delivery. Section 2A-103(1)(g). Finance lease. Section 2A-103(1)(l). 240

Art. 2A
Goods. Section 2A-103(1)(n). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Reasonable time. Section 1-205. Rights. Section 1-201. Supplier. Section 2A-103(1)().

Leases

2A-222

2A-221. Casualty to Identied Goods. If a lease contract requires goods identied when the lease contract is made, and the goods suer casualty without fault of the lessee, the lessor or the supplier before delivery, or the goods suer casualty before risk of loss passes to the lessee pursuant to the lease agreement or Section 2A219: (a) if the loss is total, the lease contract is terminated; and (b) if the loss is partial or the goods have so deteriorated as to no longer conform to the lease contract, the lessee may nevertheless demand inspection and at the lessee's option either treat the lease contract as terminated or, except in a nance lease that is not a consumer lease, accept the goods with due allowance from the rent payable for the balance of the lease term for the deterioration or the deciency in quantity but without further right against the lessor. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-613. Changes: Revised to reect leasing practices and terminology. Purpose: Due to the vagaries of determining the amount of due allowance (Section 2-613(b)), no attempt was made in subsection (b) to treat a problem unique to lease contracts and installment sales contracts: determining how to recapture the allowance, e.g., application to the rst or last rent payments or allocation, pro rata, to all rent payments. Cross References: Section 2-613. Denitional Cross References: Conforming. Section 2A-103(1)(c). Consumer lease. Section 2A-103(1)(f). Delivery. Section 2A-103(1)(g). Fault. Section 2A-103(1)(k). Finance lease. Section 2A-103(1)(l). Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease agreement. Section 2A-103(1)(k). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Rights. Section 1-201. Supplier. Section 2A-103(1)().

2A-222. Legal Recognition of Electronic Contracts, Records and Signatures. (1) A record or signature may not be denied legal eect or enforceability solely because it is in electronic form.
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(2) A contract may not be denied legal eect or enforceability solely because an electronic record was used in its formation. (3) This article does not require a record or signature to be created, generated, sent, communicated, received, stored, or otherwise processed by electronic means or in electronic form. (4) A contract formed by the interaction of an individual and an electronic agent under Section 2A-204(4)(b) does not include terms provided by the individual if the individual had reason to know that the agent could not react to the terms as provided. As added in 2003. Ocial Comment
1. Subsections (1) and (2) are derived from Section 7(a) and (b) of the Uniform Electronic Transactions Act (UETA), and subsection (3) is derived from Section 5(a) of UETA. Subsection (4) is based on Section 206(c) of the Uniform Computer Information Transactions Act (UCITA). Each subsection conforms to the federal Electronic Signatures in Global and National Commerce Act (15 U.S.C. 7001 et seq.). 2. This section sets forth the premise that the medium in which a record, signature, or contract is created, presented or retained does not aect its legal signicance. Subsections (1) and (2) are designed to eliminate the single element of medium as a reason to deny effect or enforceability to a record, signature, or contract. The fact that the information is set forth in an electronic, as opposed to paper, medium is irrelevant. 3. A contract may have legal eect and yet be unenforceable. See Restatement 2d Contracts Section 8. To the extent that a contract in electronic form may have legal eect but be unenforceable, because it is in electronic form, subsection (2) validates its legality. Likewise, to the extent that a record or signature in electronic form may have legal eect but be unenforceable, because it is in electronic form, subsection (1) validates the legality of the record or signature. Whether an electronic record or signature is valid under other law is not addressed by this Act. 4. While subsection (2) validates the legality of an electronic contract, it does not in any way diminish the requirements for the formation of contracts under Sections 2A-204 and 2A-206. 5. Paper leases are tangible chattel paper under Article 9, and lease nanciers and syndicators often perfect security interests in the paper by taking physical possession of it. Sections 9-102(a)(11), (78), 9-310(b)(6), 9-313(a). Article 9 provides for control as an analogue to possession for electronic chattel paper. Sections 9-102(a)(11), (31), 9-105, 9-310(b)(8), 9-314(a). To acquire control, a secured party must comply with each of the requirements of Section 9-105. Cross References: Point 3: Section 2-201 Point 4: Sections 2A-204 and 2A-206. Denitional Cross References: Electronic Section 2A-103(1)(h). Electronic Agent. Section 2A-103(1)(i). Electronic Record. Section 2A-103(1)(j). Record. Section 2A-103 (1)(cc). Sign. Section 2A-103(1)(dd).

As added in 2003. 2A-223. Attribution. An electronic record or electronic signature is attributed to a person if it was the act of the person or the person's electronic agent or the person is otherwise legally bound by the act. As added in 2003.
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Ocial Comment
1. This section is based on Section 9 of the Uniform Electronic Transactions Act (UETA). 2. As long as an electronic record is created by a person or the electronic signature results from a person's action it is attributed to that person. The legal eect of the attribution is derived from other provisions of this Act or from other law. This section simply assures that these rules will be applied in the electronic environment. A person's actions include actions taken by a human agent of the person as well as actions taken by an electronic agent, of the person. Although this section may appear to state the obvious, it assures that the record or signature is not ascribed to a machine, as opposed to the person operating or programming the machine. 3. Nothing in this section aects the use of an electronic signature as a means of attributing a record to a person. Once an electronic signature is attributed to the person, the electronic record with which it is associated would also be attributed to the person unless the person established fraud, forgery, or other invalidating cause. However, an electronic signature is not the only method for attribution of a record. 4. In the context of attribution of records, normally the content of the record will provide the necessary information for a nding of attribution. It is also possible that an established course of dealing between parties may result in a nding of attribution. Just as with a paper record, evidence of forgery or counterfeiting may be introduced to rebut the evidence of attribution. The use of facsimile transmissions provides a number of examples of attribution using information other than a signature. A facsimile may be attributed to a person because of the information printed across the top of the page that indicates the machine from which it was sent. Similarly, the transmission may contain a letterhead which identies the sender. Some cases have held that the letterhead actually constituted a signature because it was a symbol adopted by the sender with intent to sign the record. See Cox Engineering v. Funston Mach. & Supply, 749 S.W.2d 508, 511 (Tex.App.1988) (plainti's letterhead, including address, appearing at top of invoice, provides authentication that identies the party to be charged and thus satises the statute of frauds' signature requirement); Owen v. Kroger Co., 936 F. Supp. 579 (S.D. Ind. 1996) (determining that a letterhead satises the signature requirement of the UCC). However, the signature determination resulted from the necessary nding of intention in that case. Other cases have found letterheads NOT to be signatures because the requisite intention was not present. See First National Bank in Alamosa v. Ford Motor Credit Co., 748 F. Supp 1464 (D. Colo, 1990) (determining that a pre-printed name on a draft was not a signature for the purpose of accepting a draft). The critical point is that with or without a signature, information within the electronic record may well suce to provide the facts resulting in attribution of an electronic record to a particular party. 5. Certain information may be present in an electronic environment that does not appear to attribute but which clearly links a person to a particular record. Numerical codes, personal identication numbers, public and private key combinations, all serve to establish the party to which an electronic record should be attributed. Security procedures will be another piece of evidence available to establish attribution. 6. Once it is established that a record or signature is attributable to a particular person, the legal signicance of the record or signature is determined by the context and surrounding circumstances in which the recorder signature is created, including the parties' agreement, if any. This will primarily be governed by other sections of this article. See, e.g., sections 2-201, 2-202, 2-204, 2-206, and 2-209 and Sections 2A-201, 2A-202, 2A-204, 2A-206 and 2A-209. Cross References: Point 6: Sections 2-201, 2-202, 2-204, 2-206, and 2-209 and Sections 2A-201, 2A-202, 2A-204, 2A-206 and 2A-209. Denitional Cross References: Electronic Section 2A-103(1)(h). Electronic Agent. Section 2A-103(1)(i). Electronic Record. Section 2A-103(1)(j). Record. Section 2A-103 (1)(cc). Sign. Section 2A-103(1)(dd).

As added in 2003.
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2A-224. Electronic Communication. (1) If the receipt of an electronic communication has a legal eect, it has that eect even if no individual is aware of its receipt. (2) Receipt of an electronic acknowledgment of an electronic communication establishes that the communication was received but, in itself, does not establish that the content sent corresponds to the content received. As added in 2003. Ocial Comment
1. This section is adapted from Sections 15(e) and (f) of the Uniform Electronic Transactions Act (UETA). 2. This section deals with electronic communications generally, and it is not limited to electronic records which must be retrievable in perceivable form. The section does not resolve the questions of when or where electronic communications are determined to be sent or received, nor does it indicate that a communication has any particular substantive legal eect. 3. Under subsection (1), receipt is not dependent on a person having notice communication. An analogy in a paper based transaction is the recipient that does not read a notice received in the mail. 4. Subsection (2) provides legal certainty about the eect of an electronic acknowledgment. This subsection only addresses the fact of the receipt, and it does not set forth the legal signicance of the quality of the content, nor whether the electronic communication was read or opened. 5. This section does not address the question of whether the exchange of electronic communications constitutes the formation of a contract. Those questions are addressed by Sections 2A-204 and 2A-206. Cross References: Point 5: Section 2A-204 and 2A-206. Denitional Cross References: Electronic Section 2A-103(1)(h). Electronic Agent. Section 2A-103(1)(i). Electronic Record. Section 2A-103(1)(j). Record. Section 2A-103 (1)(cc). Sign. Section 2A-103(1)(dd).

As added in 2003.

PART 3. EFFECT OF LEASE CONTRACT

2A-301. Enforceability Of Lease Contract. Except as otherwise provided in this Article, a lease contract is eective and enforceable according to its terms between the parties, against purchasers of the goods and against creditors of the parties. Ocial Comment
Uniform Statutory Source: Section 9-201. Changes: The rst sentence of Section 9-201 was incorporated, modied to reect leasing terminology. The second sentence of Section 9-201 was eliminated as not relevant to leasing practices. Purposes: 1. This section establishes a general rule regarding the validity and enforceability of a lease contract. The lease contract is eective and enforceable between the parties and against third parties. Exceptions to this general rule arise where there is a specic rule to the contrary in this Article. Enforceability is, thus, dependent upon the lease contract meeting the requirements of the Statute of Frauds provisions of Section 2A-201. Enforceability is also a function of the lease contract conforming to the principles of construction 244

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and interpretation contained in the Article on General Provisions (Article 1). Section 2A103(4). 2. The eectiveness or enforceability of the lease contract is not dependent upon the lease contract or any nancing statement or the like being led or recorded; however, the priority of the interest of a lessor of xtures with respect to the interests of certain third parties in such xtures is subject to the provisions of the Article on Secured Transactions (Article 9). Section 2A-309. Prior to the adoption of this Article ling or recording was not required with respect to leases, only leases intended as security. The denition of security interest, as amended concurrently with the adoption of this Article, more clearly delineates leases and leases intended as security and thus signals the need to le. Section 1-201(37). Those lessors who are concerned about whether the transaction creates a lease or a security interest will continue to le a protective nancing statement. Section 9-408. Coogan, Leasing and the Uniform Commercial Code, in Equipment Leasing-Leveraged Leasing 681, 74446 (2d ed. 1980). 3. Hypothetical: (a) In construing this section it is important to recognize its relationship to other sections in this Article. This is best demonstrated by reference to a hypothetical. Assume that on February 1 A, a manufacturer of combines and other farm equipment, leased a eet of six combines to B, a corporation engaged in the business of farming, for a 12 month term. Under the lease agreement between A and B, A agreed to defer B's payment of the rst two months' rent to April 1. On March 1 B recognized that it would need only four combines and thus subleased two combines to C for an 11 month term. (b) This hypothetical raises a number of issues that are answered by the sections contained in this part. Since lease is dened to include sublease (Section 2A-103(1)(j) and (w)), this section provides that the prime lease between A and B and the sublease between B and C are enforceable in accordance with their terms, except as otherwise provided in this Article; that exception, in this case, is one of considerable scope. (c) The separation of ownership, which is in A, and possession, which is in B with respect to four combines and which is in C with respect to two combines, is not relevant. Section 2A-302. A's interest in the six combines cannot be challenged simply because A parted with possession to B, who in turn parted with possession of some of the combines to C. Yet it is important to note that by the terms of Section 2A-302 this conclusion is subject to change if otherwise provided in this Article. (d) B's entering the sublease with C raises an issue that is treated by this part. In a dispute over the leased combines A may challenge B's right to sublease. The rule is permissive as to transfers of interests under a lease contract, including subleases. Section 2A-303(2). However, the rule has two signicant qualications. If the prime lease contract between A and B prohibits B from subleasing the combines, or makes such a sublease an event of default, Section 2A-303(2) applies; thus, while B's interest under the prime lease may be transferred under the sublease to C, A may have a remedy pursuant to Section 2A-303(5). Absent a prohibition or default provision in the prime lease contract A might be able to argue that the sublease to C materially increases A's risk; thus, while B's interest under the prime lease may be transferred under the sublease to C, A may have a remedy pursuant to Section 2A-303(5). Section 2A-303(5)(b)(ii). (e) Resolution of this issue is also a function of the section dealing with the sublease of goods by a prime lessee (Section 2A-305). Subsection (1) of Section 2A-305, which is subject to the rules of Section 2A-303 stated above, provides that C takes subject to the interest of A under the prime lease between A and B. However, there are two exceptions. First, if B is a merchant (Sections 2A-103(3) and 2-104(1)) dealing in goods of that kind and C is a sublessee in the ordinary course of business (Sections 2A-103(1)(o) and 2A103(1)(n)), C takes free of the prime lease between A and B. Second, if B has rejected the six combines under the prime lease with A, and B disposes of the goods by sublease to C, C takes free of the prime lease if C can establish good faith. Section 2A-511(4). (f) If the facts of this hypothetical are expanded and we assume that the prime lease obligated B to maintain the combines, an additional issue may be presented. Prior to entering the sublease, B, in satisfaction of its maintenance covenant, brought the two combines that it desired to sublease to a local independent dealer of A's. The dealer did the requested work for B. C inspected the combines on the dealer's lot after the work was completed. C signed the sublease with B two days later. C, however, was prevented from taking delivery of the two combines as B refused to pay the dealer's invoice for the repairs. The dealer furnished the repair service to B in the ordinary course of the dealer's business. If under applicable law the dealer has a lien on repaired goods in the dealer's 245

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possession, the dealer's lien will take priority over B's and C's interests and also should take priority over A's interest, depending upon the terms of the lease contract and the applicable law. Section 2A-306. (g) Now assume that C is in nancial straits and one of C's creditors obtains a judgment against C. If the creditor levies on C's subleasehold interest in the two combines, who will prevail? Unless the levying creditor also holds a lien covered by Section 2A-306, discussed above, the judgment creditor will take its interest subject to B's rights under the sublease and A's rights under the prime lease. Section 2A-307(1). The hypothetical becomes more complicated if we assume that B is in nancial straits and B's creditor holds the judgment. Here the judgment creditor takes subject to the sublease unless the lien attached to the two combines before the sublease contract became enforceable. Section 2A-307(2)(a). However, B's judgment creditor cannot prime A's interest in the goods because, with respect to A, the judgment creditor is a creditor of B in its capacity as lessee under the prime lease between A and B. Thus, here the judgment creditor's interest is subject to the lease between A and B. Section 2A-307(1). (h) Finally, assume that on April 1 B is unable to pay A the deferred rent then due under the prime lease, but that C is current in its payments under the sublease from B. What eect will B's default under the prime lease between A and B have on C's rights under the sublease between B and C? Section 2A-301 provides that a lease contract is effective against the creditors of either party. Since a lease contract includes a sublease contract (Section 2A-103(1)(l)), the sublease contract between B and C arguably could be enforceable against A, a prime lessor who has extended unsecured credit to B, the prime lessee/sublessor, if the sublease contract meets the requirements of Section 2A-201. However, the rule stated in Section 2A-301 is subject to other provisions in this Article. Under Section 2A-305, C, as sublessee, would take subject to the prime lease contract in most cases. Thus, B's default under the prime lease will in most cases lead to A's recovery of the goods from C. Section 2A-523. A and C could provide otherwise by agreement. Section 2A-311. C's recourse will be to assert a claim for damages against B. Sections 2A-211(1) and 2A-508. 4. Relationship Between Sections: (a) As the analysis of the hypothetical demonstrates, Part 3 of the Article focuses on issues that relate to the enforceability of the lease contract (Sections 2A-301, 2A-302 and 2A-303) and to the priority of various claims to the goods subject to the lease contract (Sections 2A-304, 2A-305, 2A-306, 2A-307, 2A-308, 2A-309, 2A-310, and 2A-311). (b) This section states a general rule of enforceability, which is subject to specic rules to the contrary stated elsewhere in the Article. Section 2A-302 negates any notion that the separation of title and possession is fraudulent as a rule of law. Finally, Section 2A-303 states rules with respect to the transfer of the lessor's interest (as well as the residual interest in the goods) or the lessee's interest under the lease contract. Qualications are imposed as a function of various issues, including whether the transfer is the creation or enforcement of a security interest or one that is material to the other party to the lease contract. In addition, a system of rules is created to deal with the rights and duties among assignor, assignee and the other party to the lease contract. (c) Sections 2A-304 and 2A-305 are twins that deal with good faith transferees of goods subject to the lease contract. Section 2A-304 creates a set of rules with respect to transfers by the lessor of goods subject to a lease contract; the transferee considered is a subsequent lessee of the goods. The priority dispute covered here is between the subsequent lessee and the original lessee of the goods (or persons claiming through the original lessee). Section 2A-305 creates a set of rules with respect to transfers by the lessee of goods subject to a lease contract; the transferees considered are buyers of the goods or sublessees of the goods. The priority dispute covered here is between the transferee and the lessor of the goods (or persons claiming through the lessor). (d) Section 2A-306 creates a rule with respect to priority disputes between holders of liens for services or materials furnished with respect to goods subject to a lease contract and the lessor or the lessee under that contract. Section 2A-307 creates a rule with respect to priority disputes between the lessee and creditors of the lessor and priority disputes between the lessor and creditors of the lessee. (e) Section 2A-308 creates a series of rules relating to allegedly fraudulent transfers and preferences. The most signicant rule is that set forth in subsection (3) which validates sale-leaseback transactions if the buyer-lessor can establish that he or she bought for value and in good faith. (f) Sections 2A-309 and 2A-310 create a series of rules with respect to priority disputes between various third parties and a lessor of xtures or accessions, respectively, with respect thereto. 246

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(g) Finally, Section 2A-311 allows parties to alter the statutory priorities by agreement. Cross References: Point 1: Section 2A-201 Point 2: Sections 1-201 and 1-203, Section 2A-309 and Article 9. Point 3: Sections 2A-103, 2A-201, 2A-211, 2A-303, 2A-305, 2A-306, 2A-307 2A-511, 2A523. Point 4: Sections 2A-301 through 2A-311. Denitional Cross References: Creditor. Section 1-201. Goods. Section 2A-103(1)(n). Lease contract. Section 2A-103(1)(r). Party. Section 1-201. Purchaser. Section 1-201. Term. Section 1-201.

As amended in 1990.
See Appendix F for material relating to changes made in the Ocial Comment in 1990.

2A-302. Title to and Possession of Goods. Except as otherwise provided in this Article, each provision of this Article applies whether the lessor or a third party has title to the goods, and whether the lessor, the lessee, or a third party has possession of the goods, notwithstanding any statute or rule of law that possession or the absence of possession is fraudulent. Ocial Comment
Uniform Statutory Source: Section 9-202. Changes: Section 9-202 was modied to reect leasing terminology and to clarify the law of leases with respect to fraudulent conveyances or transfers. Purposes: The separation of ownership and possession of goods between the lessor and the lessee (or a third party) has created problems under certain fraudulent conveyance statutes. See, e.g., In re Ludlum Enters., 510 F.2d 996 (5th Cir. 1975); Suburbia Fed. Sav. & Loan Ass'n v. Bel-Air Conditioning Co., 385 So.2d 1151 (Fla.Dist.Ct.App.1980). This section provides, among other things, that separation of ownership and possession per se does not aect the enforceability of the lease contract. Sections 2A-301 and 2A-308. Cross References: Sections 2A-301, 2A-308 and Section 9-202. Denitional Cross References: Goods. Section 2A-103(1)(n). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v).

2A-303. Alienability of Party's Interest under Lease Contract or of Lessor's Residual Interest in Goods; Delegation of Performance; Transfer of Rights. (1) As used in this section, creation of a security interest includes the sale of a lease contract that is subject to Article 9 by reason of Section 9-109(a)(3). (2) Subject to subsection (3) and except as otherwise provided in Section 9-407 or as otherwise agreed, a provision in a lease agreement which (i) prohibits the voluntary or involuntary transfer, including a transfer by sale, sublease, creation or enforcement of a security interest, or attachment, levy, or other judicial process, of an interest of a party under the
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lease contract or of the lessor's residual interest in the goods, or (ii) makes such a transfer an event of default, gives rise to the rights and remedies provided in subsection (4). However, a transfer that is prohibited or is an event of default under the lease agreement is otherwise eective. (3) A provision in a lease agreement which (i) prohibits a transfer of a right to damages for default with respect to the whole lease contract or of a right to payment arising out of the transferor's due performance of the transferor's entire obligation, or (ii) makes such a transfer an event of default, is not enforceable, and such a transfer is not a transfer that materially impairs the prospect of obtaining return performance by, materially changes the duty of, or materially increases the burden or risk imposed on, the other party to the lease contract within subsection (4). (4) Subject to subsection (3) and Section 9-407: (a) if a transfer is made that is an event of default under a lease agreement, the party to the lease contract not making the transfer, unless that party waives the default or otherwise agrees, has the rights and remedies described in Section 2A-501(2); (b) if paragraph (a) is not applicable and if a transfer is made that (i) is prohibited under a lease agreement or (ii) materially impairs the prospect of obtaining return performance by, materially changes the duty of, or materially increases the burden or risk imposed on, the other party to the lease contract, unless the party not making the transfer agrees at any time to the transfer in the lease contract or otherwise, then, except as limited by contract, (i) the transferor is liable to the party not making the transfer for damages caused by the transfer to the extent that the damages could not reasonably be prevented by the party not making the transfer and (ii) a court having jurisdiction may grant other appropriate relief, including cancellation of the lease contract or an injunction against the transfer. (5) A transfer of the lease or of all my rights under the lease, or a transfer in similar general terms, is a transfer of rights and, unless the language or the circumstances, as in a transfer for security, indicate the contrary, the transfer is a delegation of duties by the transferor to the transferee. Acceptance by the transferee constitutes a promise by the transferee to perform those duties. The promise is enforceable by either the transferor or the other party to the lease contract. (6) Unless otherwise agreed by the lessor and the lessee, a delegation of performance does not relieve the transferor as against the other party of any duty to perform or of any liability for default. (7) In a consumer lease, to prohibit the transfer of an interest of a party under the lease contract or to make a transfer an event of default, the language must be specic, by a record, and conspicuous. As amended in 1990, 1999 and 2003.
See Appendix F for material relating to changes made in text in 1990. See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999. See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (2) states a rule, consistent with Section 9-401(b), that voluntary and involuntary transfers of an interest of a party under the lease contract or of the lessor's residual 248

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interest, including by way of the creation or enforcement of a security interest, are eective, notwithstanding a provision in the lease agreement prohibiting the transfer or making the transfer an event of default. Although the transfers are eective, the provision in the lease agreement is nevertheless enforceable, but only as provided in subsection (4). Under subsection (4) the prejudiced party is limited to the remedies on default under the lease contract in this Article and, except as limited by this Article, as provided in the lease agreement, if the transfer has been made an event of default. Section 2A-501(2). Usually, there will be a specic provision to this eect or a general provision making a breach of a covenant an event of default. In those cases where the transfer is prohibited, but not made an event of default, the prejudiced party may recover damages; or, if the damage remedy would be ineective adequately to protect that party, the court can order cancellation of the lease contract or enjoin the transfer. This rule that such provisions generally are enforceable is subject to subsection (3) and Section 9-407, which make such provisions unenforceable in certain instances. 2. Under Section 9-407, a provision in a lease agreement which prohibits the creation or enforcement of a security interest, including sales of lease contracts subject to Article 9 (Section 9-109(a)(3)), or makes it an event of default is generally not enforceable, reecting the policy of Section 9-406 and former Section 9-318(4). 3. Subsection (3) is based upon Section 2-210(2) and Section 9-406. It makes unenforceable a prohibition against transfers of certain rights to payment or a provision making the transfer an event of default. It also provides that such transfers do not materially impair the prospect of obtaining return performance by, materially change the duty of, or materially increase the burden or risk imposed on, the other party to the lease contract so as to give rise to the rights and remedies stated in subsection (4). Accordingly, a transfer of a right to payment cannot be prohibited or made an event of default, or be one that materially impairs performance, changes duties or increases risk, if the right is already due or will become due without further performance being required by the party to receive payment. Thus, a lessor can transfer the right to future payments under the lease contract, including by way of a grant of a security interest, and the transfer will not give rise to the rights and remedies stated in subsection (4) if the lessor has no remaining performance under the lease contract. The mere fact that the lessor is obligated to allow the lessee to remain in possession and to use the goods as long as the lessee is not in default does not mean that there is remaining performance on the part of the lessor. Likewise, the fact that the lessor has potential liability under a non-operating lease contract for breaches of warranty does not mean that there is remaining performance. In contrast, the lessor would have remaining performance under a lease contract requiring the lessor to regularly maintain and service the goods or to provide upgrades of the equipment on a periodic basis in order to avoid obsolescence. The basic distinction is between a mere potential duty to respond which is not remaining performance, and an armative duty to render stipulated performance. Although the distinction may be dicult to draw in some cases, it is instructive to focus on the dierence between operating and non-operating leases as generally understood in the marketplace. Even if there is remaining performance under a lease contract, a transfer for security of a right to payment that is made an event of default or that is in violation of a prohibition against transfer does not give rise to the rights and remedies under subsection (4) if it does not constitute an actual delegation of a material performance under Section 9-407. 4. The application of either the rule of Section 9-407 or the rule of subsection (3) to the grant by the lessor of a security interest in the lessor's right to future payment under the lease contract may produce the same result. Both provisions generally protect security transfers by the lessor in particular because the creation by the lessor of a security interest or the enforcement of that interest generally will not prejudice the lessee's rights if it does not result in a delegation of the lessor's duties. To the contrary, the receipt of loan proceeds or relief from the enforcement of an antecedent debt normally should enhance the lessor's ability to perform its duties under the lease contract. Nevertheless, there are circumstances where relief might be justied. For example, if ownership of the goods is transferred pursuant to enforcement of a security interest to a party whose ownership would prevent the lessee from continuing to possess the goods, relief might be warranted. See 49 U.S.C. 1401(a) and (b) which places limitations on the operation of aircraft in the United States based on the citizenship or corporate qualication of the registrant. 5. Relief on the ground of material prejudice when the lease agreement does not prohibit 249

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the transfer or make it an event of default should be aorded only in extreme circumstances, considering the fact that the party asserting material prejudice did not insist upon a provision in the lease agreement that would protect against such a transfer. 6. Subsection (4) implements the rule of subsection (2). Subsection (2) provides that, even though a transfer is eective, a provision in the lease agreement prohibiting it or making it an event of default may be enforceable as provided in subsection (4). See Brummond v. First National Bank of Clovis, 656 P.2d 884, 35 U.C.C.Rep.Serv. (Callaghan) 1311 (N.Mex. 1983), stating the analogous rule for Section 9-311. If the transfer prohibited by the lease agreement is made an event of default, then, under subsection (4)(a), unless the default is waived or there is an agreement otherwise, the aggrieved party has the rights and remedies referred to in Section 2A-501(2), viz. those in this Article and, except as limited in the Article, those provided in the lease agreement. In the unlikely circumstance that the lease agreement prohibits the transfer without making a violation of the prohibition an event of default or, even if there is no prohibition against the transfer, and the transfer is one that materially impairs performance, changes duties, or increases risk (for example, a sublease or assignment to a party using the goods improperly or for an illegal purpose), then subsection (4)(b) is applicable. In that circumstance, unless the party aggrieved by the transfer has otherwise agreed in the lease contract, such as by assenting to a particular transfer or to transfers in general, or agrees in some other manner, the aggrieved party has the right to recover damages from the transferor and a court may, in appropriate circumstances, grant other relief, such as cancellation of the lease contract or an injunction against the transfer. 7. If a transfer gives rise to the rights and remedies provided in subsection (4), the transferee as an alternative may propose, and the other party may accept, adequate cure or compensation for past defaults and adequate assurance of future due performance under the lease contract. Subsection (4) does not preclude any other relief that may be available to a party to the lease contract aggrieved by a transfer subject to an enforceable prohibition, such as an action for interference with contractual relations. 8. Subsection (7) requires that a provision in a consumer lease prohibiting a transfer, or making it an event of default, must be specic, written and conspicuous. See Section 1-201(10). This assists in protecting a consumer lessee against surprise assertions of default. 9. Subsection (5) is taken almost verbatim from the provisions of Section 2-210(5). The subsection states a rule of construction that distinguishes a commercial assignment, which substitutes the assignee for the assignor as to rights and duties, and an assignment for security or nancing assignment, which substitutes the assignee for the assignor only as to rights. Note that the assignment for security or nancing assignment is a subset of all security interests. Security interest is dened to include any interest of a buyer of chattel paper. Section 1-201(37). Chattel paper is dened to include a lease. Section 9-102. Thus, a buyer of leases is the holder of a security interest in the leases. That conclusion should not inuence this issue, as the policy is quite dierent. Whether a buyer of leases is the holder of a commercial assignment, or an assignment for security or nancing assignment should be determined by the language of the assignment or the circumstances of the assignment. Cross References: Point 1: Section 2A-501 and Sections 9-401 and 9-407. Point 2: Sections 9-109, 9-318, 9-416 and 9-417. Point 3: Section 2-210 and Sections 9-406 and 9-407. Point 4: Section 9-407. Point 6: Section 2A-501 and Section 9-311. Point 8: Section 1-201. Point 9: Section 1-201 and Section 2-210 and Section 9-102. Denitional Cross References: Agreed and Agreement. Section 1-201. Conspicuous. Section 2A-103(1)(d). Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). 250

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Lessor. Section 2A-103(1)(v). Lessor's residual interest. Section 2A-103(1)(w). Notice. Section 1-202. Party. Section 1-201. Person. Section 1-201. Reasonable time. Section 1-205. Record. Section 2A-103(1)(cc). Rights. Section 1-201. Term. Section 1-201.

As amended in 1999.
See Appendix I contained within revised Article 9 for material relating to changes made in Ocial Comment in 1999.

2A-304. Subsequent Lease of Goods by Lessor. (1) Subject to Section 2A-303, a subsequent lessee from a lessor of goods under an existing lease contract obtains, to the extent of the leasehold interest transferred, the leasehold interest in the goods that the lessor had or had power to transfer, and except as provided in subsection (2) and Section 2A-527(4), takes subject to the existing lease contract. A lessor with voidable title has power to transfer a good leasehold interest to a good faith subsequent lessee for value, but only to the extent set forth in the preceding sentence. If goods have been delivered under a transaction of purchase, the lessor has that power even if: (a) the lessor's transferor was deceived as to the identity of the lessor; (b) the delivery was in exchange for a check which is later dishonored; (c) it was agreed that the transaction was to be a cash sale; or (d) the delivery was procured through criminal fraud. (2) A subsequent lessee in ordinary course of business from a lessor that is a merchant dealing in goods of that kind to which the goods were entrusted by the existing lessee of that lessor before the interest of the subsequent lessee became enforceable against that lessor obtains, to the extent of the leasehold interest transferred, all of that lessor's and the existing lessee's rights to the goods, and takes free of the existing lease contract. (3) A subsequent lessee from the lessor of goods that are subject to an existing lease contract and are covered by a certicate of title issued under a statute of this State or of another jurisdiction takes no greater rights than those provided both by this section and by the certicate of title statute. As amended in 1990 and 2003.
See Appendix F for material relating to changes made in text in 1990. See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-403. Changes: While Section 2-403 was used as a model for this section, the provisions of Section 2-403 were signicantly revised to reect leasing practices and to integrate this Article with certicate of title statutes. Purposes: 1. This section must be read in conjunction with, as it is subject to, the provisions of Section 2A-303, which govern voluntary and involuntary transfers of rights and duties 251

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under a lease contract, including the lessor's residual interest in the goods. 2. This section must also be read in conjunction with Section 2-403. This section and Section 2A-305 are derived from Section 2-403, which states a unied policy on good faith purchases of goods. Given the scope of the denition of purchaser (Section 1-201(33)), a person who bought goods to lease as well as a person who bought goods subject to an existing lease from a lessor will take pursuant to Section 2-403. Further, a person who leases such goods from the person who bought them should also be protected under Section 2-403, rst because the lessee's rights are derivative and second because the denition of purchaser should be interpreted to include one who takes by lease; no negative implication should be drawn from the inclusion of lease in the denition of purchase in this Article. Section 2A103(1)(v). 3. There are hypotheticals that relate to an entrustee's unauthorized lease of entrusted goods to a third party that are outside the provisions of Sections 2-403, 2A-304 and 2A-305. Consider a sale of goods by M, a merchant, to B, a buyer. After paying for the goods B allows M to retain possession of the goods as B is short of storage. Before B calls for the goods M leases the goods to L, a lessee. This transaction is not governed by Section 2-403(2) as L is not a buyer in the ordinary course of business. Section 1-201(9). Further, this transaction is not governed by Section 2A-304(2) as B is not an existing lessee. Finally, this transaction is not governed by Section 2A-305(2) as B is not M's lessor. Section 2A-307(2) resolves the potential dispute between B, M and L. By virtue of B's entrustment of the goods to M and M's lease of the goods to L, B has a cause of action against M under the common law. Sections 2A-103(4) and 1-103. See, e.g., Restatement (Second) of Torts 222A243. Thus, B is a creditor of M. Sections 2A-103(4) and 1-201(12). Section 2A-307(2) provides that B, as M's creditor, takes subject to M's lease to L. Thus, if L does not default under the lease, L's enjoyment and possession of the goods should be undisturbed. However, B is not without recourse. B's action should result in a judgment against M providing, among other things, a turnover of all proceeds arising from M's lease to L, as well as a transfer of all of M's right, title and interest as lessor under M's lease to L, including M's residual interest in the goods. Section 2A-103(1)(q). 4. Subsection (1) states a rule with respect to the leasehold interest obtained by a subsequent lessee from a lessor of goods under an existing lease contract. The interest will include such leasehold interest as the lessor has in the goods as well as the leasehold interest that the lessor had the power to transfer. Thus, the subsequent lessee obtains unimpaired all rights acquired under the law of agency, apparent agency, ownership or other estoppel, whether based upon statutory provisions or upon case law principles. Sections 2A-103(4) and 1-103. In general, the subsequent lessee takes subject to the existing lease contract, including the existing lessee's rights thereunder. Furthermore, the subsequent lease contract is, of course, limited by its own terms, and the subsequent lessee takes only to the extent of the leasehold interest transferred thereunder. 5. Subsection (1) further provides that a lessor with voidable title has power to transfer a good leasehold interest to a good faith subsequent lessee for value. In addition, subsections (1)(a) through (d) provide specically for the protection of the good faith subsequent lessee for value in a number of specic situations which have been troublesome under prior law. 6. The position of an existing lessee who entrusts leased goods to its lessor is not distinguishable from the position of other entrusters. Thus, subsection (2) provides that the subsequent lessee in the ordinary course of business takes free of the existing lease contract between the lessor entrustee and the lessee entruster, if the lessor is a merchant dealing in goods of that kind. Further, the subsequent lessee obtains all of the lessor entrustee's and the lessee entruster's rights to the goods, but only to the extent of the leasehold interest transferred by the lessor entrustee. Thus, the lessor entrustee retains the residual interest in the goods. Section 2A-103(1)(q). However, entrustment by the existing lessee must have occurred before the interest of the subsequent lessee became enforceable against the lessor. Entrusting is dened in Section 2-403(3) and that denition applies here. Section 2A103(3). 7. Subsection (3) states a rule with respect to a transfer of goods from a lessor to a subsequent lessee where the goods are subject to an existing lease and covered by a certicate of title. The subsequent lessee's rights are no greater than those provided by this section and the applicable certicate of title statute, including any applicable case law construing such statute. Where the relationship between the certicate of title statute and Section 2-403, the statutory analogue to this section, has been construed by a court, that construc252

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tion is incorporated here. Sections 2A-103(4) and 1-102(1) and (2). The better rule is that the certicate of title statutes are in harmony with Section 2-403 and thus would be in harmony with this section. E.g., Atwood Chevrolet-Olds v. Aberdeen Mun. School Dist., 431 So.2d 926, 928 (Miss.1983); Godfrey v. Gilsdorf, 476 P.2d 3, 6, 86 Nev. 714, 718 (1970); Martin v. Nager, 192 N.J.Super. 189, 19798, 469 A.2d 519, 523 (Super.Ct.Ch.Div.1983). Where the certicate of title statute is silent on this issue of transfer, this section will control. Cross References: Point 1: Section 2A-303. Point 2: Sections 2-201 and 2-403 and Sections 2A-103 and 2A-305. Point 3: Section 1-201 and Section 2-403 and Sections 2A-103, 2A-304, 2A-305, 2A-307. Point 4: Section 1-103 and Section 2A-103. Point 6: Section 1-102 and Section 2-403 and Sections 2A-103. Point 7: Section 1-201 and Section 2-403 and Sections 2A-103. Denitional Cross References: Agreed. Section 1-201. Delivery. Section 2A-103(1)(g). Entrusting. Section 2-403(3). Good faith. Sections 2A-103(1)(m). Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease contract. Section 2A-103(1)(r). Leasehold interest. Section 2A-103(1)(s). Lessee. Section 2A-103(1)(t). Lessee in the ordinary course of business. Section 2A-103(1)(o). Lessor. Section 2A-103(1)(v). Merchant. Section 2-104(1). Purchase. Section 2A-103(1)(bb). Rights. Section 1-201. Value. Section 1-204.

2A-305. Sale or Sublease of Goods by Lessee. (1) Subject to Section 2A-303, a buyer or sublessee from the lessee of goods under an existing lease contract obtains, to the extent of the interest transferred, the leasehold interest in the goods that the lessee had or had power to transfer, and except as provided in subsection (2) and Section 2A511(4), takes subject to the existing lease contract. A lessee with a voidable leasehold interest has power to transfer a good leasehold interest to a good faith buyer for value or a good faith sublessee for value, but only to the extent set forth in the preceding sentence. If goods have been delivered under a transaction of lease the lessee has that power even if: (a) the lessor was deceived as to the identity of the lessee; (b) the delivery was in exchange for a check which is later dishonored; or (c) the delivery was procured through criminal fraud. (2) A buyer in ordinary course of business or a sublessee in ordinary course of business from a lessee that is a merchant dealing in goods of that kind to which the goods were entrusted by the lessor obtains, to the extent of the interest transferred, all of the lessor's and lessee's rights to the goods, and takes free of the existing lease contract. (3) A buyer or sublessee from the lessee of goods that are subject to an existing lease contract and are covered by a certicate of title issued under
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a statute of this State or of another jurisdiction takes no greater rights than those provided both by this section and by the certicate of title statute. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-403. Changes: While Section 2-403 was used as a model for this section, the provisions of Section 2-403 were signicantly revised to reect leasing practice and to integrate this Article with certicate of title statutes. Purposes: This section, a companion to Section 2A-304, states the rule with respect to the leasehold interest obtained by a buyer or sublessee from a lessee of goods under an existing lease contract. Cf. Section 2A-304 ocial comment. Note that this provision is consistent with existing case law, which prohibits the bailee's transfer of title to a good faith purchaser for value under Section 2-403(1). Rohweder v. Aberdeen Product. Credit Ass'n, 765 F.2d 109 (8th Cir. 1985). Subsection (2) is also consistent with existing case law. American Standard Credit, Inc. v. National Cement Co., 643 F.2d 248, 26970 (5th Cir. 1981); but cf. Exxon Co., U.S.A. v. TLW Computer Indus., 37 U.C.C.Rep.Serv. (Callaghan) 1052, 105758 (D.Mass.1983). Unlike Section 2A-304(2), this subsection does not contain any requirement with respect to the time that the goods were entrusted to the merchant. In Section 2A-304(2) the competition is between two customers of the merchant lessor; the time of entrusting was added as a criterion to create additional protection to the customer who was rst in time: the existing lessee. In subsection (2) the equities between the competing interests were viewed as balanced. There appears to be some overlap between Section 2-403(2) and Section 2A-305(2) with respect to a buyer in the ordinary course of business. However, an examination of this Article's denition of buyer in the ordinary course of business (Section 2A-103(1)(a)) makes clear that this reference was necessary to treat entrusting in the context of a lease. Subsection (3) states a rule of construction with respect to a transfer of goods from a lessee to a buyer or sublessee, where the goods are subject to an existing lease and covered by a certicate of title. Cf. Section 2A-304 ocial comment. Cross References: Sections 2-403, 2A-103(1)(a), 2A-304 and 2A-305(2). Denitional Cross References: Buyer. Section 2-103(1)(a). Buyer in the ordinary course of business. Section 2A-103(1)(a). Delivery. Section 2A-103(1)(g). Entrusting. Section 2-403(3). Good faith. Sections 2A-103(1)(m). Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease contract. Section 2A-103(1)(r). Leasehold interest. Section 2A-103(1)(s). Lessee. Section 2A-103(1)(t). Lessee in the ordinary course of business. Section 2A-103(1)(o). Lessor. Section 2A-103(1)(v). Merchant. Section 2-104(1). Rights. Section 1-201. Sale. Section 2-106(1). Sublease. Section 2A-103(1)(ee). Value. Section 1-204.

2A-306. Priority of Certain Liens Arising by Operation of Law. If a person in the ordinary course of its business furnishes services or
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materials with respect to goods subject to a lease contract, a lien upon those goods in the possession of that person given by statute or rule of law for those materials or services takes priority over any interest of the lessor or lessee under the lease contract or this Article unless the lien is created by statute and the statute provides otherwise or unless the lien is created by rule of law and the rule of law provides otherwise. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 9-310. Changes: The approach reected in the provisions of Section 9-310 was included, but revised to conform to leasing terminology and to expand the exception to the special priority granted to protected liens to cover liens created by rule of law as well as those created by statute. Purposes: This section should be interpreted to allow a qualied lessor or a qualied lessee to be the competing lienholder if the statute or rule of law so provides. The reference to statute includes applicable regulations and cases; these sources must be reviewed in resolving a priority dispute under this section. Cross Reference: Section 9-333. Denitional Cross References: Goods. Section 2A-103(1)(n). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Lien. Section 2A-103(1)(x). Person. Section 1-201.

2A-307. Priority of Liens Arising by Attachment or Levy On, Security Interests In, and Other Claims to Goods. (1) Except as otherwise provided in Section 2A-306, a creditor of a lessee takes subject to the lease contract. (2) Except as otherwise provided in subsection (3) and Sections 2A-306 and 2A-308, a creditor of a lessor takes subject to the lease contract unless the creditor holds a lien that attached to the goods before the lease contract became enforceable. (3) Except as otherwise provided in Sections 9-317, 9-321, and 9-323, a lessee takes a leasehold interest subject to a security interest held by a creditor of the lessor. As amended in 1990, 1999 and 2003.
See VI for material relating to changes made in text in 1990. See Appendix I contained within revised Article 9 for material related to changes made in text in 1999. See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (1) states a general rule of priority that a creditor of the lessee takes subject to the lease contract. The term lessee (Section 2A-102(a)(25)) includes sublessee. Therefore, this subsection not only covers disputes between the prime lessor and a creditor of the prime lessee but also disputes between the prime lessor, or the sublessor, and a creditor of the sublessee. Furthermore, by using the term creditor (Section 1-201(13)), this subsection covers disputes with a general creditor, a secured creditor, a lien creditor and 255

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any representative of creditors. 2. Subsection (2) states a general rule of priority that a creditor of a lessor takes subject to the lease contract. Thus, the section only covers disputes between the prime lessee and a creditor of the prime lessor but also disputes between the prime lessee, or the sublessee, and a creditor of the sublessor. 3. To take priority over the lease contract, and the interests derived from the lease contract the creditor's lien must have attached before the lease contract became enforceable. 4. The rules of this section operate in favor of whichever party to the lease contract can enforce it, even if one party may not, e.g., because of Section 2A-201(1)(b). 5. The provisions of the predecessor of this section, original Section 2A-307, which dealt with the relationship between a secured creditor of the lessor and a lessee have been moved to revised Article 9 in Sections 9-317, 9-321, and 9-323. Cross References: Point 1: Section 1-201. Point 4: Section 2A-201. Point 5: Section 2A-307 and Sections 9-317, 9-321 and 9-323. Denitional Cross References: Creditor. Section 1-201. Goods. Section 2A-103(1)(n). Knowledge. Section 1-202. Lease. Section 2A-103(1)(p). Lease contract. Section 2A-103(1)(r). Leasehold interest. Section 2A-103(1)(s). Lessee. Section 2A-103(1)(t). Lessee in the ordinary course of business. Section 2A-103(1)(o). Lessor. Section 2A-103(1)(v). Lien. Section 2A-103(1)(x). Party. Section 1-201. Pursuant to commitment. Section 2A-103(3). Security interest. Section 1-201.

As amended in 1999 and 2003.

See Appendix I contained within revised Article 9 for material relating to changes made in Ocial Comment in 1999. See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-308. Special Rights of Creditors. (1) A creditor of a lessor in possession of goods subject to a lease contract may treat the lease contract as void if as against the creditor retention of possession by the lessor is fraudulent under any statute or rule of law, but retention of possession in good faith and current course of trade by the lessor for a commercially reasonable time after the lease contract becomes enforceable is not fraudulent. (2) Nothing in this Article impairs the rights of creditors of a lessor if the lease contract (a) becomes enforceable, not in current course of trade but in satisfaction of or as security for a pre-existing claim for money, security, or the like, and (b) is made under circumstances which under any statute or rule of law apart from this Article would constitute the transaction a fraudulent transfer or voidable preference. (3) A creditor of a seller may treat a sale or an identication of goods to a contract for sale as void if as against the creditor retention of possession by the seller is fraudulent under any statute or rule of law, but retention of possession of the goods pursuant to a lease contract entered into by the
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seller as lessee and the buyer as lessor in connection with the sale or identication of the goods is not fraudulent if the buyer bought for value and in good faith. Ocial Comment
Uniform Statutory Source: Section 2-402(2) and (3)(b). Changes: Rephrased and new material added to conform to leasing terminology and practice. Purposes: Subsection (1) states a general rule of avoidance where the lessor has retained possession of goods if such retention is fraudulent under any statute or rule of law. However, the subsection creates an exception under certain circumstances for retention of possession of goods for a commercially reasonable time after the lease contract becomes enforceable. Subsection (2) also preserves the possibility of an attack on the lease by creditors of the lessor if the lease was made in satisfaction of or as security for a pre-existing claim, and would constitute a fraudulent transfer or voidable preference under other law. Finally, subsection (3) states a new rule with respect to sale-leaseback transactions, i.e., transactions where the seller sells goods to a buyer but possession of the goods is retained by the seller pursuant to a lease contract between the buyer as lessor and the seller as lessee. Notwithstanding any statute or rule of law that would treat such retention as fraud, whether per se, prima facie, or otherwise, the retention is not fraudulent if the buyer bought for value (Section 1-201(44)) and in good faith (Sections 1-201(19) and 2-103(1)(b)). Section 2A-103(3) and (4). This provision overrides Section 2-402(2) to the extent it would otherwise apply to a sale-leaseback transaction. Cross References: Section 1-201, Section 2-402(2) and Section 2A-103(4). Denitional Cross References: Buyer. Section 2-103(1)(a). Contract. Section 1-201. Creditor. Section 1-201. Good faith. Sections 2A-103(1)(m). Goods. Section 2A-103(1)(n). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Money. Section 1-201. Reasonable time. Section 1-205. Rights. Section 1-201. Sale. Section 2-106(1). Seller. Section 2-103(1)(o). Value. Section 1-204.

2A-309. Lessor's and Lessee's Rights When Goods Become Fixtures. (1) In this section: (a) goods are xtures if they become so related to particular real property that an interest in them arises under real property law; (b) a xture ling is the ling, in the oce where a mortgage on the real property would be led or recorded, of a nancing statement covering goods that are or are to become xtures and conforming to the requirements of Section 9-502(a) and (b); (c) a lease is a purchase money lease unless the lessee has possession or use of the goods or the right to possession or use of the goods before the lease agreement is enforceable; (d) a mortgage is a construction mortgage to the extent it secures an
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obligation incurred for the construction of an improvement on land, including the acquisition cost of the land, if a recorded record of the mortgage so indicates; and (e) encumbrance includes real property mortgages and other liens on real property and all other rights in real property that are not ownership interests. (2) Under this Article a lease may be of goods that are xtures or may continue in goods that become xtures, but no lease exists under this Article of ordinary building materials incorporated into an improvement on land. (3) This Article does not prevent creation of a lease of xtures pursuant to real property law. (4) The perfected interest of a lessor of xtures has priority over a conicting interest of an encumbrancer or owner of the real property if: (a) the lease is a purchase money lease, the conicting interest of the encumbrancer or owner arises before the goods become xtures, the interest of the lessor is perfected by a xture ling before the goods become xtures or within 10 days thereafter, and the lessee has an interest of record in the real property or is in possession of the real property; or (b) the interest of the lessor is perfected by a xture ling before the interest of the encumbrancer or owner is of record, the lessor's interest has priority over any conicting interest of a predecessor in title of the encumbrancer or owner, and the lessee has an interest of record in the real property or is in possession of the real property. (5) The interest of a lessor of xtures, whether or not perfected, has priority over the conicting interest of an encumbrancer or owner of the real property if: (a) the xtures are readily removable factory or oce machines, readily removable equipment that is not primarily used or leased for use in the operation of the real property, or readily removable replacements of domestic appliances that are goods subject to a consumer lease, and before the goods become xtures the lease contract is enforceable; or (b) the conicting interest is a lien on the real property obtained by legal or equitable proceedings after the lease contract is enforceable; or (c) the encumbrancer or owner has consented in a record to the lease or has disclaimed an interest in the goods as xtures; or (d) the lessee has a right to remove the goods as against the encumbrancer or owner, but if the lessee's right to remove terminates, the priority of the interest of the lessor continues for a reasonable time. (6) Notwithstanding subsection (4)(a) but otherwise subject to subsections (4) and (5), the interest of a lessor of xtures, including the lessor's residual interest, is subordinate to the conicting interest of an encumbrancer of the real property under a construction mortgage recorded before the goods become xtures if the goods become xtures before the completion of the construction. To the extent given to renance a construction mortgage, the conicting interest of an encumbrancer of the real property under a mortgage has this priority to the same extent as the encumbrancer of the real property under the construction mortgage.
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(7) In cases not covered by subsections (3) through (6), priority between the interest of a lessor of xtures, including the lessor's residual interest, and the conicting interest of an encumbrancer or owner of the real property that is not the lessee is determined by the priority rules governing conicting interests in real property. (8) If the interest of a lessor of xtures, including the lessor's residual interest, has priority over all conicting interests of all owners and encumbrancers of the real property, the lessor or the lessee may (i) on default, expiration, termination, or cancellation of the lease agreement but subject to the agreement and this Article, or (ii) if necessary to enforce other rights and remedies of the lessor or lessee under this Article, remove the goods from the real property, free and clear of all conicting interests of all owners and encumbrancers of the real property, but the lessor or lessee must reimburse any encumbrancer or owner of the real property that is not the lessee and that has not otherwise agreed for the cost of repair of any physical injury, but not for any diminution in value of the real property caused by the absence of the goods removed or by any necessity of replacing them. A person entitled to reimbursement may refuse permission to remove until the party seeking removal gives adequate security for the performance of this obligation. (9) Even if the lease agreement does not create a security interest, the interest of a lessor of xtures, including the lessor's residual interest, is perfected by ling a nancing statement as a xture ling for leased goods that are or are to become xtures in accordance with the relevant provisions of Article 9. As amended in 1990, 1999 and 2003.
See Appendix F for material relating to changes made in text in 1990. See Appendix I within revised Article 9 for material relating to changes made in text in 1999. See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 9-313. Changes: Revised to reect leasing terminology and to add new material. Purposes: 1. While Section 9-313 provided a model for this section, certain provisions were substantially revised. 2. Section 2A-309(1)(c), which is new, denes purchase money lease to exclude leases where the lessee had possession or use of the goods or the right thereof before the lease agreement became enforceable. This term is used in subsection (4)(a) as one of the conditions that must be satised to obtain priority over the conicting interest of an encumbrancer or owner of the real estate. 3. Section 2A-309(4), which states one of several priority rules found in this section, deletes reference to oce machines and the like (Section 9-313(4)(c)) as well as certain liens (Section 9-313(4)(d)). However, these items are included in subsection (5), another priority rule that is more permissive than the rule found in subsection (4) as it applies whether or not the interest of the lessor is perfected. In addition, subsection (5)(a) expands the scope of the provisions of Section 9-313(4)(c) to include readily removable equipment not primarily used or leased for use in the operation of real estate; the qualier is intended to exclude from the expanded rule equipment integral to the operation of real estate, e.g., heating and air conditioning equipment. 4. The rule stated in subsection (7) is more liberal than the rule stated in Section 9-313(7) in that issues of priority not otherwise resolved in this subsection are left for resolution by 259

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the priority rules governing conicting interests in real estate, as opposed to the Section 9-313(7) automatic subordination of the security interest in xtures. Note that, for the purpose of this section, where the interest of an encumbrancer or owner of the real estate is paramount to the interest of the lessor, the latter term includes the residual interest of the lessor. 5. The rule stated in subsection (8) is more liberal than the rule stated in Section 9-313(8) in that the right of removal is extended to both the lessor and the lessee and the occasion for removal includes expiration, termination or cancellation of the lease agreement, and enforcement of rights and remedies under this Article, as well as default. The new language also provides that upon removal the goods are free and clear of conicting interests of owners and encumbrancers of the real estate. 6. Finally, subsection (9) provides a mechanism for the lessor of xtures to perfect its interest by ling a nancing statement under the provisions of the Article on Secured Transactions (Article 9), even though the lease agreement does not create a security interest. Section 1-201(37). The relevant provisions of Article 9 must be interpreted permissively to give eect to this mechanism as it implicitly expands the scope of Article 9 so that its ling provisions apply to transactions that create a lease of xtures, even though the lease agreement does not create a security interest. This mechanism is similar to that provided in Section 2-326(3)(c) for the seller of goods on consignment, even though the consignment is not intended as security. Section 1-201(37). Given the lack of litigation with respect to the mechanism created for consignment sales, this new mechanism should prove eective. Cross References: Point 1: Section 9-313, 9-334 and 9-604. Point 3: Section 9-334. Point 4: Section 9-334. Point 5: Section 9-604. Point 6: Section 1-201 and Section 2-326. Denitional Cross References: Agreed. Section 1-201. Cancellation. Section 2A-103(1)(a). Conforming. Section 2A-103(1)(c). Consumer lease. Section 2A-103(1)(f). Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease agreement. Section 2A-103(1)(k). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Lien. Section 2A-103(1)(x). Mortgage. Section 9-105(1)(j). Party. Section 1-201. Person. Section 1-201. Reasonable time. Section 1-205. Record. Section 2A-103(1)(cc). Remedy. Section 1-201. Rights. Section 1-201. Security interest. Section 1-201. Termination. Section 2A-103(1)(hh). Value. Section 1-204.

2A-310. Lessor's and Lessee's Rights When Goods Become Accessions. (1) Goods are accessions when they are installed in or axed to other goods. (2) The interest of a lessor or a lessee under a lease contract entered into
260

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before the goods became accessions is superior to all interests in the whole except as stated in subsection (4). (3) The interest of a lessor or a lessee under a lease contract entered into at the time or after the goods became accessions is superior to all subsequently acquired interests in the whole except as stated in subsection (4) but is subordinate to interests in the whole existing at the time the lease contract was made unless the holders of such interests in the whole have in a record consented to the lease or disclaimed an interest in the goods as part of the whole. (4) The interest of a lessor or a lessee under a lease contract described in subsection (2) or (3) is subordinate to the interest of (a) a buyer in the ordinary course of business or a lessee in the ordinary course of business of any interest in the whole acquired after the goods became accessions; or (b) a creditor with a security interest in the whole perfected before the lease contract was made to the extent that the creditor makes subsequent advances without knowledge of the lease contract. (5) When under subsections (2) or (3) and (4) a lessor or a lessee of accessions holds an interest that is superior to all interests in the whole, the lessor or the lessee may (a) on default, expiration, termination, or cancellation of the lease contract by the other party but subject to the provisions of the lease contract and this Article, or (b) if necessary to enforce other rights and remedies under this Article, remove the goods from the whole, free and clear of all interests in the whole, but the lessor or the lessee must reimburse any holder of an interest in the whole who is not the lessee and who has not otherwise agreed for the cost of repair of any physical injury but not for any diminution in value of the whole caused by the absence of the goods removed or by any necessity for replacing them. A person entitled to reimbursement may refuse permission to remove until the party seeking removal gives adequate security for the performance of this obligation. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 9-314. Changes: Revised to reect leasing terminology and to add new material. Purposes: Subsections (1) and (2) restate the provisions of subsection (1) of Section 9-314 to clarify the denition of accession and to add leasing terminology to the priority rule that applies when the lease is entered into before the goods become accessions. Subsection (3) restates the provisions of subsection (2) of Section 9-314 to add leasing terminology to the priority rule that applies when the lease is entered into on or after the goods become accessions. Unlike the rule with respect to security interests, the lease is merely subordinate, not invalid. Subsection (4) creates two exceptions to the priority rules stated in subsections (2) and (3). Subsection (4) deletes the special priority rule found in the provisions of Section 9-314(3)(b) as the interests of the lessor and lessee are entitled to greater protection. Finally, subsection (5) is modeled on the provisions of Section 9-314(4) with respect to removal of accessions, restated to reect the parallel changes in Section 2A-309(8). Neither this section nor Section 9-314 governs where the accession to the goods is not subject to the interest of a lessor or a lessee under a lease contract and is not subject to the interest of a secured party under a security agreement. This issue is to be resolved by the 261

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courts, case by case. Unlike the rules governing a security interest under Article 9, there is never a requirement in this Article that a lessor make a public ling to fully protect its interest in the leased goods against third party claims. Similarly, a lessor need not make a public ling to protect any interest in accessions to those leased goods. Accordingly, priority rules involving leased accessions should not be resolved by reference to Article 9's ling rules. Cross References: Section 2A-309(8), and Sections 9-102 and 9-335. Denitional Cross References: Agreed. Section 1-201. Buyer in the ordinary course of business. Section 2A-103(1)(a). Cancellation. Section 2A-103(1)(a). Creditor. Section 1-201. Goods. Section 2A-103(1)(n). Holder. Section 1-201. Knowledge. Section 1-202. Lease. Section 2A-103(1)(p). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessee in the ordinary course of business. Section 2A-103(1)(o). Lessor. Section 2A-103(1)(v). Party. Section 1-201. Person. Section 1-201. Remedy. Section 1-201. Rights. Section 1-201. Security interest. Section 1-201. Termination. Section 2A-103(1)(hh). Value. Section 1-204. Writing. Section 1-201.

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-311. Priority Subject to Subordination. Nothing in this Article prevents subordination by agreement by any person entitled to priority. As added in 1990. Ocial Comment
Uniform Statutory Source: Section 9-316. Purposes: The several preceding sections deal with questions of priority. This section is inserted to make it entirely clear that a person entitled to priority may eectively agree to subordinate the claim. Only the person entitled to priority may make such an agreement: the rights of such a person cannot be adversely aected by an agreement to which that person is not a party. Cross References: Section 1-102 and Sections 2A-304 through 2A-310. Denitional Cross References: Agreement. Section 1-201. Person. Section 1-201.

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2A-402

PART 4. PERFORMANCE OF LEASE CONTRACT: REPUDIATED, SUBSTITUTED AND EXCUSED

2A-401. Insecurity: Adequate Assurance of Performance. (1) A lease contract imposes an obligation on each party that the other's expectation of receiving due performance will not be impaired. (2) If reasonable grounds for insecurity arise with respect to the performance of either party, the insecure party may demand in a record adequate assurance of due performance. Until the insecure party receives that assurance, if commercially reasonable the insecure party may suspend any performance for which the insecure party has not already received the agreed return. (3) A repudiation of the lease contract occurs if assurance of due performance adequate under the circumstances of the particular case is not provided to the insecure party within a reasonable time, not to exceed 30 days after receipt of a demand by the other party. (4) Between merchants, the reasonableness of grounds for insecurity and the adequacy of any assurance oered must be determined according to commercial standards. (5) Acceptance of any nonconforming delivery or payment does not prejudice the aggrieved party's right to demand adequate assurance of future performance. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-609. Changes: Revised to reect leasing practices and terminology. Note that in the analogue to subsection (3) (Section 2-609(4)), the adjective justied modies demand. The adjective was deleted here as unnecessary, implying no substantive change. Denitional Cross References: Aggrieved party. Section 1-201. Agreed. Section 1-201. Between merchants. Section 2-104(3). Conforming. Section 2A-103(1)(c). Delivery. Section 2A-103(1)(g). Lease contract. Section 2A-103(1)(r). Party. Section 1-201. Reasonable time. Section 1-205. Receipt. Section 2-103(1)(c). Record. Section 2A-103(1)(cc). Rights. Section 1-201.

2A-402. Anticipatory Repudiation. (1) If either party repudiates a lease contract with respect to a performance not yet due under the lease contract, the loss of which performance will substantially impair the value of the lease contract to the other, the aggrieved party may: (a) for a commercially reasonable time, await retraction of repudiation and performance by the repudiating party; (b) make demand pursuant to Section 2A-401 and await assurance of
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future performance adequate under the circumstances of the particular case; or (c) resort to any right or remedy upon default under the lease contract or this Article, even if the aggrieved party has notied the repudiating party that the aggrieved party would await the repudiating party's performance and assurance and has urged retraction. In addition, whether or not the aggrieved party is pursuing one of the foregoing remedies, the aggrieved party may suspend performance or, if the aggrieved party is the lessor, proceed in accordance with the provisions of this Article on the lessor's right to identify goods to the lease contract notwithstanding default or to salvage unnished goods under Section 2A-524. (2) Repudiation includes language that a reasonable person would interpret to mean that the other person will not or cannot make a performance still due under the contract or voluntary, armative conduct that would appear to a reasonable party to make a future performance by the other party impossible. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-610. Changes: Revised to reect leasing practices and terminology. Subsection (2), provides guidance on when a party can be considered to have repudiated a performance obligation based upon the Restatement (Second) of Contracts 250 and does not purport to be an exclusive statement of when a repudiation has occurred. Repudiation centers upon an overt communication of intention, actions which render performance impossible, or a demonstration of a clear determination not to perform. Repudiation does not require that performance be made utterly impossible, rather, actions which reasonably indicate rejection of the performance obligation suce. Failure to provide adequate assurance of due performance under Section 2A-401 also operates as a repudiation. Cross Reference: Section 2A-401. Denitional Cross References: Aggrieved party. Section 1-201. Goods. Section 2A-103(1)(n). Lease contract. Section 2A-103(1)(r). Lessor. Section 2A-103(1)(v). Noties. Section 1-201. Party. Section 1-201. Reasonable time. Section 1-205. Remedy. Section 1-201. Rights. Section 1-201. Value. Section 1-204.

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-403. Retraction of Anticipatory Repudiation. (1) Until the repudiating party's next performance is due, the repudiating party can retract the repudiation unless, since the repudiation, the aggrieved party has cancelled the lease contract or materially changed the aggrieved party's position or otherwise indicated that the aggrieved party considers the repudiation nal.
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Art. 2A

Leases

2A-405

(2) Retraction may be by any method that clearly indicates to the aggrieved party that the repudiating party intends to perform under the lease contract and includes any assurance demanded under Section 2A401. (3) Retraction reinstates a repudiating party's rights under a lease contract with due excuse and allowance to the aggrieved party for any delay occasioned by the repudiation. Ocial Comment
Uniform Statutory Source: Section 2-611. Changes: Revised to reect leasing practices and terminology. Note that in the analogue to subsection (2) (Section 2-611(2)) the adjective justiably modies demanded. The adjective was deleted here (as it was in Section 2A-401) as unnecessary, implying no substantive change. Denitional Cross References: Aggrieved party. Section 1-201. Cancellation. Section 2A-103(1)(a). Lease contract. Section 2A-103(1)(r). Party. Section 1-201. Rights. Section 1-201.

2A-404. Substituted Performance. (1) If without fault of the lessee, the lessor and the supplier, the agreed berthing, loading, or unloading facilities fail or the agreed type of carrier becomes unavailable or the agreed manner of performance otherwise becomes commercially impracticable, but a commercially reasonable substitute is available, the substitute performance must be tendered and accepted. (2) If the agreed means or manner of payment fails because of domestic or foreign governmental regulation: (a) the lessor may withhold or stop delivery or cause the supplier to withhold or stop delivery unless the lessee provides a means or manner of payment that is commercially a substantial equivalent; and (b) if delivery has already been taken, payment by the means or in the manner provided by the regulation discharges the lessee's obligation unless the regulation is discriminatory, oppressive, or predatory. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-614. Changes: Revised to reect leasing practices and terminology. Denitional Cross References: Agreed. Section 1-201. Delivery. Section 2A-103(1)(g). Fault. Section 2A-103(1)(k). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Supplier. Section 2A-103(1)().

2A-405. Excused Performance. Subject to Section 2A-404 on substituted performance, the following rules apply:
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(a) Delay in performance or nonperformance in whole or in part by a lessor or a supplier that complies with paragraphs (b) and (c) is not a default under the lease contract if performance as agreed has been made impracticable by the occurrence of a contingency the nonoccurrence of which was a basic assumption on which the lease contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation or order, whether or not the regulation or order later proves to be invalid. (b) If the causes mentioned in paragraph (a) aect only part of the lessor's or the supplier's capacity to perform, the lessor or supplier shall allocate production and deliveries among customers but at the lessor's or supplier's option may include regular customers not then under contract for sale or lease as well as the lessor's or supplier's own requirements for further manufacture. The lessor or supplier may so allocate in any manner that is fair and reasonable. (c) The lessor seasonably shall notify the lessee and in the case of a nance lease the supplier seasonably shall notify the lessor and the lessee, if known, that there will be delay or nonperformance and, if allocation is required under paragraph (b), of the estimated quota thus made available for the lessee. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-615. Changes: Revised to reect leasing practices and terminology. Although the section has been expanded beyond the context of delivery to apply to delay in performance or nonperformance, it does not apply unless the lessor's delay or nonperformance would otherwise constitute a default under the lease contract. The section by its terms applies only to lessors, although the rationale might in an appropriate case apply and entitle a lessee to an excuse. In a nance lease that is not a consumer lease, however, the statutory hell or high water provision of Section 2A-407 precludes the lessee from claiming the excuse. Denitional Cross References: Agreed. Section 1-201. Contract. Section 1-201. Delivery. Section 2A-103(1)(g). Finance lease. Section 2A-103(1)(l). Good faith. Sections 2A-103(1)(m). Knows. Section 1-201. Lease. Section 2A-103(1)(p). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Noties. Section 1-201 Sale. Section 2-106(1). Seasonably. Section 1-204(3). Supplier. Section 2A-103(1)().

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-406. Procedure on Excused Performance. (1) If the lessee receives notication of a material or indenite delay or
266

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2A-407

an allocation justied under Section 2A-405, the lessee may by notication in a record to the lessor as to any goods involved, and with respect to all of the goods if under an installment lease contract the value of the whole lease contract is substantially impaired (Section 2A-510): (a) terminate the lease contract (Section 2A-505(2)); or (b) except in a nance lease that is not a consumer lease, modify the lease contract by accepting the available quota in substitution, with due allowance from the rent payable for the balance of the lease term for the deciency but without further right against the lessor. (2) If, after receipt of a notication from the lessor under Section 2A-405, the lessee fails so to modify the lease agreement within a reasonable time not exceeding 30 days, the lease contract is terminated with respect to any performance aected. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-616(1) and (2). Changes: Revised to reect leasing practices and terminology. Note that subsection 1(a) allows the lessee under a lease, including a nance lease, the right to terminate the lease for excused performance (Sections 2A-404 and 2A-405). However, subsection 1(b), which allows the lessee the right to modify the lease for excused performance, excludes a nance lease that is not a consumer lease. This exclusion is compelled by the same policy that led to codication of provisions with respect to irrevocable promises. Section 2A-407. Denitional Cross References: Consumer lease. Section 2A-103(1)(f). Delivery. Section 2A-103(1)(g). Finance lease. Section 2A-103(1)(l). Goods. Section 2A-103(1)(n). Installment lease contract. Section 2A-103(1)(o). Lease agreement. Section 2A-103(1)(q). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Notice. Section 1-202. Reasonable time. Section 1-205. Receipt. Section 2-103(1)(c). Record. Section 2A-103(1)(cc). Rights. Section 1-201. Termination. Section 2A-103(1)(hh). Value. Section 1-204.

2A-407. Irrevocable Promises: Finance Leases. (1) In the case of a nance lease that is not a consumer lease the lessee's promises under the lease contract become irrevocable and independent upon the lessee's acceptance of the goods. (2) A promise that has become irrevocable and independent under subsection (1): (a) is eective and enforceable between the parties, and by or against third parties including assignees of the parties; and (b) is not subject to cancellation, termination, modication, repudiation, excuse, or substitution without the consent of the party to whom the promise runs.
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(3) This section does not aect the validity under any other law of a covenant in any lease contract making the lessee's promises irrevocable and independent upon the lessee's acceptance of the goods. Ocial Comment
Uniform Statutory Source: None. Purposes: 1. This section extends the benets of the classic hell or high water clause to a nance lease that is not a consumer lease. This section is self-executing; no special provision need be added to the contract. This section makes covenants in a nance lease irrevocable and independent due to the function of the nance lessor in a three party relationship: the lessee is looking to the supplier to perform the essential covenants and warranties. Section 2A-209. Thus, upon the lessee's acceptance of the goods the lessee's promises to the lessor under the lease contract become irrevocable and independent. The provisions of this section remain subject to the obligation of good faith (Sections 2A-103(4) and 1-203), and the lessee's revocation of acceptance (Section 2A-517). 2. The section requires the lessee to perform even if the lessor's performance after the lessee's acceptance is not in accordance with the lease contract; the lessee may, however, have and pursue a cause of action against the lessor, e.g., breach of certain limited warranties (Sections 2A-210 and 2A-211(1)). This is appropriate because the benet of the supplier's promises and warranties to the lessor under the supply contract and, in some cases, the warranty of a manufacturer who is not the supplier, is extended to the lessee under the nance lease. Section 2A-209. Despite this balance, this section excludes a nance lease that is a consumer lease. That a consumer be obligated to pay notwithstanding defective goods or the like is a principle that is not tenable under case law (Unico v. Owen, 50 N.J. 101, 232 A.2d 405 (1967)), state statute (Unif.Consumer Credit Code 3.403.405, 7A U.L.A. 12631 (1974)), or federal statute (15 U.S.C. 1666i (1982)). 3. The relationship of the three parties to a transaction that qualies as a nance lease is best demonstrated by a hypothetical. A, the potential lessor, has been contacted by B, the potential lessee, to discuss the lease of an expensive line of equipment that B has recently placed an order for with C, the manufacturer of such goods. The negotiation is completed and A, as lessor, and B, as lessee, sign a lease of the line of equipment for a 60-month term. B, as buyer, assigns the purchase order with C to A. If this transaction creates a lease (Section 2A-103(1)(j)), this transaction should qualify as a nance lease. Section 2A-103(1) (g). 4. The line of equipment is delivered by C to B's place of business. After installation by C and testing by B, B accepts the goods by signing a certicate of delivery and acceptance, a copy of which is sent by B to A and C. One year later the line of equipment malfunctions and B falls behind in its manufacturing schedule. 5. Under this Article, because the lease is a nance lease, no warranty of tness or merchantability is extended by A to B. Sections 2A-212(1) and 2A-213. Absent an express provision in the lease agreement, application of Section 2A-210 or Section 2A-211(1), or application of the principles of law and equity, including the law with respect to fraud, duress, or the like (Sections 2A-103(4) and 1-103), B has no claim against A. B's obligation to pay rent to A continues as the obligation became irrevocable and independent when B accepted the line of equipment (Section 2A-407(1)). B has no right of set-o with respect to any part of the rent still due under the lease. Section 2A-508(6). However, B may have another remedy. Despite the lack of privity between B and C (the purchase order with C having been assigned by B to A), B may have a claim against C. Section 2A-209(1). 6. This section does not address whether a hell or high water clause, i.e., a clause that is to the eect of this section, is enforceable if included in a nance lease that is a consumer lease or a lease that is not a nance lease. That issue will continue to be determined by the facts of each case and other law which this section does not aect. Sections 2A-104, 2A103(4), 9-206 and 9-318. However, with respect to nance leases that are not consumer leases courts have enforced hell or high water clauses. In re O.P.M. Leasing Servs., 21 Bankr. 993, 1006 (Bankr.S.D.N.Y.1982). 7. Subsection (2) further provides that a promise that has become irrevocable and independent under subsection (1) is enforceable not only between the parties but also against third parties. Thus, the nance lease can be transferred or assigned without disturbing 268

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enforceability. Further, subsection (2) also provides that the promise cannot, among other things, be cancelled or terminated without the consent of the lessor. Cross References: Point 1: Sections 1-203 and Sections 2A-103, 2A-209, and 2A-517. Point 2: Sections 2A-209, 2A-210, and 2A-211. Point 3: Section 2A-103. Point 5: Section 1-203 and Sections 2A-209, 2A-210, 2A-211, 2A-212, 2A-213, 2A-407, 2A508. Point 6: Sections 2A-103, 2A-104 and Sections 9-403 and 9-404. Denitional Cross References: Cancellation. Section 2A-103(1)(a). Consumer lease. Section 2A-103(1)(f). Finance lease. Section 2A-103(1)(l). Goods. Section 2A-103(1)(n). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Party. Section 1-201. Termination. Section 2A-103(1)(hh).

PART 5. DEFAULT
A. IN GENERAL 2A-501. Default: Procedure. (1) Whether the lessor or the lessee is in default under a lease contract is determined by the lease agreement and this Article. (2) If the lessor or the lessee is in default under the lease contract, the party seeking enforcement has rights and remedies as provided in this Article and, except as limited by this Article, as provided in the lease agreement. (3) If the lessor or the lessee is in default under the lease contract, the party seeking enforcement may reduce the party's claim to judgment, or otherwise enforce the lease contract by self-help or any available judicial procedure or nonjudicial procedure, including administrative proceeding, arbitration, or the like, in accordance with this Article. (4) Except as otherwise provided in Section 1-305(a) or this Article or the lease agreement, the rights and remedies referred to in subsections (2) and (3) are cumulative. (5) If the lease agreement covers both real property and goods, the party seeking enforcement may proceed under this Part as to the goods, or under other applicable law as to both the real property and the goods in accordance with that party's rights and remedies in respect of the real property, in which case this Part does not apply. As amended in 2005.
See Appendix V for material relating to changes made in text in 2005.

Ocial Comment
Uniform Statutory Source: Section 9-501. Changes: Substantially revised. Purposes: 1. Subsection (1) is new and represents a departure from the Article on Secured Transactions (Article 9) as the subsection makes clear that whether a party to the lease agreement 269

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is in default is determined by this Article as well as the agreement. Sections 2A-508 and 2A-523. It further departs from Article 9 in recognizing the potential default of either party, a function of the bilateral nature of the obligations between the parties to the lease contract. 2. Subsection (2) is a version of the rst sentence of Section 9-501(1), revised to reect leasing terminology. 3. Subsection (3), an expansive version of the second sentence of Section 9-501(1), lists the procedures that may be followed by the party seeking enforcement; in eect, the scope of the procedures listed in subsection (3) is consistent with the scope of the procedures available to the foreclosing secured party. 4. Subsection (4) establishes that the parties' rights and remedies are cumulative. DeKoven, Leases of Equipment: Puritan Leasing Company v. August, A Dangerous Decision, 12 U.S.F. L.Rev. 257, 27680 (1978). Cumulation, and largely unrestricted selection, of remedies is allowed in furtherance of the general policy of the Commercial Code, stated in Section 1-106, that remedies be liberally administered to put the aggrieved party in as good a position as if the other party had fully performed. Therefore, cumulation of, or selection among, remedies is available to the extent necessary to put the aggrieved party in as good a position as it would have been in had there been full performance. However, cumulation of, or selection among, remedies is not available to the extent that the cumulation or selection would put the aggrieved party in a better position than it would have been in had there been full performance by the other party. 5. Section 9-501(3), which, among other things, states that certain rules, to the extent they give rights to the debtor and impose duties on the secured party, may not be waived or varied, was not incorporated in this Article. Given the signicance of freedom of contract in the development of the common law as it applies to bailments for hire and the lessee's lack of an equity of redemption, there was no reason to impose that restraint. Cross References: Point 1: Sections 2A-508 and 2A-532. Point 2: Section 9-601. Point 3: Section 9-601. Point 4: Section 1-103. Point 5: Section 9-602. Denitional Cross References: Goods. Section 2A-103(1)(n). Lease agreement. Section 2A-103(1)(q). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Party. Section 1-201. Remedy. Section 1-201. Rights. Section 1-201.

2A-502. Notice after Default. Except as otherwise provided in this Article or the lease agreement, the lessor or lessee in default under the lease contract is not entitled to notice of default or notice of enforcement from the other party to the lease agreement. Ocial Comment
Uniform Statutory Source: None. Purposes: This section makes clear that absent agreement to the contrary or provision in this Article to the contrary, e.g., Section 2A-516(3)(a), the party in default is not entitled to notice of default or enforcement. While a review of Part 5 of Article 9 leads to the same conclusion with respect to giving notice of default to the debtor, it is never stated. Although Article 9 requires notice of disposition and strict foreclosure, the dierent scheme of lessors' and lessees' rights and remedies developed under the common law, and codied by this Article, generally does not require notice of enforcement; furthermore, such notice is not 270

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mandated by due process requirements. However, certain sections of this Article do require notice. E.g., Section 2A-517(2) 2A-517(4). Previous incorrect cross reference corrected by Permanent Editorial Board, November 1992. Cross References: Sections 2A-516(3)(a), 2A-517(4), and Article 9. Denitional Cross References: Lease agreement. Section 2A-103(1)(q). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Notice. Section 1-202. Party. Section 1-201.

2A-503. Modication or Impairment of Rights and Remedies. (1) Except as otherwise provided in this Article, the lease agreement may include rights and remedies for default in addition to or in substitution for those provided in this Article and may limit or alter the measure of damages recoverable under this Article. (2) Resort to a remedy provided under this Article or in the lease agreement is optional unless the remedy is expressly agreed to be exclusive. If circumstances cause an exclusive or limited remedy to fail of its essential purpose, or provision for an exclusive remedy is unconscionable, remedy may be had as provided in this Article. (3) Consequential damages may be liquidated under Section 2A-504, or may otherwise be limited, altered, or excluded unless the limitation, alteration, or exclusion is unconscionable. Limitation, alteration, or exclusion of consequential damages for injury to the person in the case of consumer goods is prima facie unconscionable but limitation, alteration, or exclusion of damages where the loss is commercial is not prima facie unconscionable. (4) Rights and remedies on default by the lessor or the lessee with respect to any obligation or promise collateral or ancillary to the lease contract are not impaired by this Article. Ocial Comment
Uniform Statutory Source: Sections 2-719 and 2-701. Changes: Rewritten to reect lease terminology and to clarify the relationship between this section and Section 2A-504. Purposes: 1. A signicant purpose of this Part is to provide rights and remedies for those parties to a lease who fail to provide them by agreement or whose rights and remedies fail of their essential purpose or are unenforceable. However, it is important to note that this implies no restriction on freedom to contract. Sections 2A-103(4) and 1-102(3). Thus, subsection (1), a revised version of the provisions of Section 2-719(1), allows the parties to the lease agreement freedom to provide for rights and remedies in addition to or in substitution for those provided in this Article and to alter or limit the measure of damages recoverable under this Article. Except to the extent otherwise provided in this Article (e.g., Sections 2A-105, 106 and 108(1) and (2)), this Part shall be construed neither to restrict the parties' ability to provide for rights and remedies or to limit or alter the measure of damages by agreement, nor to imply disapproval of rights and remedy schemes other than those set forth in this Part. 2. Subsection (2) makes explicit with respect to this Article what is implicit in Section 2-719 with respect to the Article on Sales (Article 2): if an exclusive remedy is held to be unconscionable, remedies under this Article are available. Section 2-719 ocial comment 1. 271

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3. Subsection (3), a revision of Section 2-719(3), makes clear that consequential damages may also be liquidated. Section 2A-504(1). 4. Subsection (4) is a revision of the provisions of Section 2-701. This subsection leaves the treatment of default with respect to obligations or promises collateral or ancillary to the lease contract to other law. Sections 2A-103(4) and 1-103. An example of such an obligation would be that of the lessor to the secured creditor which has provided the funds to leverage the lessor's lease transaction; an example of such a promise would be that of the lessee, as seller, to the lessor, as buyer, in a sale-leaseback transaction. Cross References: Point 1: Sections 1-102, 1-103, Section 2-719 and Sections 2A-103, 2A-105, 2A-106, 2A108. Point 2: Section 2-719. Point 3: Section 2-719 and Section 2A-504. Point 4: Section 1-103, Section 2-701 and Section 2A-103. Denitional Cross References: Agreed. Section 1-201. Consumer goods. Section 9-109(1). Lease agreement. Section 2A-103(1)(q). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Person. Section 1-201. Remedy. Section 1-201. Rights. Section 1-201.

2A-504. Liquidation of Damages. (1) Damages payable by either party for default, or any other act or omission, including indemnity for loss or diminution of anticipated tax benets or loss or damage to lessor's residual interest, may be liquidated in the lease agreement but only at an amount or by a formula that is reasonable in light of the then anticipated harm caused by the default or other act or omission. Section 2A-503 determines the enforceability of a term that limits but does not liquidate damages. (2) If the lease agreement provides for liquidation of damages, and such provision does not comply with subsection (1), or such provision is an exclusive or limited remedy that circumstances cause to fail of its essential purpose, remedy may be had as provided in this Article. (3) If the lessor justiably withholds delivery of goods or stops performance because of the lessee's default or insolvency, the lessee is entitled to restitution of any amount by which the sum of the lessee's payments exceeds the amount to which the lessor is entitled by virtue of terms liquidating the lessor's damages in accordance with subsection (1). (4) A lessee's right to restitution under subsection (3) is subject to oset to the extent the lessor establishes: (a) a right to recover damages under the provisions of this Article other than subsection (1); and (b) the amount or value of any benets received by the lessee directly or indirectly by reason of the lease contract. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
1. Many leasing transactions are predicated on the parties' ability to agree to an appropriate amount of damages or formula for damages in the event of default or other act or 272

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omission. The rule with respect to sales of goods (Section 2-718) may not be suciently exible to accommodate this practice. Thus, consistent with the common law emphasis upon freedom to contract with respect to bailments for hire, this section has created a revised rule that allows greater exibility with respect to leases of goods. 2. Subsection (1), also in variance to the provisions of Section 2-718(1), provides for liquidation of damages in the lease agreement not only at a stated amount but also by a formula. Section 2-718(1) does not by its express terms include liquidation by a formula; this dierence was compelled by modern leasing practice. Subsection (1), also in variance with Section 2-718(1), provides for liquidation of damages for default as well as any other act or omission. 3. A liquidated damages formula that is common in leasing practice provides that the sum of lease payments past due, accelerated future lease payments, and the lessor's estimated residual interest, less the net proceeds of disposition (whether by sale or release) of the leased goods is the lessor's damages. Tax indemnities, costs, interest and attorney's fees are also added to determine the lessor's damages. Another common liquidated damages formula utilizes a periodic depreciation allocation as a credit to the aforesaid amount in mitigation of a lessor's damages. A third formula provides for a xed number of periodic payments as a means of liquidating damages. Stipulated loss or stipulated damage schedules are also common. Whether these formulae are enforceable will be determined in the context of each case by applying a standard of reasonableness in light of the harm anticipated when the formula was agreed to. Whether the inclusion of these formulae will aect the classication of the transaction as a lease or a security interest is to be determined by the facts of each case. Section 1-201(37). E.g., In re Noack, 44 Bankr. 172, 17475 (Bankr.E.D.Wis.1984). 4. This section does not incorporate two other tests that under sales law determine enforceability of liquidated damages in a consumer sale, i.e., diculties of proof of loss and inconvenience or nonfeasibility of otherwise obtaining an adequate remedy. The ability to liquidate damages is critical to modern leasing practice; given the parties' freedom to contract at common law, the policy behind retaining these two additional requirements here was thought to be outweighed. Further, given the expansion of subsection (1) to enable the parties to liquidate the amount payable with respect to an indemnity for loss or diminution of anticipated tax benets resulted in another change: the last sentence of Section 2-718(1), providing that a term xing unreasonably large liquidated damages is void as a penalty, was also not incorporated. The impact of local, state and federal tax laws on a leasing transaction can result in an amount payable with respect to the tax indemnity many times greater than the original purchase price of the goods. By deleting the reference to unreasonably large liquidated damages the parties are free to negotiate a formula, restrained by the rule of reasonableness in this section. These changes should invite the parties to liquidate damages. Peters, Remedies for Breach of Contracts Relating to the Sale of Goods Under the Uniform Commercial Code: A Roadmap for Article Two, 73 Yale L.J. 199, 278 (1963). 5. Subsection (2), a revised version of Section 2-719(2), provides that if the liquidated damages provision is not enforceable or fails of its essential purpose, remedy may be had as provided in this Article. 6. The lessee is entitled to restitution to the extent the lessee's payments exceed the amounts to which the lessor is entitled under a term limiting or liquidating damages that is enforceable under subsection (1). In the absence of such a term, pursuant to subsection (4), a lessor that withholds or stops performance under subsection (3) may retain payments made by the lessee, which would include any deposit or down payment, but only to the extent the lessor is able to prove damages. Cross References: Point 1: Sections 2-718. Point 2: Section 2-718. Point 4: Section 2-718. Point 5: Section 2-719. Denitional Cross References: Consumer lease. Section 2A-103(1)(f). Delivery. Section 2A-103(1)(g). Goods. Section 2A-103(1)(n). 273

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Insolvent. Section 1-201. Lease agreement. Section 2A-103(1)(q). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Lessor's residual interest. Section 2A-103(1)(w). Party. Section 1-201. Present value. Section 2A-103(1)(aa). Remedy. Section 1-201. Rights. Section 1-201. Term. Section 1-201. Value. Section 1-204.

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-505. Cancellation and Termination and Eect of Cancellation, Termination, Rescission, or Fraud on Rights and Remedies. (1) On cancellation of the lease contract, all obligations that are still executory on both sides are discharged, but any right based on prior default or performance survives, and the cancelling party also retains any remedy for default of the whole lease contract or any unperformed balance. (2) On termination of the lease contract, all obligations that are still executory on both sides are discharged but any right based on prior default or performance survives. (3) Unless the contrary intention clearly appears, expressions of cancellation, rescission, or the like of the lease contract may not be construed as a renunciation or discharge of any claim in damages for an antecedent default. (4) Rights and remedies for material misrepresentation or fraud include all rights and remedies available under this Article for default. (5) Neither rescission nor a claim for rescission of the lease contract nor rejection or return of the goods may bar or be deemed inconsistent with a claim for damages or other right or remedy. Ocial Comment
Uniform Statutory Source: Sections 2-106(3) and (4), 2-720 and 2-721. Changes: Revised to reect leasing practices and terminology. Denitional Cross References: Cancellation. Section 2A-103(1)(a). Goods. Section 2A-103(1)(n). Lease contract. Section 2A-103(1)(r). Party. Section 1-201. Remedy. Section 1-201. Rights. Section 1-201. Termination. Section 2A-103(1)(hh).

2A-506. Statute of Limitations. (1) An action for default under a lease contract, including breach of warranty or indemnity, must be commenced within four years after the cause of action accrued. Except in a consumer lease or an action for indemnity,
274

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the original lease agreement may reduce the period of limitations to not less than one year. (2) A cause of action for default accrues when the act or omission on which the default or breach of warranty is based is or should have been discovered by the aggrieved party, or when the default occurs, whichever is later. A cause of action for indemnity accrues when the act or omission on which the claim for indemnity is based is or should have been discovered by the indemnied party, whichever is later. (3) If an action commenced within the time limited by subsection (1) is so terminated as to leave available a remedy by another action for the same default or breach of warranty or indemnity, the other action may be commenced after the expiration of the time limited and within six months after the termination of the rst action unless the termination resulted from voluntary discontinuance or from dismissal for failure or neglect to prosecute. (4) This section does not alter the law on tolling of the statute of limitations nor does it apply to causes of action that have accrued before this Article becomes eective. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (1) does not incorporate the limitation found in Section 2-725(1) prohibiting the parties from extending the period of limitation. Breach of warranty and indemnity claims often arise in a lease transaction; with the passage of time such claims often diminish or are eliminated. To encourage the parties to commence litigation under these circumstances makes little sense. 2. As amended, subsection (1) now contains the similar limitations contained in amended Section 2-725, which restricts the parties right to reduce the four year limitation period in the consumer lease. 3. Subsection (2) states two rules for determining when a cause of action accrues. With respect to default, the rule of Section 2-725(2) is not incorporated in favor of a more liberal rule of the later of the date when the default occurs or when the act or omission on which it is based is or should have been discovered. With respect to indemnity, a similarly liberal rule is adopted. Cross References: Point 1: Sections 2-725. Point 2: Sections 2-725. Point 3: Sections 2-725. Denitional Cross References: Action. Section 1-201. Aggrieved party. Section 1-201. Lease contract. Section 2A-103(1)(r). Party. Section 1-201. Remedy. Section 1-201. Termination. Section 2A-103(1)(hh).

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-507. Proof of Market Rent: Time and Place. (1) Damages based on market rent (Section 2A-519 or 2A-528) are
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determined according to the rent for the use of the goods concerned for a lease term identical to the remaining lease term of the original lease agreement and prevailing at the times specied in Sections 2A-519 and 2A-528. (2) If evidence of rent for the use of the goods concerned for a lease term identical to the remaining lease term of the original lease agreement and prevailing at the times or places described in this Article is not readily available, the rent prevailing within any reasonable time before or after the time described or at any other place or for a dierent lease term which in commercial judgment or under usage of trade would serve as a reasonable substitute for the one described may be used, making any proper allowance for the dierence, including the cost of transporting the goods to or from the other place. (3) Evidence of a relevant rent prevailing at a time or place or for a lease term other than the one described in this Article oered by one party is not admissible unless and until he [or she] has given the other party notice the court nds sucient to prevent unfair surprise. (4) If the prevailing rent or value of any goods regularly leased in any established market is in issue, reports in ocial publications or trade journals or in newspapers or periodicals of general circulation published as the reports of that market are admissible in evidence. The circumstances of the preparation of the report may be shown to aect its weight but not its admissibility. Ocial Comment
Uniform Statutory Source: Sections 2-723 and 2-724. Changes: Revised to reect leasing practices and terminology. Sections 2A-519 and 2A-528 specify the times as of which market rent is to be determined. Denitional Cross References: Goods. Section 2A-103(1)(h). Lease. Section 2A-103(1)(j). Lease agreement. Section 2A-103(1)(k). Notice. Section 1-201(25). Party. Section 1-201(29). Reasonable time. Section 1-204(1) and (2). Usage of trade. Section 1-205. Value. Section 1-201(44).

2A-507A. Right to Specic Performance or Replevin or the Like. (1) Specic performance may be decreed if the goods are unique or in other proper circumstances. In a contract other than a consumer lease, specic performance may be decreed if the parties have agreed to that remedy. However, even if the parties agree to specic performance, specic performance may not be decreed if the breaching party's sole remaining contractual obligation is the payment of money. (2) A decree for specic performance may include any terms and conditions as to payment of the rent, damages, or other relief that the court deems just. (3) A lessee has a right of replevin or similar remedy for goods identied to the lease contract if after reasonable eort the lessee is unable to eect cover for those goods or the circumstances reasonably indicate that the effort will be unavailing.
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Legislative Note: To maintain its relative position in this Act, Section 2A-507A may have to be renumbered according to the convention used by a particular state. For example, in some states it may be designated as 2A-507.1.

As added in 2003 and amended in 2005.

See Appendix V for material relating to changes made in text in 2005.

Ocial Comment
1. This provision has been moved from its former location, Section 2A-521, because it has been amended to give rights to both lessors and lessees. Section 2A-521 is in Part B (Default by Lessor). This provision is now placed in the general default provisions. 2. Subsection (1) provides that a court may decree specic performance if the parties have agreed to that remedy. The parties' agreement to specic performance can be enforced even if legal remedies are entirely adequate. Even in a commercial contract, the third sentence of subsection (1) prevents the aggrieved party from obtaining specic performance if the only obligation of the party in breach is the payment of money. Whether a lessee is obligated to pay the price is determined by Section 2A-529, not by this section. Nothing in this section constrains the court's exercise of its equitable discretion to decide whether to enter a decree for specic performance or to determine the conditions or terms of the decree. This section assumes that the decree for specic performance is conditioned on a tender of full performance by the party that seeks the remedy. Cross References: Point 1: Section 2A-521. Point 2: Section 2-709. Denitional Cross References: Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease agreement. Section 2A-103(1)(q). Notice. Section 1-202. Party. Section 1-201. Reasonable time. Section 1-205. Usage of trade. Section 1-303. Value. Section 1-204.

As added in 2003. B. DEFAULT BY LESSOR 2A-508. Lessee's Remedies. (1) If a lessor fails to deliver the goods in conformity to the lease contract or repudiates the contract, or a lessee rightfully rejects the goods or justiably revokes acceptance of the goods, the lessor is in default under the lease contract, and the lessee may do one or more of the following: (a) cancel the lease contract; (b) recover so much of the rent and security as has been paid and is just under the circumstances; (c) cover and obtain damages under Section 2A-518; (d) recover damages for nondelivery under Section 2A-519(1); (e) if an acceptance of goods has not been justiably revoked, recover damages for default with regard to accepted goods under Section 2A-519(3) and (4); (f) enforce a security interest under subsection (4); (g) recover identied goods under Section 2A-522; (h) obtain specic performance or obtain the goods by replevin or similar remedy under Section 2A-507A;
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(i) recover liquidated damages under Section 2A-504; (j) enforce limited remedies under Section 2A-503; (k) exercise any other right or pursue any other remedy as provided in the lease contract. (2) If a lessor is otherwise in default under a lease contract, the lessee may exercise the rights and pursue the remedies provided in the lease contract, which may include a right to cancel the lease, and in Section 2A519(3). (3) If a lessor has breached a warranty, whether express or implied, the lessee may recover damages (Section 2A-519(4)). (4) On rightful rejection or justiable revocation of acceptance, a lessee has a security interest in goods in the lessee's possession or control for any rent and security that has been paid and any expenses reasonably incurred in their inspection, receipt, transportation, and care and custody and may hold those goods and dispose of them in good faith and in a commercially reasonable manner, subject to Section 2A-527(5). (5) Subject to the provisions of Section 2A-407, a lessee, on notifying the lessor of the lessee's intention to do so, may deduct all or any part of the damages resulting from any default under the lease contract from any part of the rent still due under the same lease contract. As amended in 2003 and 2005.
See Appendix U for material relating to changes made in text in 2003. See Appendix V for material relating to changes made in text in 2005.

Ocial Comment
1. This section is an index to Sections 2A-503 through 2A-505 and 2A-509 through 2A-522 which set out the lessee's rights and remedies after the lessor's default. The lessor and the lessee can agree to modify the rights and remedies available under this Article; they can, among other things, provide that for defaults other than those specied in subsection (1) the lessee can exercise the rights and remedies referred to in subsection (1); and they can create a new scheme of rights and remedies triggered by the occurrence of the default. Sections 2A-103(4) and 1-302. 2. Subsection (1), a substantially rewritten version of the provisions of Section 2-711(1), lists the cumulative remedies of the lessee where the lessor has failed to deliver conforming goods or has repudiated the contract, or the lessee has rightfully rejected or justiably revoked. Sections 2A-501(2) and (4). Subsection (1) also allows the lessee to exercise any contractual remedy. This Article rejects any general doctrine of election of remedy. To determine if one remedy bars another in a particular case is a function of whether the lessee has been put in as good a position as if the lessor had fully performed the lease agreement. Use of multiple remedies is barred only if the eect is to put the lessee in a better position than it would have been in had the lessor fully performed under the lease. Sections 2A-103(4), 2A-501(4). Subsection (1)(b), in recognition that no bright line can be created that would operate fairly in all installment lease cases and in recognition of the fact that a lessee may be able to cancel the lease (revoke acceptance of the goods) after the goods have been in use for some period of time, does not require that all lease payments made by the lessee under the lease be returned upon cancellation. Rather, only such portion as is just of the rent and security payments made may be recovered. If a defect in the goods is discovered immediately upon tender to the lessee and the goods are rejected immediately, then the lessee should recover all payments made. If, however, for example, a 36-month equipment lease is terminated in the 12th month because the lessor has materially breached the contract by failing to perform its maintenance obligations, it may be just to return only a small part or none of the rental payments already made. 3. Subsection (2) covers defaults which do not deprive the lessee of the goods and which are not so serious as to justify rejection or revocation of acceptance under subsection (1). It 278

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also covers defaults for which the lessee could have rejected or revoked acceptance of the goods but elects not to do so and retains the goods. In either case, a lessee which retains the goods is entitled to recover damages as stated in Section 2A-519(3). That measure of damages is the loss resulting in the ordinary course of events from the lessor's default as determined in any manner that is reasonable together with incidental and consequential damages, less expenses saved in consequence of the lessor's breach. 4. Subsection (1)(k) and subsection (2) recognize that the lease agreement may provide rights and remedies in addition to or dierent from those which Article 2A provides. In particular, subsection (2) provides that the lease agreement may give the remedy of cancellation of the lease for defaults by the lessor that would not otherwise be material defaults which would justify cancellation under subsection (1). If there is a right to cancel, there is, of course, a right to reject or revoke acceptance of the goods. 5. Subsection (3) adds to the completeness of the index by including a reference to the lessee's recovery of damages upon the lessor's breach of warranty. This breach may not rise to the level of a default by the lessor justifying revocation of acceptance. If the lessee properly rejects or revokes acceptance of the goods because of a breach of warranty, the rights and remedies are those provided in subsection (1) rather than those in Section 2A519(4). 6. Subsection (4), a revised version of the provisions of Section 2-711(3), recognizes, on rightful rejection or justiable revocation, the lessee's security interest in goods in its possession and control. Section 9-110 recognizes security interests arising under that Article. Pursuant to Section 2A-511(4), a purchaser who purchases goods from the lessee in good faith takes free of any rights of the lessor, or in the case of a nance lease, the supplier. These goods, however, must have been rightfully rejected and disposed of pursuant to Section 2A-511 or 2A-512. However, Section 2A-517(5) provides that the lessee will have the same rights and duties with respect to goods where acceptance has been revoked as with respect to goods rejected. Thus, Section 2A-511(4) will apply to the lessee's disposition of the goods. 7. Pursuant to Section 2A-527(5), the lessee must account to the lessor for the excess proceeds of such disposition, after satisfaction of the claim secured by the lessee's security interest. 8. Subsection (5) sanctions a right of set-o by the lessee, subject to the rule of Section 2A-407 with respect to irrevocable promises in a nance lease that is not a consumer lease, and further subject to an enforceable hell or high water clause in the lease agreement. Section 2A-407 ocial comment. No attempt is made to state how the set-o should occur. This is to be determined by the facts of each case. 9. There is no special treatment of the nance lease in this section. Absent supplemental principles of law and equity to the contrary, in the case of most nance leases, following the lessee's acceptance of the goods, the lessee will have no rights or remedies against the lessor, because the lessor's obligations to the lessee are minimal. Sections 2A-210 and 2A211(1). Since the lessee will look to the supplier for performance, this is appropriate. Section 2A-209. Cross References: Point 1: Section 1-302 and Sections 2A-103, 2A-503 through 2A-505 and 2A-509 through 2A-522. Point 2: Section 2-711 and Section 2A-501. Point 3: Section 2A-519. Point 5: Section 2A-519. Point 6: Section 2-711 and Sections 2A-511, 2A-512, 2A-517 and Section 9-110. Point 7: Section 2A-527. Point 8: Section 2A-407. Point 9: Sections 2A-209, 2A-210 and 2A-211. Denitional Cross References: Conforming. Section 2A-103(1)(c). Delivery. Section 2A-103(1)(g). Good faith. Sections 2A-103(1)(m). Goods. Section 2A-103(1)(n). Installment lease contract. Section 2A-103(1)(o). 279

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Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Noties. Section 1-201. Receipt. Section 2-103(1)(c). Remedy. Section 1-201. Rights. Section 1-201. Security interest. Section 1-201. Value. Section 1-204.

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-509. Lessee's Rights on Improper Delivery; Manner and Eect of Rejection. (1) Subject to Sections 2A-503, 2A-504, and 2A-510, if the goods or the tender of delivery fail in any respect to conform to the contract, the lessee may: (a) reject the whole; (b) accept the whole; or (c) accept any commercial unit or units and reject the rest. (2) Rejection of goods must be within a reasonable time after their delivery or tender. It is ineective unless the lessee seasonably noties the lessor or supplier. (3) Subject to Sections 2A-511, 2A-512, and 2A-517(6): (a) after rejection any use by the lessee with respect to any commercial unit is wrongful as against the lessor or supplier; and (b) if the lessee has before rejection taken physical possession of goods in which the lessee does not have a security interest under Section 2A508(4), the lessee is under a duty after rejection to hold them with reasonable care at the lessor's or supplier's disposition for a time sucient to permit the lessor or supplier to remove them; but (c) the lessee has no further obligations with regard to goods rightfully rejected. (d) The lessor's or supplier's remedies with respect to goods wrongfully rejected are governed by Section 2A-523. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Sections 2-601 and 2-602(1). Changes: Revised to reect leasing practices and terminology. 1. This section, which conforms with amended Article 2, contains the parallel rules for a sales contract that are contained in Section 2-601 and 2-602. The amendments clarify that this section is subject not only to Section 2A-510, but also Sections 2A-503 and 2A-504. 2. Subsection (3) was originally contained in the prior version of 2A-512, and this has been moved for logical clarity. This subsection sets forth the duties of the lessee upon rejection. In addition to the duty to hold the goods with reasonable care for the lessor's disposition, the lessee also has those duties, as appropriate, specied in Sections 2A-511, 2A-512 and 2A-517(6). 3. Elimination of the word rightful in the title makes it clear that a lessee can ef280

Art. 2A

Leases

2A-510

fectively reject goods even though the rejection is wrongful and constitutes a breach. The word rightfully has also been deleted from the titles to Section 2A-511 and 2A-512. Cross References: Point 1: Section 2-601 and 2-602 and Section 2A-510, 2A-503 and 2A-504. Point 2: Section 2-603, 2-604 and 2-608(4). Point 3: Section 2-603, 2-604 and 2-703. Denitional Cross References: Commercial unit. Section 2A-103(1)(b). Conforming. Section 2A-103(1)(c). Delivery. Section 2A-103(1)(g). Goods. Section 2A-103(1)(n). Installment lease contract. Section 2A-103(1)(o). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Noties. Section 1-201. Reasonable time. Section 1-205. Rights. Section 1-201. Seasonably. Section 1-204(3).

As amended in 2003 and 2005.

See Appendix U for material relating to changes made in Ocial Comment in 2003. See Appendix V for material relating to changes made in Ocial Comment in 2005.

2A-510. Installment Lease Contracts: Rejection and Default. (1) Under an installment lease contract a lessee may reject any delivery that is nonconforming if the nonconformity substantially impairs the value of that delivery to the lessee or the nonconformity is a defect in the required documents; but if the nonconformity does not fall within subsection (2) and the lessor or the supplier gives adequate assurance of its cure, the lessee must accept that delivery. (2) If a nonconformity or default with respect to one or more deliveries substantially impairs the value of the installment lease contract as a whole there is a default with respect to the whole. But, the aggrieved party reinstates the installment lease contract as a whole if the aggrieved party accepts a nonconforming delivery without seasonably notifying of cancellation or brings an action with respect only to past deliveries or demands performance as to future deliveries. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-612. Changes: Revised to reect leasing practices and terminology. Subsection (1) makes it clear that the lessee's right in the rst instance to reject an installment depends upon whether there has been a substantial impairment of the value of the installment to the lessee and not on the lessor's ability to cure the nonconformity. The lessor can prevent a rightful rejection by giving adequate assurances of cure. Subsection (1) uses the words to the lessee to clarify the standard for rejecting an installment consistent is the same standard for revoking acceptance under Section 2A-517. Therefore, the test is not what the lessor had reason to know at the time of the lease agreement; the question is whether the non-conformity is one that will cause a substantial impairment of value to the 281

 2A-510

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Art. 2A

lessee even though the lessor had no knowledge about the lessee's particular circumstances at the time of the lease agreement. Cross Reference: Section 2A-517. Denitional Cross References: Action. Section 1-201(b)(1). Aggrieved party. Section 1-201(b)(2). Cancellation. Section 2A-103(1)(a). Conforming. Section 2A-103(1)(c). Delivery. Section 2A-103(1)(g). Installment lease contract. Section 2A-103(1)(o). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Noties. Section 1-201. Seasonably. Section 1-204(3). Supplier. Section 2A-103(1)(). Value. Section 1-204.

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-511. Merchant Lessee's Duties as to Rejected Goods. (1) Subject to any security interest of a lessee (Section 2A-508(4)), if a lessor or a supplier has no agent or place of business at the market of rejection, a merchant lessee, after rejection of goods in the lessee's possession or control, shall follow any reasonable instructions received from the lessor or the supplier with respect to the goods. In the absence of those instructions, a merchant lessee shall make reasonable eorts to sell, lease, or otherwise dispose of the goods for the lessor's account if they threaten to decline in value speedily. In the case of a rightful rejection instructions are not reasonable if on demand indemnity for expenses is not forthcoming. (2) If a merchant lessee (subsection (1)) or any other lessee (Section 2A512) disposes of goods following a rightful rejection, the lessee is entitled to reimbursement either from the lessor or the supplier or out of the proceeds for reasonable expenses of caring for and disposing of the goods and, if the expenses include no disposition commission, to such commission as is usual in the trade, or if there is none, to a reasonable sum not exceeding 10 percent of the gross proceeds. (3) In complying with this section or Section 2A-512, the lessee is held only to good faith. Good faith conduct hereunder is neither acceptance or conversion nor the basis of an action for damages. (4) A purchaser that purchases in good faith from a lessee pursuant to this section or Section 2A-512 takes the goods free of any rights of the lessor and the supplier even if the lessee fails to comply with one or more of the requirements of this Article. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Sections 2-603 and 2-706(5). Changes: Revised to reect leasing practices and terminology. This section, by its terms, 282

Art. 2A

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applies to merchants as well as others. Thus, in construing the section it is important to note that under this Act the term good faith is dened dierently for merchants (Section 2-103(1)(b)) than for others (Section 1-201(19)). Section 2A-103(3) and (4). Denitional Cross References: Action. Section 1-201. Good faith. Sections 2A-103(1)(m). Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Merchant lessee. Section 2A-103(1)(z). Purchaser. Section 1-201. Rights. Section 1-201. Security interest. Section 1-201. Supplier. Section 2A-103(1)(). Value. Section 1-204.

2A-512. Lessee's Duties as to Rejected Goods. (1) If the lessor or the supplier gives no instructions within a reasonable time after notication of rejection, the lessee may store the rejected goods for the lessor's or the supplier's account or ship them to the lessor or the supplier or dispose of them for the lessor's or the supplier's account with reimbursement in the manner provided in Section 2A-511. (2) Action by the lessee pursuant to subsection (1) is not acceptance or conversion. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Changes: The change in the title conforms to amended Article 2. Original subsections (1)(a) and (c) have been moved to Section 2A-509(3). Cross References: Section 2A-509. Denitional Cross References: Action. Section 1-201. Goods. Section 2A-103(1)(n). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Notication. Section 1-202. Reasonable time. Section 1-205. Seasonably. Section 1-204(3). Security interest. Section 1-201. Supplier. Section 2A-103(1)(). Value. Section 1-204.

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-513. Cure by Lessor of Improper Tender or Delivery; Replacement. (1) If the lessee rejects goods or a tender of delivery under Section 2A-509 or 2A-510 or, except in a consumer contract, justiably revokes acceptance under Section 2A-517(1)(b) and the agreed time for performance has not
283

 2A-513

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expired, a lessor or a supplier that has performed in good faith, upon seasonable notice to the lessee, and at the lessor's or supplier's own expense, may cure the default by making a conforming tender of delivery within the agreed time. The lessor or supplier shall compensate the lessee for all of the lessee's reasonable expenses caused by the lessor's or supplier's default and subsequent cure. (2) If the lessee rejects goods or a tender of delivery under Section 2A-509 or 2A-510 or, except in a consumer lease, justiably revokes acceptance under Section 2A-517(1)(b) and the agreed time for performance has expired, a lessor or supplier that has performed in good faith may, upon seasonable notice to the lessee and at the lessor's or supplier's own expense, cure the default, if the cure is appropriate and timely under the circumstances, by making a tender of conforming goods. The lessor or supplier shall compensate the lessee for all of the lessee's reasonable expenses caused by the lessor's or supplier's default and subsequent cure. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-508. Changes: Revised to reect leasing practices and terminology. This section is based on and conforms to amended Article 2, Section 2-508. The ocial commentary to that Section may be of aid in the interpretation of this section. Denitional Cross References: Conforming. Section 2A-103(1)(c). Delivery. Section 2A-103(1)(g). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Money. Section 1-201. Noties. Section 1-201. Reasonable time. Section 1-205. Seasonably. Section 1-204(3). Supplier. Section 2A-103(1)().

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-514. Waiver of Lessee's Objections. (1) A lessee's failure to state in connection with rejection a particular defect or in connection with revocation of acceptance a defect that justies revocation precludes the lessee from relying on the unstated defect to justify rejection or revocation of acceptance if the defect is ascertainable by reasonable inspection (a) if the lessor or supplier had a right to cure the defect and could have cured it if stated seasonably; or (b) between merchants if the lessor or the supplier after rejection or revocation of acceptance has made a request in a record for a full and nal statement in a record of all defects on which the lessee proposes to rely. (2) A lessee's failure to reserve rights when paying rent or other
284

Art. 2A

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consideration against documents presented to the lessee precludes recovery of the payment for defects apparent in the documents. As amended in 2003 and 2005.
See Appendix U for material relating to changes made in text in 2003. See Appendix V for material relating to changes made in text in 2005.

Ocial Comment
Uniform Statutory Source: Section 2-605. Changes: Revised to reect leasing practices and terminology. Purposes: This section is based on and conforms to amended Article 2 Section 2-605. The ocial commentary to that Section may aid in the interpretation of this section. Cross Reference: Section 2-605 ocial comment 4. Denitional Cross References: Between merchants. Section 2-104(3). Goods. Section 2A-103(1)(n). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Record. Section 2A-103(1)(cc). Rights. Section 1-201. Seasonably. Section 1-204(3). Supplier. Section 2A-103(1)().

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-515. Acceptance of Goods. (1) Acceptance of goods occurs when the lessee: (a) after a reasonable opportunity to inspect the goods signies to the lessor or supplier that the goods are conforming or will be taken or retained in spite of their nonconformity; (b) fails to make an eective rejection under Section 2A-509(2), but such acceptance does not occur until the lessee has had a reasonable opportunity to inspect them; or (c) subject to Section 2A-517(6), uses the goods in any manner that is inconsistent with the lessor's or supplier's rights. (2) Acceptance of a part of any commercial unit is acceptance of that entire unit. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
This section parallels the rules for acceptance under Article 2 (Section 2-606). Cross Reference: Section 2-608. Denitional Cross References: Commercial unit. Section 2A-103(1)(b). Conforming. Section 2A-103(1)(c). Goods. Section 2A-103(1)(n). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Supplier. Section 2A-103(1)(). 285

 2A-515

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Art. 2A

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-516. Eect of Acceptance of Goods; Notice of Default; Burden of Establishing Default after Acceptance; Notice of Claim or Litigation to Person Answerable Over. (1) A lessee must pay rent for any goods accepted in accordance with the lease contract. (2) A lessee's acceptance of goods precludes rejection of the goods accepted. In the case of a nance lease, if made with knowledge of a nonconformity, acceptance may not be revoked because of it. In any other case, if made with knowledge of a nonconformity, acceptance may not be revoked because of it unless the acceptance was on the reasonable assumption that the nonconformity would be seasonably cured. Acceptance does not of itself impair any other remedy provided by this Article or the lease agreement for nonconformity. (3) If a tender has been accepted: (a) within a reasonable time after the lessee discovers or should have discovered any default, the lessee shall notify the lessor and the supplier, if any; however, failure to give timely notice bars the lessee from a remedy only to the extent that the lessor or supplier is prejudiced by the failure; (b) except in the case of a consumer lease, within a reasonable time after the lessee receives notice of litigation for infringement or the like (Section 2A-211) the lessee shall notify the lessor or be barred from any remedy over for liability established by the litigation; and (c) the burden is on the lessee to establish any default. (4) If a lessee is sued for indemnity, breach of a warranty or other obligation for which another party is answerable over the following rules apply: (a) The lessee may give the other party notice of the litigation in a record. If the notice states that the person notied may come in and defend and that if the person notied does not do so that person will be bound in any action against that person by the lessee by any determination of fact common to the two litigations, then unless the person notied after seasonable receipt of the notice does come in and defend that person is so bound. (b) The other party may demand in a record that the lessee turn over control of the litigation including settlement if the claim is one for infringement or the like (Section 2A-211) or else be barred from any remedy over. If the demand states that the other party agrees to bear all expense and to satisfy any adverse judgment, then unless the lessee after seasonable receipt of the demand does turn over control the lessee is so barred. (5) Subsections (3) and (4) apply to any obligation of a lessee to hold the lessor or the supplier harmless against infringement or the like (Section 2A-211). As amended in 2003.
286

Art. 2A

Leases

2A-516

See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-607. Changes: Substantially Revised. Purposes: 1. Subsection (2) creates a special rule for nance leases, precluding revocation if acceptance is made with knowledge of nonconformity with respect to the lease agreement, as opposed to the supply agreement; this is not inequitable as the lessee has a direct claim against the supplier. Section 2A-209(1). Revocation of acceptance of a nance lease is permitted if the lessee's acceptance was without discovery of the nonconformity (with respect to the lease agreement, not the supply agreement) and was reasonably induced by the lessor's assurances. Section 2A-517(1)(b). Absent exclusion or modication, the lessor under a nance lease makes certain warranties to the lessee. Sections 2A-210 and 2A-211(1). Revocation of acceptance is not prohibited even after the lessee's promise has become irrevocable and independent. Section 2A-407 ocial comment. Where the nance lease creates a security interest, the rule may be to the contrary. General Elec. Credit Corp. of Tennessee v. Ger-Beck Mach. Co., 806 F.2d 1207 (3rd Cir. 1986). 2. Subsection (3)(a) requires the lessee to give notice of default within a reasonable time after the lessee discovered or should have discovered the default. Failure to provide the notice bars the lessee from any remedy to the extent that the lessor or supplier is prejudiced by the lack of notice. In a nance lease, notice may be given either to the supplier, the lessor, or both, but remedy is barred against either party if that party is not notied and that party is prejudiced by the lack of notice. In a nance lease, the lessor is usually not liable for defects in the goods and the essential notice is to the supplier. While notice to the nance lessor will often not give any additional rights to the lessee, it would be good practice to give the notice since the nance lessor has an interest in the goods. Subsection (3)(a) does not use the term nance lease, but the denition of supplier is a person from whom a lessor buys or leases goods to be leased under a nance lease. Section 2A-103(1)(x). Therefore, there can be a supplier only in a nance lease. Subsection (4) applies similar notice rules if a lessee is sued for a breach of warranty or other obligation for which another party is answerable over. 3. Subsection (3)(b) requires the lessee to give the lessor notice of litigation for infringement or the like. There is an exception created for a consumer lease. While the exception was considered for a nance lease, it was not created because it was not necessarythe lessor in a nance lease does not give a warranty against infringement. Section 2A-211(2). Even though not required under subsection (3)(b), the lessee who takes under a nance lease should consider giving notice of litigation for infringement or the like to the supplier, because the lessee obtains the benet of the suppliers' promises subject to the suppliers' defenses or claims. Sections 2A-209(1) and 2-607(3)(b). Cross References: Point 1: Section 2A-209, 2A-210, 2A-211 2A-407, 2A-517. Point 2: Sections 2A-103. Point 3: Section 2-607 and 2A-209, 2A-211. Denitional Cross References: Action. Section 1-201. Agreement. Section 1-201. Burden of establishing. Section 1-201. Conforming. Section 2A-103(1)(c). Consumer lease. Section 2A-103(1)(f). Delivery. Section 2A-103(1)(g). Discover. Section 1-201. Finance lease. Section 2A-103(1)(l). Goods. Section 2A-103(1)(n). Knowledge. Section 1-202. Lease agreement. Section 2A-103(1)(q). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). 287

 2A-516

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Art. 2A

Lessor. Section 2A-103(1)(v). Notice. Section 1-202. Noties. Section 1-202. Person. Section 1-201. Reasonable time. Section 1-205. Receipt. Section 2-103(1)(c). Record. Section 2A-103(1)(cc). Remedy. Section 1-201. Seasonably. Section 1-204(3). Supplier. Section 2A-103(1)().

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-517. Revocation of Acceptance of Goods. (1) A lessee may revoke acceptance of a lot or commercial unit whose nonconformity substantially impairs its value to the lessee if the lessee has accepted it: (a) except in the case of a nance lease, on the reasonable assumption that its nonconformity would be cured and it has not been seasonably cured; or (b) without discovery of the nonconformity if the lessee's acceptance was reasonably induced either by the lessor's assurances or, except in the case of a nance lease, by the diculty of discovery before acceptance. (2) Except in the case of a nance lease that is not a consumer lease, a lessee may revoke acceptance of a lot or commercial unit if the lessor defaults under the lease contract and the default substantially impairs the value of that lot or commercial unit to the lessee. (3) If the lease agreement so provides, the lessee may revoke acceptance of a lot or commercial unit because of other defaults by the lessor. (4) Revocation of acceptance must occur within a reasonable time after the lessee discovers or should have discovered the ground for it and before any substantial change in condition of the goods which is not caused by the nonconformity. Revocation is not eective until the lessee noties the lessor. (5) A lessee that so revokes has the same rights and duties with regard to the goods involved as if the lessee had rejected them. (6) If a lessee uses the goods after a rightful rejection or justiable revocation of acceptance, the following rules apply: (a) Any use by the lessee which is unreasonable under the circumstances is wrongful as against the lessor or supplier and is an acceptance only if ratied by the lessor or supplier. (b) Any use of the goods which is reasonable under the circumstances is not wrongful as against the lessor or supplier and is not an acceptance, but in an appropriate case the lessee shall be obligated to the lessor or supplier for the value of the use to the lessee. As amended in 2003 and 2005.
See Appendix U for material relating to changes made in text in 2003. See Appendix V for material relating to changes made in text in 2005.
288

Art. 2A

Leases

2A-517

Ocial Comment
Uniform Statutory Source: Section 2-608. Changes: Revised to reect leasing practices and terminology. Note that in the case of a nance lease the lessee retains a limited right to revoke acceptance. Sections 2A-517(1)(b) and 2A-516 ocial comment. New subsections (2) and (3) added. Purposes: 1. The section states the situations under which the lessee may return the goods to the lessor and cancel the lease. Subsection (2) recognizes that the lessor may have continuing obligations under the lease and that a default as to those obligations may be suciently material to justify revocation of acceptance of the leased items and cancellation of the lease by the lessee. For example, a failure by the lessor to fulll its obligation to maintain leased equipment or to supply other goods which are necessary for the operation of the leased equipment may justify revocation of acceptance and cancellation of the lease. 2. Subsection (3) specically provides that the lease agreement may provide that the lessee can revoke acceptance for defaults by the lessor which in the absence of such an agreement might not be considered suciently serious to justify revocation. That is, the parties are free to contract on the question of what defaults are so material that the lessee can cancel the lease. 3. Subsection (6) deals with the problem of post-rejection or revocation use of the goods. If the lessee's use after an eective rejection or a justied revocation of acceptance is unreasonable under the circumstances, it is inconsistent with the rejection or revocation of acceptance and is wrongful as against the lessor. This gives the lessor the option of ratifying the use, thereby treating it as an acceptance, or pursuing a non-Code remedy for conversion. If the lessee's use is reasonable under the circumstances, the lessee's actions cannot be treated as an acceptance. The lessee must, in appropriate circumstances, compensate the lessor for the value of the use of the goods to the lessee. Determining the appropriate level of compensation requires a consideration of the lessee's particular circumstances and should take into account the defective condition of the goods. There may be circumstances, such as where the use is solely for the purpose of protecting the lessee's security interest in the goods, where no compensation is due the lessor. In other circumstances, the lessor's right to compensation must be netted out against any right of the lessee to damages. In general, a lessee that either rejects or revokes acceptance of the goods should not subsequently use the goods in a manner that is inconsistent with the lessor's interest. In some instances, however, the use may be reasonable. An example might involve a commercial lessee that is unable immediately to obtain cover and must use the goods to fulll the lessee's obligations to third parties. If circumstances change so that the lessee's use is no longer reasonable, the continued use of the goods is unreasonable and is wrongful against the lessor. Of course, a lessee's rejection must be rightful, or its revocation must be justied; a lessee cannot make a false claim of nonconformity and limit the obligation to pay rent to the value of the use to the lessee. Cross Reference: Section 2A-516 ocial comment. Denitional Cross References: Commercial unit. Section 2A-103(1)(b). Conforming. Section 2A-103(1)(c). Discover. Section 1-201. Finance lease. Section 2A-103(1)(l). Goods. Section 2A-103(1)(n). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Lot. Section 2A-103(1)(y). Noties. Section 1-201. Reasonable time. Section 1-205. Rights. Section 1-201. Seasonably. Section 1-204(3). Value. Section 1-204.

As amended in 2003 and 2005.

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See Appendix U for material relating to changes made in Ocial Comment in 2003. See Appendix V for material relating to changes made in Ocial Comment in 2005.

2A-518. Cover; Substitute Goods. (1) After a default by a lessor under the lease contract of the type described in Section 2A-508(1), or, if agreed, after other default by the lessor, the lessee may cover by making any purchase or lease of or contract to purchase or lease goods in substitution for those due from the lessor. (2) Except as otherwise provided with respect to damages liquidated in the lease agreement (Section 2A-504) or otherwise determined pursuant to agreement of the parties (Sections 1-102(3) and 2A-503), if a lessee's cover is by a lease agreement substantially similar to the original lease agreement and the new lease agreement is made in good faith and in a commercially reasonable manner, the lessee may recover from the lessor as damages (i) the present value, as of the date of the commencement of the term of the new lease agreement, of the rent under the new lease agreement applicable to that period of the new lease term which is comparable to the then remaining term of the original lease agreement minus the present value as of the same date of the total rent for the then remaining lease term of the original lease agreement, and (ii) any incidental or consequential damages, less expenses saved in consequence of the lessor's default. (3) If a lessee's cover is by lease agreement that for any reason does not qualify for treatment under subsection (2), or is by purchase or otherwise, the lessee may recover from the lessor as if the lessee had elected not to cover and Section 2A-519 governs. Ocial Comment
Uniform Statutory Source: Section 2-712. Changes: Substantially revised. Purposes: 1. Subsection (1) allows the lessee to take action to x its damages after default by the lessor. Such action may consist of the lease of goods. The decision to cover is a function of commercial judgment, not a statutory mandate replete with sanctions for failure to comply. Cf. Section 9-507. 2. Subsection (2) states a rule for determining the amount of lessee's damages provided that there is no agreement to the contrary. The lessee's damages will be established using the new lease agreement as a measure if the following three criteria are met: (i) the lessee's cover is by lease agreement, (ii) the lease agreement is substantially similar to the original lease agreement, and (iii) such cover was eected in good faith, and in a commercially reasonable manner. Thus, the lessee will be entitled to recover from the lessor the present value, as of the date of commencement of the term of the new lease agreement, of the rent under the new lease agreement applicable to that period which is comparable to the then remaining term of the original lease agreement less the present value of the rent reserved for the remaining term under the original lease, together with incidental or consequential damages less expenses saved in consequence of the lessor's default. Consequential damages may include loss suered by the lessee because of deprivation of the use of the goods during the period between the default and the acquisition of the goods under the new lease agreement. If the lessee's cover does not satisfy the criteria of subsection (2), Section 2A-519 governs. 3. Two of the three criteria to be met by the lessee are familiar, but the concept of the new lease agreement being substantially similar to the original lease agreement is not. 290

Art. 2A

Leases

2A-518

Given the many variables facing a party who intends to lease goods and the rapidity of change in the market place, the policy decision was made not to draft with specicity. It was thought unwise to seek to establish certainty at the cost of fairness. Thus, the decision of whether the new lease agreement is substantially similar to the original will be determined case by case. 4. While the section does not draw a bright line, it is possible to describe some of the factors that should be considered in nding that a new lease agreement is substantially similar to the original. First, the goods subject to the new lease agreement should be examined. For example, in a lease of computer equipment the new lease might be for more modern equipment. However, it may be that at the time of the lessor's breach it was not possible to obtain the same type of goods in the market place. Because the lessee's remedy under Section 2A-519 is intended to place the lessee in essentially the same position as if he had covered, if goods similar to those to have been delivered under the original lease are not available, then the computer equipment in this hypothetical should qualify as a commercially reasonable substitute. See Section 2-712(1). 5. Second, the various elements of the new lease agreement should also be examined. Those elements include the presence or absence of options to purchase or release; the lessor's representations, warranties and covenants to the lessee, as well as those to be provided by the lessee to the lessor; and the services, if any, to be provided by the lessor or by the lessee. All of these factors allocate cost and risk between the lessor and the lessee and thus aect the amount of rent to be paid. If the dierences between the original lease and the new lease can be easily valued, it would be appropriate for a court to adjust the dierence in rental to take account of the dierence between the two leases, nd that the new lease is substantially similar to the old lease, and award cover damages under this section. If, for example, the new lease requires the lessor to insure the goods in the hands of the lessee, while the original lease required the lessee to insure, the usual cost of such insurance could be deducted from the rent due under the new lease before determining the dierence in rental between the two leases. 6. Having examined the goods and the agreement, the test to be applied is whether, in light of these comparisons, the new lease agreement is substantially similar to the original lease agreement. These ndings should not be made with scientic precision, as they are a function of economics, nor should they be made independently with respect to the goods and each element of the agreement, as it is important that a sense of commercial judgment pervade the nding. To establish the new lease as a proper measure of damage under subsection (2), these factors, taken as a whole, must result in a nding that the new lease agreement is substantially similar to the original. 7. A new lease can be substantially similar to the original lease even though its term extends beyond the remaining term of the original lease, so long as both (a) the lease terms are commercially comparable (e.g., it is highly unlikely that a one-month rental and a veyear lease would reect similar commercial realities), and (b) the court can fairly apportion a part of the rental payments under the new lease to that part of the term of the new lease which is comparable to the remaining lease term under the original lease. Also, the lease term of the new lease may be comparable to the term of the original lease even though the beginning and ending dates of the two leases are not the same. For example, a two-month lease of agricultural equipment for the months of August and September may be comparable to a two-month lease running from the 15th of August to the 15th of October if in the particular location two-month leases beginning on August 15th are basically interchangeable with two-month leases beginning August 1st. Similarly, the term of a one-year truck lease beginning on the 15th of January may be comparable to the term of a one-year truck lease beginning January 2d. If the lease terms are found to be comparable, the court may base cover damages on the entire dierence between the costs under the two leases. Cross References: Point 1: Section 9-625 and 9-626. Point 2: Section 2A-519. Point 4: Section 2-712 and Section 2A-519. Denitional Cross References: Agreement. Section 1-201. Contract. Section 1-201. Good faith. Sections 2A-103(1)(m). 291

 2A-518

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Art. 2A

Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease agreement. Section 2A-103(1)(q). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Party. Section 1-201. Present value. Section 2A-103(1)(aa). Purchase. Section 2A-103(1)(bb).

2A-519. Lessee's Damages for Non-delivery, Repudiation, Default, and Breach of Warranty in Regard to Accepted Goods. (1) Except as otherwise provided with respect to damages liquidated in the lease agreement (Section 2A-504) or otherwise determined pursuant to agreement of the parties (Sections 1-102(3) and 2A-503), if a lessee elects not to cover or a lessee elects to cover and the cover is by lease agreement that for any reason does not qualify for treatment under Section 2A-518(2), or is by purchase or otherwise, the measure of damages for non-delivery or repudiation by the lessor or for rejection or revocation of acceptance by the lessee is the present value, as of the date of the default, of the then market rent minus the present value as of the same date of the original rent, computed for the remaining lease term of the original lease agreement, together with incidental and consequential damages, less expenses saved in consequence of the lessor's default. (2) Market rent is to be determined as of the place for tender or, in cases of rejection after arrival or revocation of acceptance, as of the place of arrival. (3) Except as otherwise agreed, if the lessee has accepted goods and given notication (Section 2A-516(3)), the measure of damages for nonconforming tender or delivery or other default by a lessor is the loss resulting in the ordinary course of events from the lessor's default as determined in any manner that is reasonable together with incidental and consequential damages, less expenses saved in consequence of the lessor's default. (4) Except as otherwise agreed, the measure of damages for breach of warranty is the present value at the time and place of acceptance of the dierence between the value of the use of the goods accepted and the value if they had been as warranted for the lease term, unless special circumstances show proximate damages of a dierent amount, together with incidental and consequential damages, less expenses saved in consequence of the lessor's default or breach of warranty. Ocial Comment
Uniform Statutory Source: Sections 2-713 and 2-714. Changes: Substantially revised. Purposes: 1. Subsection (1), a revised version of the provisions of Section 2-713(1), states the basic rule governing the measure of lessee's damages for non-delivery or repudiation by the lessor or for rightful rejection or revocation of acceptance by the lessee. This measure will apply, absent agreement to the contrary, if the lessee does not cover or if the cover does not qualify under Section 2A-518. There is no sanction for cover that does not qualify. 2. The measure of damage is the present value, as of the date of default, of the market 292

Art. 2A

Leases

2A-520

rent for the remaining term of the lease less the present value of the original rent for the remaining term of the lease, plus incidental and consequential damages less expenses saved in consequence of the default. Note that the reference in Section 2A-519(1) is to the date of default not to the date of an event of default. An event of default under a lease agreement becomes a default under a lease agreement only after the expiration of any relevant period of grace and compliance with any notice requirements under this Article and the lease agreement. American Bar Foundation, Commentaries on Indentures, 5-1, at 216217 (1971). Section 2A-501(1). This conclusion is also a function of whether, as a matter of fact or law, the event of default has been waived, suspended or cured. Sections 2A-103(4) and 1-103. 3. Subsection (2), a revised version of the provisions of Section 2-713(2), states the rule with respect to determining market rent. 4. Subsection (3), a revised version of the provisions of Section 2-714(1) and (3), states the measure of damages where goods have been accepted and acceptance is not revoked. The subsection applies both to defaults which occur at the inception of the lease and to defaults which occur subsequently, such as failure to comply with an obligation to maintain the leased goods. The measure in essence is the loss, in the ordinary course of events, owing from the default. 5. Subsection (4), a revised version of the provisions of Section 2-714(2), states the measure of damages for breach of warranty. The measure in essence is the present value of the dierence between the value of the goods accepted and of the goods if they had been as warranted. 6. Subsections (1), (3) and (4) specically state that the parties may by contract vary the damages rules stated in those subsections. Cross References: Point 1: Section 2-713 and Section 2A-518. Point 2: Sections 2A-501 and 2A-519. Point 3: Section 2-713. Point 4: Section 2-714. Point 5: Section 2-714. Denitional Cross References: Conforming. Section 2A-103(1)(c). Delivery. Section 2A-103(1)(g). Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease agreement. Section 2A-103(1)(q). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Notication. Section 1-202. Present value. Section 2A-103(1)(aa). Value. Section 1-204.

2A-520. Lessee's Incidental and Consequential Damages. (1) Incidental damages resulting from a lessor's default include expenses reasonably incurred in inspection, receipt, transportation, and care and custody of goods rightfully rejected or goods the acceptance of which is justiably revoked, any commercially reasonable charges, expenses or commissions in connection with eecting cover, and any other reasonable expense incident to the default. (2) Consequential damages resulting from a lessor's default include: (a) any loss resulting from general or particular requirements and needs of which the lessor at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise; and (b) injury to person or property proximately resulting from any breach of warranty.
293

 2A-520

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Art. 2A

Ocial Comment
Uniform Statutory Source: Section 2-715. Changes: Revised to reect leasing terminology and practices. Purposes: Subsection (1), a revised version of the provisions of Section 2-715(1), lists some examples of incidental damages resulting from a lessor's default; the list is not exhaustive. Subsection (1) makes clear that it applies not only to rightful rejection, but also to justiable revocation. Subsection (2), a revised version of the provisions of Section 2-715(2), lists some examples of consequential damages resulting from a lessor's default; the list is not exhaustive. Cross References: Section 2-715. Denitional Cross References: Goods. Section 2A-103(1)(n). Knows. Section 1-201. Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Person. Section 1-201. Receipt. Section 2-103(1)(c).

2A-521. Reserved.
Legislative Note: The section on specic performance has been moved to Section 2A-507A because it has been amended so that the remedy is available to both lessors and lessees.

2A-522. Lessee's Right to Goods on Lessor's Insolvency. (1) Subject to subsection (2) and even if the goods have not been shipped, a lessee that has paid a part or all of the rent and security for goods identied to a lease contract (Section 2A-217) on making and keeping good a tender of any unpaid portion of the rent and security due under the lease contract may recover the goods identied from the lessor if (a) in the case of goods leased by a consumer, the lessor repudiates or fails to deliver as required by the lease contract; or (b) in all cases, the lessor becomes insolvent within 10 days after receipt of the rst installment on their rent and security. (2) A lessee acquires the right to recover goods identied to a lease contract only if they conform to the lease contract. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-502. Changes: Revised to reect leasing practices and terminology. 1. This section gives the lessee the goods identied under Section 2A-217 upon making and keeping good a tender of any unpaid portion of the rent and security, in two limited circumstances. First, a consumer lessee may recover the goods if the lessor repudiates the contract or fails to deliver the goods. Second, in any case, the lessee may recover the goods if the lessor becomes insolvent within 10 days after the lessor receives the rst installment on their price. The lessee's right to recover the goods under this section is an exception to the usual rule, under which the disappointed lessee must resort to an action to recover damages. 2. The lessee's right to recover goods to a lease contract is dependent upon the goods conforming to the lease contract. Cross References: Point 1: Sections 2A-217. Denitional Cross References: 294

Art. 2A
Conforming. Section 2A-103(1)(c). Goods. Section 2A-103(1)(n). Insolvent. Section 1-201. Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Receipt. Section 2-103(1)(c). Rights. Section 1-201.

Leases

2A-523

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

C. DEFAULT BY LESSEE 2A-523. Lessor's Remedies. (1) If the lessee wrongfully rejects or attempts to revoke acceptance of goods or fails to make a payment when due or repudiates with respect to a part or the whole, the lessee is in default under the lease contract with respect to any goods involved and the lessor may do one or more of the following: (a) withhold delivery of the goods and take possession of goods previously delivered under Section 2A-525; (b) stop delivery of the goods by any carrier or bailee under Section 2A-526; (c) proceed under Section 2A-524 with respect to goods still unidentied to the lease contract or unnished; (d) obtain specic performance under Section 2A-507A or recover the rent under Section 2A-529; (e) dispose of the goods and recover damages under Section 2A-527 or retain the goods and recover damages under Section 2A-528; (f) cancel the lease contract; (g) recover liquidated damages under Section 2A-504; (h) enforce limited remedies under Section 2A-503; (i) exercise any other rights or pursue any other remedies provided in the lease agreement. (2) If a lessee becomes insolvent but is not in default of the lease contract under subsections (1) or (4), the lessor may: (a) refuse to deliver the goods under Section 2A-525(1); (b) take possession of the goods under Section 2A-525(2); (c) stop delivery of the goods by any bailee or carrier under Section 2A-526(1). (3) If a lessor does not fully exercise a right or obtain a remedy to which the lessor is entitled under subsection (1), the lessor may recover the loss resulting in the ordinary course of events from the lessee's default as determined in any reasonable manner, together with incidental or consequential damages allowed under Section 2A-530, less expenses saved in consequence of the lessee's default. (4) If a lessee is otherwise in default under a lease contract, the lessor
295

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may exercise the rights and pursue the remedies provided in the lease contract, which may include a right to cancel the lease. In addition, unless otherwise provided in the lease contract: (a) if the default substantially impairs the value of the lease contract to the lessor, the lessor may exercise the rights and pursue the remedies provided in subsections (1) or (2); or (b) if the default does not substantially impair the value of the lease contract to the lessor, the lessor may recover as provided in subsection (2). As amended in 2003 and 2005.
See Appendix U for material relating to changes made in text in 2003. See Appendix V for material relating to changes made in text in 2005.

Ocial Comment
1. Subsection (1) is an index to Sections 2A-503 through 2A-505, Section 2A-507 and Sections 2A-524 through 2A-531 and states that the remedies provided in those sections are available for the defaults referred to in subsection (1): wrongful rejection or revocation of acceptance, failure to make a payment when due, or repudiation. In addition, remedies provided in the lease contract are available. Subsection (3) sets out a remedy if the lessor does not pursue to completion a right or actually obtain a remedy available under subsection (1), and subsection (4) sets out statutory remedies for defaults not specically referred to in subsection (1). Subsection (4) provides that, if any default by the lessee other than those specically referred to in subsection (1) is material, the lessor can exercise the remedies provided in subsection (1) or (3); otherwise the available remedy is as provided in subsection (4). A lessor who has brought an action seeking or has nonjudicially pursued one or more of the remedies available under subsection (1) may amend so as to claim or may nonjudicially pursue a remedy under subsection (3) unless the right or remedy rst chosen has been pursued to an extent actually inconsistent with the new course of action. The intent of the provision is to reject the doctrine of election of remedies and to permit an alteration of course by the lessor unless such alteration would actually have an eect on the lessee that would be unreasonable under the circumstances. Furthermore, the lessor may pursue remedies under both subsections (1) and (3) unless doing so would put the lessor in a better position than it would have been in had the lessee fully performed. 2. The lessor and the lessee can agree to modify the rights and remedies available under the Article; they can, among other things, provide that for defaults other than those specied in subsection (1) the lessor can exercise the rights and remedies referred to in subsection (1), whether or not the default would otherwise be held to substantially impair the value of the lease contract to the lessor; they can also create a new scheme of rights and remedies triggered by the occurrence of the default. Sections 2A-103(4) and 1-302. 3. This Article rejects any general doctrine of election of remedy. Whether, in a particular case, one remedy bars another, is a function of whether lessor has been put in as good a position as if the lessee had fully performed the lease contract. Multiple remedies are barred only if the eect is to put the lessor in a better position than it would have been in had the lessee fully performed under the lease. Sections 2A-103(4), 2A-501(4), and 1-305(a). 4. Hypothetical: To better understand the application of subsection (1) it is useful to review a hypothetical. Assume that A is a merchant in the business of selling and leasing new bicycles of various types. B is about to engage in the business of subleasing bicycles to summer residents of and visitors to an island resort. A, as lessor, has agreed to lease 60 bicycles to B. While there is one master lease, deliveries and terms are staggered. 20 bicycles are to be delivered by A to B's island location on June 1; the term of the lease of these bicycles is four months. 20 bicycles are to be delivered by A to B's island location on July 1; the term of the lease of these bicycles is three months. Finally, 20 bicycles are to be delivered by A to B's island location on August 1; the term of the lease of these bicycles is two months. B is obligated to pay rent to A on the 15th day of each month during the term for the lease. Rent is $50 per month, per bicycle. B has no option to purchase or release and must return the bicycles to A at the end of the term, in good condition, reasonable wear and tear excepted. Since the retail price of each bicycle is $400 and bicycles used in the 296

Art. 2A

Leases

2A-523

retail rental business have a useful economic life of 36 months, this transaction creates a lease. Sections 2A-103(1)(j) and 1-302. 5. A's current inventory of bicycles is not large. Thus, upon signing the lease with B in February, A agreed to purchase 60 new bicycles from A's principal manufacturer, with special instructions to drop ship the bicycles to B's island location in accordance with the delivery schedule set forth in the lease. 6. The rst shipment of 20 bicycles was received by B on May 21. B inspected the bicycles, accepted the same as conforming to the lease and signed a receipt of delivery and acceptance. However, due to poor weather that summer, business was terrible and B was unable to pay the rent due on June 15. Pursuant to the lease A sent B notice of default and proceeded to enforce his rights and remedies against B. 7. A's counsel rst advised A that under Section 2A-510(2) and the terms of the lease B's failure to pay was a default with respect to the whole. Thus, to minimize A's continued exposure, A was advised to take possession of the bicycles. If A had possession of the goods A could refuse to deliver. Section 2A-525(1). However, the facts here are dierent. With respect to the bicycles in B's possession, A has the right to take possession of the bicycles, without breach of the peace. Section 2A-525(2). If B refuses to allow A access to the bicycles, A can proceed by action, including replevin or injunctive relief. 8. With respect to the 40 bicycles that have not been delivered, this Article provides various alternatives. First, assume that 20 of the remaining 40 bicycles have been manufactured and delivered by the manufacturer to a carrier for shipment to B. Given the size of the shipment, the carrier was using a small truck for the delivery and the truck had not yet reached the island ferry when the manufacturer (at the request of A) instructed the carrier to divert the shipment to A's place of business. A's right to stop delivery is recognized under these circumstances. Section 2A-526(1). Second, assume that the 20 remaining bicycles were in the process of manufacture when B defaulted. A retains the right (as between A as lessor and B as lessee) to exercise reasonable commercial judgment whether to complete manufacture or to dispose of the unnished goods for scrap. Since A is not the manufacturer and A has a binding contract to buy the bicycles, A elected to allow the manufacturer to complete the manufacture of the bicycles, but instructed the manufacturer to deliver the completed bicycles to A's place of business. Section 2A-524(2). 9. Thus, so far A has elected to exercise the remedies referred to in subparagraphs (b) through (d) in subsection (1). None of these remedies bars any of the others because A's election and enforcement merely resulted in A's possession of the bicycles. Had B performed A would have recovered possession of the bicycles. Thus A is in the process of obtaining the benet of his bargain. Note that A could exercise any other rights or pursue any other remedies provided in the lease contract (Section 2A-523(1)(f)), or elect to recover his loss due to the lessee's default under Section 2A-523(2). 10. A's counsel next would determine what action, if any, should be taken with respect to the goods. As stated in subparagraph (e) and as discussed fully in Section 2A-527(1) the lessor may, but has no obligation to, dispose of the goods by a substantially similar lease (indeed, the lessor has no obligation whatsoever to dispose of the goods at all) and recover damages based on that action, but lessor will not be able to recover damages which put it in a better position than performance would have done, nor will it be able to recover damages for losses which it could have reasonably avoided. In this case, since A is in the business of leasing and selling bicycles, A will probably inventory the 60 bicycles for its retail trade. 11. A's counsel then will determine which of the various means of ascertaining A's damages against B are available. Subparagraph (e) catalogues each relevant section. First, under Section 2A-527(2) the amount of A's claim is computed by comparing the original lease between A and B with any subsequent lease of the bicycles but only if the subsequent lease is substantially similar to the original lease contract. While the section does not dene this term, the ocial comment does establish some parameters. If, however, A elects to lease the bicycles to his retail trade, it is unlikely that the resulting lease will be substantially similar to the original, as leases to retail customers are considerably dierent from leases to wholesale customers like B. If, however, the leases were substantially similar, the damage claim is for accrued and unpaid rent to the beginning of the new lease, plus the present value as of the same date, of the rent reserved under the original lease for the balance of its term less the present value as of the same date of the rent reserved under the 297

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replacement lease for a term comparable to the balance of the term of the original lease, together with incidental damages less expenses saved in consequence of the lessee's default. 12. If the new lease is not substantially similar or if A elects to sell the bicycles or to hold the bicycles, damages are computed under Section 2A-528 or 2A-529. 13. If A elects to pursue his claim under Section 2A-528(1) the damage rule is the same as that stated in Section 2A-528(2) except that damages are measured from default if the lessee never took possession of the goods or from the time when the lessor did or could have regained possession and that the standard of comparison is not the rent reserved under a substantially similar lease entered into by the lessor but a market rent, as dened in Section 2A-507. Further, if the facts of this hypothetical were more elaborate A may be able to establish that the measure of damage under subsection (1) is inadequate to put him in the same position that B's performance would have, in which case A can claim the present value of his lost prots. 14. Yet another alternative for computing A's damage claim against B which will be available in some situations is recovery of the present value, as of entry of judgment, of the rent for the then remaining lease term under Section 2A-529. However, this formulation is not available if the goods have been repossessed or tendered back to A. For the 20 bicycles repossessed and the remaining 40 bicycles, A will be able to recover the present value of the rent only if A is unable to dispose of them, or circumstances indicate the eort will be unavailing. If A has prevailed in an action for the rent, at any time up to collection of a judgment by A against B, A might dispose of the bicycles. In such case A's claim for damages against B is governed by Section 2A-527 or 2A-528. Section 2A-529(3). The resulting recalculation of claim should reduce the amount recoverable by A against B and the lessor is required to cause an appropriate credit to be entered against the earlier judgment. However, the nature of the post-judgment proceedings to resolve this issue, and the sanctions for a failure to comply, if any, will be determined by other law. 15. Finally, if the lease agreement had so provided pursuant to subparagraph (f), A's claim against B would not be determined under any of these statutory formulae, but pursuant to a liquidated damages clause. Section 2A-504(1). 16. These various methods of computing A's damage claim against B are alternatives subject to Section 2A-501(4). However, the pursuit of any one of these alternatives is not a bar to, nor has it been barred by, A's earlier action to obtain possession of the 60 bicycles. These formulae, which vary as a function of an overt or implied mitigation of damage theory, focus on allowing A a recovery of the benet of his bargain with B. Had B performed, A would have received the rent as well as the return of the 60 bicycles at the end of the term. 17. Finally, A's counsel should also advise A of his right to cancel the lease contract under subparagraph (a). Section 2A-505(1). Cancellation will discharge all existing obligations but preserve A's rights and remedies. 18. Subsection (2) recognizes that a lessor who is entitled to exercise the rights or to obtain a remedy granted by subsection (1) may choose not to do so. In such cases, the lessor can recover damages as provided in subsection (2). For example, for non-payment of rent, the lessor may decide not to take possession of the goods and cancel the lease, but rather to merely sue for the unpaid rent as it comes due plus lost interest or other damages determined in any reasonable manner. Subsection (2) also negates any loss of alternative rights and remedies by reason of having invoked or commenced the exercise or pursuit of any one or more rights or remedies. 19. Subsection (3) allows the lessor access to a remedy scheme provided in this Article as well as that contained in the lease contract if the lessee is in default for reasons other than those stated in subsection (1). Note that the reference to this Article includes supplementary principles of law and equity, e.g., fraud, misrepresentation and duress. Sections 2A-103(4) and 1-103. 20. There is no special treatment of the nance lease in this section. Absent supplementary principles of law to the contrary, in most cases the supplier will have no rights or remedies against the defaulting lessee. Section 2A-209(2)(ii). Given that the supplier will look to the lessor for payment, this is appropriate. However, there is a specic exception to this rule with respect to the right to identify goods to the lease contract. Section 2A-524(2). The parties are free to create a dierent result in a particular case. Sections 2A-103(4) and 1-302. Cross References: 298

Art. 2A

Leases

2A-524

Point 1: Section 2A-524, 2A-531. Point 2: Section 1-302 and Section 2A-103. Point 3: Section 1-106 and Sections 2A-103 and 2A-501. Point 4: Section 1-302 and Section 2A-103. Point 7: Section 2A-510, 2A-525. Point 8: Sections 2A-524 and 2A-526. Point 9: Section 2A-523. Point 10: Section 2A-527. Point 11: Section 2A-527. Point 12: Section 2A-528 and 2A-529. Point 13: 2A-507 and 2A-528. Point 14: Section 2A-527, 2A-528 and 2A-529. Point 15: Section 2A-504. Point 16: 2A-501. Point 17: Section 2A-505. Point 19: Section 1-103 and Section 2A-103. Point 20: Section 1-302 and Section 2A-103, 2A-209, 2A-524. Denitional Cross References: Delivery. Section 2A-103(1)(g). Goods. Section 2A-103(1)(n). Installment lease contract. Section 2A-103(1)(o). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Remedy. Section 1-201. Rights. Section 1-201. Value. Section 1-204.

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-524. Lessor's Right to Identify Goods to Lease Contract. (1) After default by the lessee under the lease contract of the type described in Section 2A-523(1) or 2A-523(4)(a) or, if agreed, after other default by the lessee, the lessor may: (a) identify to the lease contract conforming goods not already identied if at the time the lessor learned of the default they were in the lessor's or the supplier's possession or control; and (b) dispose of goods (Section 2A-527(1)) that demonstrably have been intended for the particular lease contract even though those goods are unnished. (2) If the goods are unnished, in the exercise of reasonable commercial judgment for the purposes of avoiding loss and of eective realization, an aggrieved lessor or the supplier may either complete manufacture and wholly identify the goods to the lease contract or cease manufacture and lease, sell, or otherwise dispose of the goods for scrap or salvage value or proceed in any other reasonable manner. As amended in 2005.
See Appendix V for material relating to changes made in text in 2005.

Ocial Comment
Uniform Statutory Source: Section 2-704. Changes: Revised to reect leasing practices and terminology. 299

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Art. 2A

Purposes: The remedies provided by this section are available to the lessor (i) if there has been a default by the lessee which falls within Section 2A-523(1) or 2A-523(3)(a), or (ii) if there has been any other default for which the lease contract gives the lessor the remedies provided by this section. Under (ii), the lease contract may give the lessor the remedies of identication and disposition provided by this section in various ways. For example, a lease provision might specically refer to the remedies of identication and disposition, or it might refer to this section by number (i.e., 2A-524), or it might do so by a more general reference such as all rights and remedies provided by Article 2A for default by the lessee. Cross References: Section 2A-523. Denitional Cross References: Aggrieved party. Section 1-201. Conforming. Section 2A-103(1)(c). Goods. Section 2A-103(1)(n). Learn. Section 1-201. Lease. Section 2A-103(1)(p). Lease contract. Section 2A-103(1)(r). Lessor. Section 2A-103(1)(v). Rights. Section 1-201. Supplier. Section 2A-103(1)(). Value. Section 1-204.

2A-525. Lessor's Right to Possession of Goods. (1) If a lessor discovers the lessee to be insolvent, the lessor may refuse to deliver the goods. (2) After a default by the lessee under the lease contract of the type described in Section 2A-523(1) or 2A-523(4)(a) or, if agreed, after other default by the lessee, the lessor has the right to take possession of the goods. If the lease contract so provides, the lessor may require the lessee to assemble the goods and make them available to the lessor at a place to be designated by the lessor which is reasonably convenient to both parties. Without removal, the lessor may render unusable any goods employed in trade or business, and may dispose of goods on the lessee's premises (Section 2A-527). (3) The lessor may proceed under subsection (2) without judicial process if it can be done without breach of the peace or the lessor may proceed by action. As amended in 2005.
See Appendix V for material relating to changes made in text in 2005.

Ocial Comment
Uniform Statutory Source: Sections 2-702(1) and 9-503. Changes: Substantially revised. Purposes: 1. Subsection (1), a revised version of the provisions of Section 2-702(1), allows the lessor to refuse to deliver goods if the lessee is insolvent. Note that the provisions of Section 2-702(2), granting the unpaid seller certain rights of reclamation, were not incorporated in this section. Subsection (2) made this unnecessary. 2. Subsection (2), a revised version of the provisions of Section 9-503, allows the lessor, on a Section 2A-523(1) or 2A-523(3)(a) default by the lessee, the right to take possession of or reclaim the goods. Also, the lessor can contract for the right to take possession of the goods for other defaults by the lessee. Therefore, since the lessee's insolvency is an event of default in a standard lease agreement, subsection (2) is the functional equivalent of Section 2-702(2). Further, subsection (2) sanctions the classic crate and delivery clause obligating 300

Art. 2A

Leases

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the lessee to assemble the goods and to make them available to the lessor. Finally, the lessor may leave the goods in place, render them unusable (if they are goods employed in trade or business), and dispose of them on the lessee's premises. 3. Subsection (3), a revised version of the provisions of Section 9-503, allows the lessor to proceed under subsection (2) without judicial process, absent breach of the peace, or by action. Sections 2A-501(3), 2A-103(4) and 1-201(1). In the appropriate case action includes injunctive relief. Clark Equip. Co. v. Armstrong Equip. Co., 431 F.2d 54 (5th Cir.1970), cert. denied, 402 U.S. 909 (1971). This Section, as well as a number of other Sections in this Part, are included in the Article to codify the lessor's common law right to protect the lessor's reversionary interest in the goods. Section 2A-103(1)(q). These Sections are intended to supplement and not displace principles of law and equity with respect to the protection of such interest. Sections 2A-103(4) and 1-103. Such principles apply in many instances, e.g., loss or damage to goods if risk of loss passes to the lessee, failure of the lessee to return goods to the lessor in the condition stipulated in the lease, and refusal of the lessee to return goods to the lessor after termination or cancellation of the lease. See also Section 2A-532. Cross References: Point 1: Section 2-702. Point 2: Section 2-702, Section 2A-523 and Section 9-503, 9-609. Point 3: Section 1-201, Sections 2A-103, 2A-501, 2A-532 and Section 9-503. Denitional Cross References: Action. Section 1-201. Delivery. Section 2A-103(1)(g). Discover. Section 1-201. Goods. Section 2A-103(1)(n). Insolvent. Section 1-201. Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Party. Section 1-201. Rights. Section 1-201.

2A-526. Lessor's Stoppage of Delivery in Transit or Otherwise. (1) A lessor may stop delivery of goods in the possession of a carrier or other bailee if the lessor discovers the lessee to be insolvent or if the lessee repudiates or fails to make a payment due before delivery, whether for rent, security or otherwise under the lease contract, or for any other reason the lessor has a right to withhold or take possession of the goods. (2) In pursuing its remedies under subsection (1), the lessor may stop delivery until (a) receipt of the goods by the lessee; (b) acknowledgment to the lessee by any bailee of the goods, except a carrier, that the bailee holds the goods for the lessee; or (c) such an acknowledgment to the lessee by a carrier via reshipment or as a warehouse. (3) (a) To stop delivery, a lessor shall so notify as to enable the bailee by reasonable diligence to prevent delivery of the goods. (b) After notication, the bailee shall hold and deliver the goods according to the directions of the lessor, but the lessor is liable to the bailee for any ensuing charges or damages. (c) A carrier that has issued a nonnegotiable bill of lading is not obliged to obey a notication to stop received from a person other than the consignor.
301

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As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-705. Changes: Revised to reect leasing practices and terminology. Denitional Cross References: Bill of lading. Section 1-201. Delivery. Section 2A-103(1)(g). Discover. Section 1-201. Goods. Section 2A-103(1)(n). Insolvent. Section 1-201. Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Noties and Notication. Section 1-202. Person. Section 1-201. Receipt. Section 2-103(1)(c). Remedy. Section 1-201. Rights. Section 1-201.

2A-527. Lessor's Rights to Dispose of Goods. (1) After a default by a lessee under the lease contract of the type described in Section 2A-523(1) or 2A-523(4)(a) or after the lessor refuses to deliver or takes possession of goods (Section 2A-525 or 2A-526), or, if agreed, after other default by a lessee, the lessor may dispose of the goods concerned or the undelivered balance thereof by lease, sale, or otherwise. (2) Except as otherwise provided with respect to damages liquidated in the lease agreement (Section 2A-504) or otherwise determined pursuant to agreement of the parties (Section 1-302 and 2A-503), if the disposition is by lease agreement substantially similar to the original lease agreement and the new lease agreement is made in good faith and in a commercially reasonable manner, the lessor may recover from the lessee as damages (i) accrued and unpaid rent as of the date of the commencement of the term of the new lease agreement, (ii) the present value, as of the same date, of the total rent for the then remaining lease term of the original lease agreement minus the present value, as of the same date, of the rent under the new lease agreement applicable to that period of the new lease term which is comparable to the then remaining term of the original lease agreement, and (iii) any incidental or consequential damages allowed under Section 2A-530, less expenses saved in consequence of the lessee's default. (3) If the lessor's disposition is by lease agreement that for any reason does not qualify for treatment under subsection (2), or is by sale or otherwise, the lessor may recover from the lessee as if the lessor had elected not to dispose of the goods and Section 2A-528 governs. (4) A subsequent buyer or lessee that buys or leases from the lessor in good faith for value as a result of a disposition under this section takes the goods free of the original lease contract and any rights of the original lessee even if the lessor fails to comply with one or more of the requirements of this Article. (5) The lessor is not accountable to the lessee for any prot made on any
302

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disposition. A lessee that has rightfully rejected or justiably revoked acceptance shall account to the lessor for any excess over the amount of the lessee's security interest (Section 2A-508(4)).
Legislative Note: The cross-reference in subsection (2) should not be changed if the jurisdiction has not adopted the 2001 Revised Article 1.

As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-706(1), (5) and (6). Changes: Substantially revised. Purposes: 1. Subsection (1), a revised version of the rst sentence of subsection 2-706(1), allows the lessor the right to dispose of goods after a statutory or other material default by the lessee (even if the goods remain in the lessee's possessionSection 2A-525(2)), after the lessor refuses to deliver or takes possession of the goods, or, if agreed, after other contractual default. The lessor's decision to exercise this right is a function of a commercial judgment, not a statutory mandate replete with sanctions for failure to comply. Cf. Section 9-507. As the owner of the goods, in the case of a lessor, or as the prime lessee of the goods, in the case of a sublessor, compulsory disposition of the goods is inconsistent with the nature of the interest held by the lessor or the sublessor and is not necessary because the interest held by the lessee or the sublessee is not protected by a right of redemption under the common law or this Article. Subsection 2A-527(5). 2. The rule for determining the measure of damages recoverable by the lessor against the lessee is a function of several variables. If the lessor has elected to eect disposition under subsection (1) and such disposition is by lease that qualies under subsection (2), the measure of damages set forth in subsection (2) will apply, absent agreement to the contrary. Sections 2A-504, 2A-103(4) and 1-102(3). 3. The lessor's damages will be established using the new lease agreement as a measure if the following three criteria are satised: (i) the lessor disposed of the goods by lease, (ii) the lease agreement is substantially similar to the original lease agreement, and (iii) such disposition was in good faith, and in a commercially reasonable manner. Thus, the lessor will be entitled to recover from the lessee the accrued and unpaid rent as of the date of commencement of the term of the new lease, and the present value, as of the same date, of the rent, under the original lease for the then remaining term less the present value as of the same date of the rent under the new lease agreement applicable to the period of the new lease comparable to the remaining term under the original lease, together with incidental damages less expenses saved in consequence of the lessee's default. If the lessor's disposition does not satisfy the criteria of subsection (2), the lessor may calculate its claim against the lessee pursuant to Section 2A-528. Section 2A-523(1)(e). 4. Two of the three criteria to be met by the lessor are familiar, but the concept of the new lease agreement that is substantially similar to the original lease agreement is not. Given the many variables facing a party who intends to lease goods and the rapidity of change in the market place, the policy decision was made not to draft with specicity. It was thought unwise to seek to establish certainty at the cost of fairness. The decision of whether the new lease agreement is substantially similar to the original will be determined case by case. 5. While the section does not draw a bright line, it is possible to describe some of the factors that should be considered in a nding that a new lease agreement is substantially similar to the original. The various elements of the new lease agreement should be examined. Those elements include the options to purchase or release; the lessor's representations, warranties and covenants to the lessee as well as those to be provided by the lessee to the lessor; and the services, if any, to be provided by the lessor or by the lessee. All of these factors allocate cost and risk between the lessor and the lessee and thus aect the amount of rent to be paid. These ndings should not be made with scientic precision, as they are a function of economics, nor should they be made independently, as it is important that a sense of commercial judgment pervade the nding. See Section 2A-507(2). To establish the new lease as a proper measure of damage under subsection (2), these various factors, taken 303

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as a whole, must result in a nding that the new lease agreement is substantially similar to the original. If the dierences between the original lease and the new lease can be easily valued, it would be appropriate for a court to nd that the new lease is substantially similar to the old lease, adjust the dierence in the rent between the two leases to take account of the dierences, and award damages under this section. If, for example, the new lease requires the lessor to insure the goods in the hands of the lessee, while the original lease required the lessee to insure, the usual cost of such insurance could be deducted from rent due under the new lease before the dierence in rental between the two leases is determined. 6. The following hypothetical illustrates the diculty of providing a bright line. Assume that A buys a jumbo tractor for $1 million and then leases the tractor to B for a term of 36 months. The tractor is delivered to and is accepted by B on May 1. On June 1 B fails to pay the monthly rent to A. B returns the tractor to A, who immediately releases the tractor to C for a term identical to the term remaining under the lease between A and B. All terms and conditions under the lease between A and C are identical to those under the original lease between A and B, except that C does not provide any property damage or other insurance coverage, and B agreed to provide complete coverage. Coverage is expensive and difcult to obtain. It is a question of fact whether it is so dicult to adjust the recovery to take account of the dierence between the two leases as to insurance that the second lease is not substantially similar to the original. 7. A new lease can be substantially similar to the original lease even though its term extends beyond the remaining term of the original lease, so long as both (a) the lease terms are commercially comparable (e.g., it is highly unlikely that a one-month rental and a veyear lease would reect similar realities), and (b) the court can fairly apportion a part of the rental payments under the new lease to that part of the term of the new lease which is comparable to the remaining lease term under the original lease. Also, the lease term of the new lease may be comparable to the remaining term of the original lease even though the beginning and ending dates of the two leases are not the same. For example, a two-month lease of agricultural equipment for the months of August and September may be comparable to a two-month lease running from the 15th of August to the 15th of October if in the particular location two-month leases beginning on August 15th are basically interchangeable with two-month leases beginning August 1st. Similarly, the term of a one-year truck lease beginning on the 15th of January may be comparable to the term of a one-year truck lease beginning January 2d. If the lease terms are found to be comparable, the court may base cover damages on the entire dierence between the costs under the two leases. 8. Subsection (3), which is new, provides that if the lessor's disposition is by lease that does not qualify under subsection (2), or is by sale or otherwise, Section 2A-528 governs. 9. Subsection (4), a revised version of subsection 2-706(5), applies to protect a subsequent buyer or lessee who buys or leases from the lessor in good faith and for value, pursuant to a disposition under this section. Note that by its terms, the rule in subsection 2A-304(1), which provides that the subsequent lessee takes subject to the original lease contract, is controlled by the rule stated in this subsection. 10. Subsection (5), a revised version of subsection 2-706(6), provides that the lessor is not accountable to the lessee for any prot made by the lessor on a disposition. This rule follows from the fundamental premise of the bailment for hire that the lessee under a lease of goods has no equity of redemption to protect. Cross References: Point 1: Section 2-706, Section 2A-525 and 2A-527 and Section 9-625 and 9-627. Point 2: Section 1-302 and Section 2A-103 and 2A-504. Point 3: Sections 2A-523 and 2A-528. Point 5: Section 2A-507. Point 8: Section 2A-528. Point 9: Section 2-706 and Section 2A-304. Point 10: Section 2-706. Denitional Cross References: Buyer and Buying. Section 2-103(1)(a). Delivery. Section 2A-103(1)(g). Good faith. Sections 2A-103(1)(m). 304

Art. 2A
Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Present value. Section 2A-103(1)(aa). Rights. Section 1-201. Sale. Section 2-106(1). Security interest. Section 1-201. Value. Section 1-204.

Leases

2A-528

2A-528. Lessor's Damages for Non-acceptance, Failure to Pay, Repudiation, or Other Default. (1) Except as otherwise provided with respect to damages liquidated in the lease agreement (Section 2A-504) or otherwise determined pursuant to agreement of the parties (Sections 1-302 and 2A-503), if a lessor elects to retain the goods or a lessor elects to dispose of the goods and the disposition is by lease agreement that for any reason does not qualify for treatment under Section 2A-527(2), or is by sale or otherwise, the lessor may recover from the lessee as damages for a default of the type described in Section 2A-523(1) or 2A-523(4)(a), or, if agreed, for other default of the lessee, (i) accrued and unpaid rent as of the date of default if the lessee has never taken possession of the goods, or, if the lessee has taken possession of the goods, as of the date the lessor repossesses the goods or an earlier date on which the lessee makes a tender of the goods to the lessor, (ii) the present value as of the date determined under clause (i) of the total rent for the then remaining lease term of the original lease agreement minus the present value as of the same date of the market rent at the place where the goods are located computed for the same lease term, and (iii) any incidental or consequential damages allowed under Section 2A-530, less expenses saved in consequence of the lessee's default. (2) If the measure of damages provided in subsection (1) is inadequate to put a lessor in as good a position as performance would have, the measure of damages is the present value of the prot, including reasonable overhead, the lessor would have made from full performance by the lessee, together with any incidental or consequential damages allowed under Section 2A-530. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (1), a substantially revised version of Section 2-708(1), states the basic rule governing the measure of lessor's damages for a default described in Section 2A-523(1) or (3)(a), and, if agreed, for a contractual default. This measure will apply if the lessor elects to retain the goods (whether undelivered, returned by the lessee, or repossessed by the lessor after acceptance and default by the lessee) or if the lessor's disposition does not qualify under subsection 2A-527(2). Section 2A-527(3). Note that under some of these conditions, the lessor may recover damages from the lessee pursuant to the rule set forth in Section 2A-529. There is no sanction for disposition that does not qualify under subsection 2A527(2). Application of the rule set forth in this section is subject to agreement to the contrary. Sections 2A-504, 2A-103(4) and 1-302. 2. If the lessee has never taken possession of the goods, the measure of damage is the accrued and unpaid rent as of the date of default together with the present value, as of the 305

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Art. 2A

date of default, of the original rent for the remaining term of the lease less the present value as of the same date of market rent, and incidental damages, less expenses saved in consequence of the default. Note that the reference in Section 2A-528(1)(i) and (ii) is to the date of default not to the date of an event of default. An event of default under a lease agreement becomes a default under a lease agreement only after the expiration of any relevant period of grace and compliance with any notice requirements under this Article and the lease agreement. American Bar Foundation, Commentaries on Indentures, 5-1, at 216217 (1971). Section 2A-501(1). This conclusion is also a function of whether, as a matter of fact or law, the event of default has been waived, suspended or cured. Sections 2A-103(4) and 1-103. If the lessee has taken possession of the goods, the measure of damages is the accrued and unpaid rent as of the earlier of the time the lessor repossesses the goods or the time the lessee tenders the goods to the lessor plus the dierence between the present value, as of the same time, of the rent under the lease for the remaining lease term and the present value, as of the same time, of the market rent. 3. Market rent is computed pursuant to Section 2A-507. 4. Subsection (2), a somewhat revised version of the provisions of subsection 2-708(2), states a measure of damages which applies if the measure of damages in subsection (1) is inadequate to put the lessor in as good a position as performance would have. The measure of damage is the lessor's prot, including overhead, together with incidental damages and consequential damages. 5. In calculating prot, a court should include any expected appreciation of the goods, e.g. the foal of a leased brood mare. Because this subsection is intended to give the lessor the benet of the bargain, a court should consider any reasonable benet or prot expected by the lessor from the performance of the lease agreement. See Honeywell, Inc. v. Lithonia Lighting, Inc., 317 F.Supp. 406, 413 (N.D.Ga.1970); Locks v. Wade, 36 N.J.Super. 128, 131, 114 A.2d 875, 877 (Super.Ct.App.Div.1955). Further, in calculating prot the concept of present value must be given eect. Taylor v. Commercial Credit Equip. Corp., 170 Ga.App. 322, 316 S.E.2d 788 (Ct.App.1984). See generally Section 2A-103(1)(u). Cross References: Point 1: Section 1-302, Section 2-708 and Sections 2A-103, 2A-504, 2A-523, 2A-527 and 2A-529. Point 2: Section 1-103 and Sections 2A-103, 2A-501, 2A-528. Point 3: Section 2A-507. Point 4: Section 2-708. Point 5: Section 2A-103. Denitional Cross References: Agreement. Section 1-201. Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(p). Lease agreement. Section 2A-103(1)(q). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Party. Section 1-201. Present value. Section 2A-103(1)(aa). Sale. Section 2-106(1).

As amended in 2003.
See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-529. Lessor's Action for the Rent. (1) After default by the lessee under the lease contract of the type described in Section 2A-523(1) or 2A-523(4)(a) or, if agreed, after other default by the lessee, if the lessor complies with subsection (2), the lessor may recover from the lessee as damages: (a) for goods accepted by the lessee and not repossessed by or tendered to the lessor, and for conforming goods lost or damaged within a com306

Art. 2A

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mercially reasonable time after risk of loss passes to the lessee (Section 2A-219), (i) accrued and unpaid rent as of the date of entry of judgment in favor of the lessor, (ii) the present value as of the same date of the rent for the then remaining lease term of the lease agreement, and (iii) any incidental or consequential damages allowed under Section 2A-530, less expenses saved in consequence of the lessee's default; and (b) for goods identied to the lease contract if the lessor is unable after reasonable eort to dispose of them at a reasonable price or the circumstances reasonably indicate that eort will be unavailing, (i) accrued and unpaid rent as of the date of entry of judgment in favor of the lessor, (ii) the present value as of the same date of the rent for the then remaining lease term of the lease agreement, and (iii) any incidental or consequential damages allowed under Section 2A-530, less expenses saved in consequence of the lessee's default. (2) Except as provided in subsection (3), the lessor shall hold for the lessee for the remaining lease term of the lease agreement any goods that have been identied to the lease contract and are in the lessor's control. (3) The lessor may dispose of the goods at any time before collection of the judgment for damages obtained pursuant to subsection (1). If the disposition is before the end of the remaining lease term of the lease agreement, the lessor's recovery against the lessee for damages is governed by Section 2A-527 or 2A-528, and the lessor will cause an appropriate credit to be provided against a judgment for damages to the extent that the amount of the judgment exceeds the recovery available pursuant to Section 2A-527 or 2A-528. (4) Payment of the judgment for damages obtained pursuant to subsection (1) entitles the lessee to the use and possession of the goods not then disposed of for the remaining lease term of and in accordance with the lease agreement. (5) After default by the lessee under the lease contract of the type described in Section 2A-523(1) or 2A-523(4)(a) or, if agreed, after other default by the lessee, a lessor that is held not entitled to rent under this section must nevertheless be awarded damages for nonacceptance under Section 2A-527 or 2A-528. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-709. Changes: Substantially revised. Purposes: 1. Absent a lease contract provision to the contrary, an action for the full unpaid rent (discounted to present value as of the time of entry of judgment as to rent due after that time) is available as to goods not lost or damaged only if the lessee retains possession of the goods or the lessor is or apparently will be unable to dispose of them at a reasonable price after reasonable eort. There is no general right in a lessor to recover the full rent from the lessee upon holding the goods for the lessee. If the lessee tenders goods back to the lessor, and the lessor refuses to accept the tender, the lessor will be limited to the damages it would have suered had it taken back the goods. The rule in Article 2 that the seller can recover the price of accepted goods is rejected here. In a lease, the lessor always has a residual interest in the goods which the lessor usually realizes upon at the end of a lease 307

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term by either sale or a new lease. Therefore, it is not a substantial imposition on the lessor to require it to take back and dispose of the goods if the lessee chooses to tender them back before the end of the lease term: the lessor will merely do earlier what it would have done anyway, sell or relet the goods. Further, the lessee will frequently encounter substantial diculties if the lessee attempts to sublet the goods for the remainder of the lease term. In contrast to the buyer who owns the entire interest in goods and can easily dispose of them, the lessee is selling only the right to use the goods under the terms of the lease and the sublessee must assume a relationship with the lessor. In that situation, it is usually more ecient to eliminate the original lessee as a middleman by allowing the lessee to return the goods to the lessor who can then redispose of them. 2. In some situations even where possession of the goods is reacquired, a lessor will be able to recover as damages the present value of the full rent due, not under this section, but under 2A-528(2) which allows a lost prot recovery if necessary to put the lessor in the position it would have been in had the lessee performed. Following is an example of such a case. A is a lessor of construction equipment and maintains a substantial inventory. B leases from A a backhoe for a period of two weeks at a rental of $1,000. After three days, B returns the backhoe and refuses to pay the rent. A has ve backhoes in inventory, including the one returned by B. During the next 11 days after the return by B of the backhoe, A rents no more than three backhoes at any one time and, therefore, always has two on hand. If B had kept the backhoe for the full rental period, A would have earned the full rental on that backhoe, plus the rental on the other backhoes it actually did rent during that period. Getting this backhoe back before the end of the lease term did not enable A to make any leases it would not otherwise have made. The only way to put A in the position it would have been in had the lessee fully performed is to give the lessor the full rentals. A realized no savings at all because the backhoe was returned early and might even have incurred additional expense if it was paying for parking space for equipment in inventory. A has no obligation to relet the backhoe for the benet of B rather than leasing that backhoe or any other in inventory for its own benet. Further, it is probably not reasonable to expect A to dispose of the backhoe by sale when it is returned in an eort to reduce damages suered by B. Ordinarily, the loss of a two-week rental would not require A to reduce the size of its backhoe inventory. Whether A would similarly be entitled to full rentals as lost prot in a one-year lease of a backhoe is a question of fact: in any event the lessor, subject to mitigation of damages rules, is entitled to be put in as good a position as it would have been had the lessee fully performed the lease contract. 3. Under subsection (2) a lessor who is able and elects to sue for the rent due under a lease must hold goods not lost or damaged for the lessee. Subsection (3) creates an exception to the subsection (2) requirement. If the lessor disposes of those goods prior to collection of the judgment (whether as a matter of law or agreement), the lessor's recovery is governed by the measure of damages in Section 2A-527 if the disposition is by lease that is substantially similar to the original lease, or otherwise by the measure of damages in Section 2A-528. Section 2A-523 ocial comment. 4. Subsection (4), which is new, further reinforces the requisites of Subsection (2). In the event the judgment for damages obtained by the lessor against the lessee pursuant to subsection (1) is satised, the lessee regains the right to use and possession of the remaining goods for the balance of the original lease term; a partial satisfaction of the judgment creates no right in the lessee to use and possession of the goods. 5. The relationship between subsections (2) and (4) is important to understand. Subsection (2) requires the lessor to hold for the lessee identied goods in the lessor's possession. Absent agreement to the contrary, whether in the lease or otherwise, under most circumstances the requirement that the lessor hold the goods for the lessee for the term will mean that the lessor is not allowed to use them. Sections 2A-103(4) and 1-203. Further, the lessor's use of the goods could be viewed as a disposition of the goods that would bar the lessor from recovery under this section, remitting the lessor to the two preceding sections for a determination of the lessor's claim for damages against the lessee. 6. Subsection (5), the analogue of subsection 2-709(3), further reinforces the thrust of subsection (3) by stating that a lessor who is held not entitled to rent under this section has not elected a remedy; the lessor must be awarded damages under Sections 2A-527 and 2A-528. This is a function of two signicant policies of this Articlethat resort to a remedy is optional, unless expressly agreed to be exclusive (Section 2A-503(2)) and that rights and remedies provided in this Article generally are cumulative. (Section 2A-501(2) and (4)). 308

Art. 2A

Leases

2A-530

Cross References: Point 2: Section 2A-528. Point 3: Section 2A-523, 2A-527 and 2A-528. Point 5: Section 1-203 and Section 2A-103. Point 6: Section 2-709 and Sections 2A-501, 2A-503, 2A-527, 2A-528. Denitional Cross References: Action. Section 1-201. Conforming. Section 2A-103(1)(c). Goods. Section 2A-103(1)(n). Lease. Section 2A-103(1)(j). Lease agreement. Section 2A-103(1)(q). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Present value. Section 2A-103(1)(aa). Reasonable time. Section 1-205.

2A-530. Lessor's Incidental and Consequential Damages. (1) Incidental damages to an aggrieved lessor include any commercially reasonable charges, expenses, or commissions incurred in stopping delivery, in the transportation, care and custody of goods after the lessee's default, in connection with return or disposition of the goods, or otherwise resulting from the default. (2) Consequential damages resulting from a lessee's default include any loss resulting from general or particular requirements and needs of which the lessee at the time of contracting had reason to know and which could not reasonably be prevented by disposition under Section 2A-527 or otherwise. (3) In a consumer lease contract, a lessor may not recover consequential damages from a consumer. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-710. Changes: Revised to reect leasing practices and terminology. 1. Subsection (1) provides for reimbursement by the lessor for the expenses reasonably incurred as a result of the lessee's breach. The section sets forth as examples the usual and normal types of damages that may arise from the breach but the provision is intended intends to provide for all commercially reasonable expenditures made by the lessor. 2. Subsection (2), permits an aggrieved lessor to recover consequential damages. Under this section the loss must result from general or particular requirements of the lessor of which the lessee had reason to know at the time of contracting. The lessee is not liable for losses that could have been mitigated. 3. Subsection (3) precludes a lessor from recovering consequential damages from a consumer. This is a non-waivable provision. Denitional Cross References: Aggrieved party. Section 1-201. Delivery. Section 2A-103(1)(g). Goods. Section 2A-103(1)(n). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v).

As amended in 2003.
309

 2A-530

Uniform Commercial Code

Art. 2A

See Appendix U for material relating to changes made in Ocial Comment in 2003.

2A-531. Standing to Sue Third Parties for Injury to Goods. (1) If a third party so deals with goods that have been identied to a lease contract as to cause actionable injury to a party to the lease contract (a) the lessor has a right of action against the third party, and (b) the lessee also has a right of action against the third party if the lessee: (a) has a security interest in the goods; (b) has an insurable interest in the goods; or (c) bears the risk of loss under the lease contract or has since the injury assumed that risk as against the lessor and the goods have been converted or destroyed. (2) If at the time of the injury the party plainti did not bear the risk of loss as against the other party to the lease contract and there is no arrangement between them for disposition of the recovery, the party plainti's suit or settlement, subject to the party plainti's own interest, is as a duciary for the other party to the lease contract. (3) Either party with the consent of the other may sue for the benet of which it may concern. As amended in 2003.
See Appendix U for material relating to changes made in text in 2003.

Ocial Comment
Uniform Statutory Source: Section 2-722. Changes: Revised to reect leasing practices and terminology. Denitional Cross References: Action. Section 1-201. Goods. Section 2A-103(1)(n). Lease contract. Section 2A-103(1)(r). Lessee. Section 2A-103(1)(t). Lessor. Section 2A-103(1)(v). Party. Section 1-201. Rights. Section 1-201. Security interest. Section 1-201.

2A-532. Lessor's Rights to Residual Interest. In addition to any other recovery permitted by this Article or other law, the lessor may recover from the lessee an amount that will fully compensate the lessor for any loss of or damage to the lessor's residual interest in the goods caused by the default of the lessee. Ocial Comment
Uniform Statutory Source: None. Purposes: This section recognizes the right of the lessor to recover under this Article (as well as under other law) from the lessee for failure to comply with the lease obligations as to the condition of leased goods when returned to the lessor, for failure to return the goods at the end of the lease, or for any other default which causes loss or injury to the lessor's residual interest in the goods. 310

Art. 2A

Leases

1-303

PART 6. TRANSITIONAL PROVISIONS

2A-601. Eective Date. This [Act] takes eect on , 20 . As added in 2003. 2A-602. Amendment of Existing Article 2A. This [Act] amends [insert citation to existing Article 2A]. As added in 2003. 2A-603. Applicability. (1) This [Act] applies to a transaction within its scope that is entered into on or after the eective date of this [Act]. (2) This [Act] does not apply to a transaction that is entered into before the eective date of this [Act] even if the transaction would be subject to this [Act] if it had been entered into after the eective date of this [Act]. (3) This [Act] does not apply to a cause of action that has accrued before the eective date of this [Act]. As added in 2003. 2A-604. Savings Clause. A transaction entered into before the eective date of this [Act] and the rights, obligations, and interests owing from that transaction are governed by any statute or other law amended or repealed by this [Act] as if amendment or repeal had not occurred and may be terminated, completed, consummated, or enforced under that statute or other law. As added in 2003.

APPENDIX I. CONFORMING AMENDMENT TO ARTICLE 1

1-303. Course of Performance, Course of Dealing, and Usage of Trade. * * * (f) Subject to Section 2-209 and Section 2A-208, a course of performance is relevant to show a waiver or modication of any term inconsistent with the course of performance.

311

ARTICLE 3. NEGOTIABLE INSTRUMENTS*

PART 1. GENERAL PROVISIONS AND DEFINITIONS
3-101. 3-102. 3-103. 3-104. 3-105. 3-106. 3-107. 3-108. 3-109. 3-110. 3-111. 3-112. 3-113. 3-114. 3-115. 3-116. 3-117. 3-118. 3-119. Short Title. Subject Matter. Denitions. Negotiable Instrument. Issue of Instrument. Unconditional Promise or Order. Instrument Payable in Foreign Money. Payable on Demand or at Denite Time. Payable to Bearer or to Order. Identication of Person to Whom Instrument Is Payable. Place of Payment. Interest. Date of Instrument. Contradictory Terms of Instrument. Incomplete Instrument. Joint and Several Liability; Contribution. Other Agreements Aecting Instrument. Statute of Limitations. Notice of Right to Defend Action.

PART 2. NEGOTIATION, TRANSFER, AND INDORSEMENT

3-201. 3-202. 3-203. 3-204. 3-205. 3-206. 3-207. Negotiation. Negotiation Subject to Rescission. Transfer of Instrument; Rights Acquired by Transfer. Indorsement. Special Indorsement; Blank Indorsement; Anomalous Indorsement. Restrictive Indorsement. Reacquisition.

PART 3. ENFORCEMENT OF INSTRUMENTS

3-301. Person Entitled to Enforce Instrument. 3-302. Holder in Due Course. 3-303. Value and Consideration.
*Article 3 was revised in 1990 and amended in 2002. For the text and Ocial Comments to Article 3 as they existed prior to revision in 1990, see Appendix G. For the 312 2002 amendments to Article 3, along with Prefatory Note and list of drafting committee members, see Appendix Q.

Art. 3 3-304. 3-305. 3-306. 3-307. 3-308. 3-309. 3-310. 3-311. 3-312.

Negotiable Instruments Overdue Instrument. Defenses and Claims in Recoupment. Claims to an Instrument. Notice of Breach of Fiduciary Duty. Proof of Signatures and Status as Holder in Due Course. Enforcement of Lost, Destroyed, or Stolen Instrument. Eect of Instrument on Obligation for Which Taken. Accord and Satisfaction by Use of Instrument. Lost, Destroyed, or Stolen Cashier's Check, Teller's Check, or Certied Check.

PART 4. LIABILITY OF PARTIES

3-401. 3-402. 3-403. 3-404. 3-405. 3-406. 3-407. 3-408. 3-409. 3-410. 3-411. 3-412. 3-413. 3-414. 3-415. 3-416. 3-417. 3-418. 3-419. 3-420. Signature. Signature by Representative. Unauthorized Signature. Impostors; Fictitious Payees. Employer's Responsibility for Fraudulent Indorsement by Employee. Negligence Contributing to Forged Signature or Alteration of Instrument. Alteration. Drawee Not Liable on Unaccepted Draft. Acceptance of Draft; Certied Check. Acceptance Varying Draft. Refusal to Pay Cashier's Checks, Teller's Checks, and Certied Checks. Obligation of Issuer of Note or Cashier's Check. Obligation of Acceptor. Obligation of Drawer. Obligation of Indorser. Transfer Warranties. Presentment Warranties. Payment or Acceptance by Mistake. Instruments Signed for Accommodation. Conversion of Instrument.

PART 5. DISHONOR
3-501. 3-502. 3-503. 3-504. 3-505. Presentment. Dishonor. Notice of Dishonor. Excused Presentment and Notice of Dishonor. Evidence of Dishonor.

PART 6. DISCHARGE AND PAYMENT

3-601. 3-602. 3-603. 3-604. 3-605. Discharge and Eect of Discharge. Payment. Tender of Payment. Discharge by Cancellation or Renunciation. Discharge of Secondary Obligors.

313

NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS

REPORTERS Robert L. Jordan, Los Angeles, California William D. Warren, Los Angeles, California DRAFTING COMMITTEE CO-CHAIRMEN Robert Haydock, Jr., Boston, Massachusetts Carlyle C. Ring, Jr., Alexandria, Virginia MEMBERS Boris Auerbach, Cincinnati, Ohio William M. Burke, Los Angeles, California William E. Hogan, New York, New York Charles W. Joiner, Ann Arbor, Michigan Frederick H. Miller, Norman, Oklahoma Donald J. Rapson, Livingston, New Jersey, The American Law Institute Representative Lawrence J. Bugge, Madison, Wisconsin, President (Member Ex Ocio) Neal Ossen, Hartford, Connecticut, Chairman, Division C (Member Ex Ocio) REVIEW COMMITTEE CHAIRMAN Frank F. Jestrab, Chevy Chase, Maryland MEMBERS Rupert R. Bullivant, Portland, Oregon Michael Franck, Lansing, Michigan CONSULTANT Fairfax Leary, Jr., Villanova, Pennsylvania ADVISORS Thomas C. Baxter, Jr., Federal Reserve Bank of New York Roland E. Brandel, American Bar Association Leon P. Ciferni, National Westminster Bank USA William B. Davenport, American Bar Association, Section of Business Law, Ad Hoc Committee on Payment Systems Carl Felsenfeld, Association of the Bar of the City of New York Thomas J. Greco, American Bankers Association Oliver I. Ireland, Board of Governors of Federal Reserve System John R.H. Kimball, Federal Reserve Bank of Boston John F. Lee, New York Clearing House Association Norman R. Nelson, New York Clearing House Association Ernest T. Patrikis, Federal Reserve Bank of New York Anne B. Pope, National Corporate Cash Management Association Paul S. Turner, Occidental Petroleum Corporation and National Corporate Cash Management Association Stanley M. Walker, Exxon Company, U.S.A. and National Corporate Cash Management Association ADDITIONAL PARTICIPANTS Henry N. Dyhouse, U.S. Central Credit Union Robert Egan, Chemical Bank 314

Art. 3

Negotiable Instruments

Paul T. Even, National Gypsum Company James Foorman, First Chicago Corporation J. Kevin French, Exxon Company, U.S.A. Richard M. Gottlieb, Manufacturers Hanover Trust Company Douglas E. Harris, Morgan Guaranty Trust Company of New York Arthur L. Herold, National Corporate Cash Management Association Shirley Holder, Atlantic Richeld Company Paul E. Homrighausen, Bankers Clearing House Association and National Automated Clearing House Association Gail M. Inaba, Morgan Guaranty Trust Company of New York Richard P. Kessler, Jr., Credit Union National Association James W. Kopp, Shell Oil Company Donald R. Lawrence, Citibank N.A. Robert M. MacAllister, Chase Manhattan Bank NA Thomas E. Montgomery, California Bankers Association W. Robert Moore, American Bankers Association Samuel Newman, Manufacturers Hanover Trust Company Nena Nodge, National Corporate Cash Management Association Robert J. Pisapia, Occidental Petroleum Corporation Deborah S. Prutzman, Arnold & Porter James S. Rogers, Professor of Law, Newton, Massachusetts Robert M. Rosenblith, Manufacturers Hanover Trust Company Jamileh Soufan, American General Corporation Irma Villarreal, Aon Corporation PREFATORY NOTE Revised Article 3 (with miscellaneous and conforming amendments to Articles 1 and 4) is a companion undertaking to Article 4A on funds transfers. Both eorts were undertaken for the purpose of accommodating modern technologies and practices in payment systems and with respect to negotiable instruments. Both eorts were drafted by the same committee over essentially the same period of time. The work on Article 4A was accorded priority and completed in 1989, and revised Article 3 was completed in 1990. Revised Article 3 may, not inappropriately, be regarded as the latest eort in the progressive codication of the common law of negotiable instruments that began with the English Bills of Exchange Act enacted by Parliament in 1882. The Uniform Negotiable Instruments Law was promulgated by the Conference in 1896, and it in turn was reorganized and modernized by original Article 3Commercial Paper as part of the Uniform Commercial Code jointly promulgated in 1952 by the Conference and the American Law Institute. Revised Article 3 in 1990 modernizes, reorganizes and claries the law. Purpose of Drafting Eort The original Articles 3 and 4 and their predecessors were based upon a paper payment system. Literally, there has been an explosion in the volume of paper to process since Articles 3 and 4 were rst promulgated. In the early 50s, around 7 billion checks were processed annually. Correctly anticipating an increase in check volume as the result of a retail approach taken by bankers at that time, the American Bankers Association in 1954 placed a team on a research and development project to identify the most ecient method of processing checks mechanically. The eminently successful MICR line technology was the result. Upon its implementation, checks were processed at high rates of speed. In major part as a result of this technology, a seven-fold explosion in check volume has occurred between the 50s and 1988. In 1988, the Federal Reserve estimated check volume at 48 billion written annually. In 1987, Congress enacted the Expedited Funds Availability Act, and the Federal Reserve Board implemented it in 1988 with Regulation CC. Regulation CC covers many aspects of the forward check collection process and all aspects of the return process. Present Articles 3 and 4, written for a paper-based system, do not adequately address the issues of responsibility and liability as they relate to modern technologies now employed and the procedures required by the current volume of checks and by the Expedited Funds 315

Uniform Commercial Code

Art. 3

Availability Act and Regulation CC. While agreements among parties to particular transactions have provided some relief, such stop-gap measures are no longer adequate. In addition, practices have developed which are not easily accommodated within existing Article 3. For example, variable rate notes were unknown when Article 3 rst was promulgated; they are common today. Questions about the cash equivalency of cashier's checks and money orders have arisen as banks have sought to raise defenses to the payment of these instruments. The revision of Article 3 and Article 4 to update, improve and maintain the viability of it is necessary to accommodate these changing practices and modern technologies, the needs of a rapidly expanding national and international economy, the requirement for more rapid funds availability, and the need for more clarity and certainty. Absent such an update, further Federal preemption of state law may likely occur. Uniformity is Essential Traditionally, the legal structures for payments have been regulated by state law through the Uniform Commercial Code. In recent years, however, the Federal government has established regulations for credit and debit cards, and for the availability of funds in a way that regulates much of the check collection process. With respect to wholesale funds transfers, on an average day two trillion dollars is transferred. Article 4A of the UCC promulgated in 1989 provides the governing comprehensive rules. In 1990, 12 states enacted Article 4A including California, New York and Illinois. In 1991, Article 4A has been introduced in the legislatures of most of the other states, and it is anticipated that most, if not all, will enact Article 4A uniformly. Within a short time, perhaps by 1992, the law of wholesale funds transfers should be uniform throughout the 50 states. The law for payments through checks and which governs other negotiable instruments similarly should be uniform and up-to-date, either through state enactments or Federal preemption. Otherwise, checks as a viable payment system in international and national transactions will be severely hampered and the utility of other negotiable instruments impaired. Process of Achieving Uniformity The essence of uniform law revision is to obtain a sucient consensus and balance among the interests of the various participants so that universal and uniform adoption by the legislatures of all 50 states may be achieved. As is the practice of the Conference, announcement of the drafting undertaking for Articles 3, 4 and 4A was widely circulated in 1985. Anyone who so requested, received notice of all meetings and was invited to attend. Upon request, names were put on a mailing list to receive copies of drafts as they progressed. In addition, the American Bar Association Ad Hoc Committee on Payments Systems closely followed the work of the Conference and widely circulated the drafts. The Drafting Committee had 3 or 4 meetings each year and, by August 1990, had held 20 meetings. The drafting meetings began on Friday morning and ended on Sunday at noon. All the meetings were well attended, and the average attendance was 50 or more. The discussion of the drafts was open for comment by all those who attended. In addition, the reporters received a substantial amount of comment and suggestions by written and other communications between meetings of the drafting committee. The work product was read line for line at the annual meetings of the Conference three dierent years. In addition, the American Law Institute circulated the drafts two or three times to its entire membership. The ALI consultative group also held a meeting to comment and make suggestions on the draft. In addition, progress reports were published annually in The Business Lawyer from 1985 through 1990. The consensus, balance and quality achieved in this lengthy deliberative process is a product not only of the ne work of the reporters and the drafting committee, but also the faithful and energetic participation of the advisors and participants in the drafting meetings. The advisors representing a variety of interests were: Thomas C. Baxter, Jr., Federal Reserve Bank of New York Roland E. Brandel, American Bar Association Leon P. Ciferni, National Westminster Bank USA William B. Davenport, American Bar Association, Section of Business Law, Ad Hoc Committee on Payment Systems Carl Felsenfeld, Association of the Bar of the City of New York 316

Art. 3

Negotiable Instruments

Thomas J. Greco, American Bankers Association Oliver I. Ireland, Board of Governors of Federal Reserve System John R. H. Kimball, Federal Reserve Bank of Boston John F. Lee, New York Clearing House Association Norman R. Nelson, New York Clearing House Association Ernest T. Patrikis, Federal Reserve Bank of New York Anne B. Pope, National Corporate Cash Management Association Paul S. Turner, Occidental Petroleum Corporation and National Corporate Cash Management Association Stanley M. Walker, Exxon Company, U.S.A. and National Corporate Cash Management Association Other participants who regularly attended drafting meetings were: Henry N. Dyhouse, U.S. Central Credit Union Robert Egan, Chemical Bank Paul T. Even, National Gypsum Corporation James Foorman, First Chicago Corporation J. Kevin French, Exxon Company, U.S.A. Richard M. Gottlieb, Manufacturers Hanover Trust Company Douglas E. Harris, National Corporate Cash Management Association Arthur L. Herold, National Corporate Cash Management Association Shirley Holder, Atlantic Richeld Company Paul E. Homrighausen, Bankers Clearing House Association Gail M. Inaba, Morgan Guaranty Trust Company of New York Richard P. Kessler, Jr., Credit Union National Association James W. Kopp, Shell Oil Company Donald R. Lawrence, Citibank, N.A. Robert M. McAllister, Chase Manhattan Bank, N.A. Thomas E. Montgomery, California Bankers Association W. Robert Moore, American Bankers Association Samuel Newman, Manufacturers Hanover Trust Company Nena Nodge, National Corporate Cash Management Association Robert J. Pisapia, Occidental Petroleum Corporation Deborah S. Prutzman, Arnold & Porter James S. Rogers, Professor of Law, Newton, Massachusetts Robert M. Rosenblith, Manufacturers Hanover Trust Company Jamileh Soufan, American General Corporation Irma Villarreal, Aon Corporation Balance Achieved The consensus reected in Revised Article 3 and in the conforming amendments to Articles 1 and 4 is supported by the participants from the banking community, the users, and the Federal regulators because it reects a balance that each interest can reasonably embrace. Some of the benets of the Revision include: A. Benets in the Public Interest CertaintyRevised Articles 3 and 4 remove numerous uncertainties that exist in the current provisions and thus reduce risk to the payment system and allow appropriate planning by its users and operators. Speed and ReliabilityThe Revision removes impediments to the use of automation, and better conforms to Regulation CC to expedite the availability of funds to customers and to reduce risks to banks. Lower CostsThe Revision by providing for modern technologies, lowers costs to banks and thus to their customers. Reduced LitigationBy clarication of troublesome issues, and by the provisions of Sections 3-404 through 3-406 which reform rules for allocation of loss from forgeries and alterations, the Revision should signicantly reduce litigation. B. Benets to Users Good FaithThe denition of good faith under Sections 3-103(a)(4) and 4-104(c) is expanded to include observance of reasonable commercial standards of fair dealing. This objective standard for good faith applies to the performance of all duties and obligations established under Articles 3 and 4. Fiduciary ProvisionsSection 3-307 protects drawers and persons owed a duciary responsibility by imposing stricter standards for obtaining holder in due course rights by a 317

Uniform Commercial Code

Art. 3

person dealing with the defaulting agent or duciary. It also spells out the circumstances under which a person receiving funds has notice of a breach of duciary duty, and resulting liability. Accord and SatisfactionUnder Section 3-311 payees can avoid the unintentional accord and satisfaction by returning the funds or by giving a notice that requires checks to be sent to a particular oce where such proposals can be handled. On the other hand, the drawer of a full settlement check is protected from the instrument being indorsed with protest and thus losing the money and being liable on the balance of the claim. Cashier's ChecksSection 3-411 and related provisions considerably improve the acceptability of bank obligations like cashier's checks as cash equivalents by providing disincentives to wrongful dishonor, such as the possible recovery of consequential damages. Indorser LiabilitySection 3-415 gives more time to hold a check before the user loses indorser liability. Reporting ForgeriesSection 4-406 increases the outside time a customer has to report forged checks or alterations to thirty days. It also requires a bank truncating checks to retain the item or the capacity to furnish legible copies for seven years. Individual Agent and Corporate LiabilitySection 3-402, as to corporate instruments signed by agents without adequate indication and representation, (except as against a holder in due course), allows a representative to show the parties did not intend individual liability. It aords full protection to the agent that signs a corporate check, even though the check does not show representative status. Also, Section 3-403(b) makes it clear that a signature of an organization is considered unauthorized if more than one signature is required and it is missing. Direct SuitsSection 3-420 allows a person whose indorsement is forged to sue the depositary bank directly, rather than each drawee of the checks involved. C. Benets to the Banking Community CertaintySection 3-104 and related provisions clarify what types of contracts are within Article 3 and how they are to be treated, thus promoting certainty of legal rules and reducing litigation costs and risks. Checks that may omit words of negotiability are included as fully negotiable; confusion over travelers checks is eliminated; variable rate instruments are included; and there is clarication of the impact of the FTC Holder Rule, clarication of the ability of parties to an instrument that is not included in Article 3 to contract for the application of its rules to their contract; and clarication of ordinary money orders as checks rather than bank obligations. Ordinary CareIn Sections 3-103(a)(7) and 4-104(c), ordinary care is dened, making clear that nancial institutions taking checks for processing or for payment by automated means need not manually handle each instrument if that is consistent with the institution's procedures and the procedures used do not vary unreasonably from the general usage of banks. This clarication is designed to accommodate and facilitate eciency, thus lowering costs and lowering expedited funds availability risks. The denition of ordinary care relates to those specic instances in the Code where the standard of ordinary care is set forth. Statute of LimitationsSections 3-118 and 4-111 include statutory periods of limitations which will make the law uniform rather than leaving the topic to widely varying state laws. Employee FraudSection 3-405 expands a per se negligence rule to the case of an indorsement forged by an employee whose duties involve handling checks. It also covers that of a faithless employee who supplies a name and then forges the indorsement, but does not require a precise match between the name of the payee and the indorsement. Bank DenitionThe denition of bank is expanded for the purposes of Articles 3 and 4 to clearly include savings and loans and credit unions so that their checks are directly governed by the Code. Section 4-104 claries that checks drawn on credit lines are subject to the rules for checks drawn on deposit accounts. TruncationSection 4-110 authorizes electronic presentment of items and related provisions remove impediments to truncation. Truncation will reduce risks from mandated funds availability and improve the check collection process. Section 4-406 allows an institution the benet of its provisions even though it does not return the checks due to truncation. If both the customer and the institution fail to use ordinary care, a comparative negligence standard is used rather than placing the full loss on the institution. 318

Art. 3

Negotiable Instruments

TABLE OF DISPOSITION OF SECTIONS IN FORMER ARTICLE 3 The reference to a section in Revised Article 3 is to the section that refers to the issue addressed by the section in Former Article 3. If there is no comparable section in Revised Article 3 to a section in Former Article 3, that fact is indicated by the word Omitted. Former Article 3 Section 3-101 ................................... 3-102(1)(a)............................. 3-102(1)(b)............................. 3-102(1)(c) ............................. 3-102(1)(d)............................. 3-102(1)(e) ............................. 3-102(2) ................................ 3-102(3) ................................ 3-102(4) ................................ 3-103(1) ................................ 3-103(2) ................................ 3-104(1) ................................ 3-104(2)(a)............................. 3-104(2)(b)............................. 3-104(2)(c) ............................. 3-104(2)(d)............................. 3-104(3) ................................ 3-105(1)(a)............................. 3-105(1)(b)............................. 3-105(1)(c) ............................. 3-105(1)(d)............................. 3-105(1)(e) ............................. 3-105(1)(f) ............................. 3-105(1)(g)............................. 3-105(1)(h)............................. 3-105(2)(a)............................. 3-105(2)(b)............................. 3-106(1) ................................ 3-106(2) ................................ 3-107(1) ................................ 3-107(2) ................................ 3-108 ................................... 3-109(1) ................................ 3-109(2) ................................ 3-110(1) ................................ 3-110(1)(a)............................. 3-110(1)(b)............................. Revised Article 3 or 4 Section 3-101 3-105(a) 3-103(a)(6) 3-103(a)(9) Omitted. See Comment 2 to 3-414. 3-104(b) 3-103(b) 3-103(c) 3-103(d) 3-102(a) 3-102(b) 3-104(a) 3-104(e) 3-104(f) 3-104(j) 3-104(e) Omitted. 3-106(a) Omitted. See Comment 1 to 3-106. Omitted. See Comment 1 to 3-106. Omitted. See Comment 1 to 3-106. Omitted. See Comment 1 to 3-106. 3-106(b)(ii) 3-106(b)(ii) 3-106(b)(ii) 3-106(a)(ii) 3-106(b)(ii) 3-104(a) Omitted. Omitted. See Comment to 3-107. 3-107 3-108(a) 3-108(b) Omitted. 3-109(b) Omitted. Omitted.
319

Uniform Commercial Code

Art. 3

Former Article 3 Section 3-110(1)(c) ............................. 3-110(1)(d)............................. 3-110(1)(e) ............................. 3-110(1)(f) ............................. 3-110(1)(g)............................. 3-110(2) ................................ 3-110(3) ................................ 3-111(a) ................................ 3-111(b) ................................ 3-111(c) ................................ 3-112(1)(a)............................. 3-112(1)(b)............................. 3-112(1)(c) ............................. 3-112(1)(d)............................. 3-112(1)(e) ............................. 3-112(1)(f) ............................. 3-112(1)(g)............................. 3-112(2) ................................ 3-113 ................................... 3-114(1) ................................ 3-114(2) ................................ 3-114(3) ................................ 3-115 ................................... 3-116(a) ................................ 3-116(b) ................................ 3-117(a) ................................ 3-117(b) ................................ 3-117(c) ................................ 3-118(a) ................................ 3-118(b) ................................ 3-118(c) ................................ 3-118(d) ................................ 3-118(e) ................................ 3-118(f)................................. 3-119 ................................... 3-120 ................................... 3-121 ................................... 3-122 ................................... 3-201(1) ................................ 3-201(2) ................................ 3-201(3) ................................ 3-202(1) ................................ 3-202(2) ................................
320

Revised Article 3 or 4 Section Omitted. 3-110(d) 3-110(c)(2)(i) 3-110(c)(2)(iv) Omitted. Omitted. 3-109(b) 3-109(a)(1) 3-109(a)(1) 3-109(a)(3) and 3-205(b) Omitted. 3-104(a)(3)(i) 3-104(a)(3)(i) 3-104(a)(3)(ii) 3-104(a)(3)(iii) 3-311 Omitted. Omitted. Omitted. Omitted. See Comment to 3-113. 3-113(a) Omitted. See Comment to 3-113. 3-115 3-110(d) 3-110(d) 3-110(c)(2)(ii) 3-110(c)(2)(i) Omitted. 3-104(e) and 3-103(a)(6) 3-114 3-114 3-112 3-116(a) Omitted. 3-117 and 3-106(a) and (b) 4-106(a) 4-106(b) Omitted. See Comment 1 to 3-118. 3-203(b) 3-204(c) 3-203(c) 3-201(a) 3-204(a)

Art. 3

Negotiable Instruments

Former Article 3 Section 3-202(3) ................................ 3-202(4) ................................ 3-203 ................................... 3-204(1) ................................ 3-204(2) ................................ 3-204(3) ................................ 3-205 ................................... 3-206(1) ................................ 3-206(2) ................................ 3-206(3) ................................ 3-206(4) ................................ 3-207(1)(a)............................. 3-207(1)(b)............................. 3-207(1)(c) ............................. 3-207(1)(d)............................. 3-207(2) ................................ 3-208 ................................... 3-301 ................................... 3-302(1) ................................ 3-302(2) ................................ 3-302(3)(a)............................. 3-302(3)(b)............................. 3-302(3)(c) ............................. 3-302(4) ................................ 3-303(a) ................................ 3-303(b) ................................ 3-303(c) ................................ 3-304(1)(a)............................. 3-304(1)(b)............................. 3-304(2) ................................ 3-304(3)(a)............................. 3-304(3)(b)............................. 3-304(3)(c) ............................. 3-304(4)(a)............................. 3-304(4)(b)............................. 3-304(4)(c) ............................. 3-304(4)(d)............................. 3-304(4)(e) ............................. 3-304(4)(f) ............................. 3-304(5) ................................ 3-304(6) ................................ 3-305(1) ................................ 3-305(2)(a).............................

Revised Article 3 or 4 Section 3-203(d) Omitted. 3-204(d) 3-205(a) 3-205(b) 3-205(c) Omitted. 3-206(a) 3-206(c)(4) and (d) 3-206(b), (c), and (e) 3-206(d) and (e) 3-202(a)(i) 3-202(a)(ii) 3-202(a)(iii) 3-202(a)(iii) 3-202(b) 3-207 Omitted. See Comment to 3-301. 3-302(a) Omitted. See Comment 4 to 3-302. 3-302(c)(i) 3-302(c)(iii) 3-302(c)(ii) 3-302(e) 3-303(a)(1) and (2) 3-303(a)(3) 3-303(a)(4) and (5) 3-302(a)(1) Omitted. 3-307(b) 3-302(a)(2)(iii); 3-304(b)(1) 3-304(b)(3) 3-304(a)(1), (2) and (3) Omitted. Omitted. Omitted. Omitted. 3-307 3-304(c) 3-302(b) Omitted. 3-306 3-305(a)(1)(i)
321

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Former Article 3 Section 3-305(2)(b)............................. 3-305(2)(c) ............................. 3-305(2)(d)............................. 3-305(2)(e) ............................. 3-306(a) ................................ 3-306(b) ................................ 3-306(c) ................................ 3-306(d) ................................ 3-307(1)(a)............................. 3-307(1)(b)............................. 3-307(2) ................................ 3-307(3) ................................ 3-401(1) ................................ 3-401(2) ................................ 3-402 ................................... 3-403(1) ................................ 3-403(2)(a)............................. 3-403(2)(b)............................. 3-403(3) ................................ 3-404(1) ................................ 3-404(2) ................................ 3-405(1)(a)............................. 3-405(1)(b)............................. 3-405(1)(c) ............................. 3-405(2) ................................ 3-406 ................................... 3-407(1)(a)............................. 3-407(1)(b)............................. 3-407(1)(c) ............................. 3-407(2)(a)............................. 3-407(2)(b)............................. 3-407(3) ................................ 3-408 ................................... 3-409(1) ................................ 3-409(2) ................................ 3-410(1) ................................ 3-410(2) ................................ 3-410(3) ................................ 3-411(1) ................................ 3-411(2) ................................ 3-411(3) ................................ 3-412(1) ................................ 3-412(2) ................................
322

Revised Article 3 or 4 Section 3-305(a)(1)(ii) 3-305(a)(1)(iii) 3-305(a)(1)(iv) 3-601(b) 3-306 3-305(a)(2) 3-305(a)(2); 3-303(b); 3-105(b) 3-305(c) 3-308(a) 3-308(a) 3-308(b) 3-308(b) 3-401(a) 3-401(b) 3-204(a) 3-402(a) 3-402(b)(2) 3-402(b)(2) 3-402(b)(1) 3-403(a) 3-403(a) 3-404(a) 3-404(b)(i) 3-405 3-403(c) 3-406 3-407(a)(i) 3-407(a)(ii) 3-407(a)(i) 3-407(b) 3-407(b) 3-407(c) 3-303(b) 3-408 Omitted. See Comment 1 to 3-408. 3-409(a) 3-409(b) 3-409(c) 3-409(d); 3-414(c); 3-415(d) 3-409(d) Omitted. 3-410(a) 3-410(b)

Art. 3

Negotiable Instruments

Former Article 3 Section 3-412(3) ................................ 3-413(1) ................................ 3-413(2) ................................ 3-413(3) ................................ 3-414(1) ................................ 3-414(2) ................................ 3-415(1) ................................ 3-415(2) ................................ 3-415(3) ................................ 3-415(4) ................................ 3-415(5) ................................ 3-416(1) ................................ 3-416(2) ................................ 3-416(3) ................................ 3-416(4) ................................ 3-416(5) ................................ 3-416(6) ................................ 3-417(1) ................................ 3-417(2) ................................ 3-417(3) ................................ 3-417(4) ................................ 3-418 ................................... 3-419(1) ................................ 3-419(2) ................................ 3-419(3) ................................ 3-419(4) ................................ 3-501(1)(a)............................. 3-501(1)(b)............................. 3-501(1)(c) ............................. 3-501(2)(a)............................. 3-501(2)(b)............................. 3-501(3) ................................ 3-501(4) ................................ 3-502(1)(a)............................. 3-502(1)(b)............................. 3-502(2) ................................ 3-503 ................................... 3-504(1) ................................ 3-504(2)(a)............................. 3-504(2)(b)............................. 3-504(2)(c) ............................. 3-504(3)(a).............................

Revised Article 3 or 4 Section 3-410(c) 3-412; 3-413(a) 3-414(b) and (e) Omitted. 3-415(a) and (b) Omitted. 3-419(a) 3-419(b) Omitted. See 3-605(h) 3-419(c) 3-419(e) Omitted. 3-419(d) Omitted. 3-419(c) Omitted. Omitted. 3-417 3-416 Omitted. Omitted. 3-418 3-420(a) 3-420(b) 3-420(c) 3-206(c)(4) and (d) 3-414(b); 3-502(b)(3) and (4) 3-415(a); 3-502(a)(1) and (2); 3-502(b), (c), (d) and (e) 3-414(f); 3-415(e) 3-503(a) Omitted. See Comment 2 to 3-414. Omitted. See Comment to 3-505. Omitted. 3-415(e) 3-414(f) Omitted. See Comment to 3-505. Omitted. See Comment to 3-502. 3-501(a) 3-501(b)(1) 3-501(b)(1) 3-501(b)(1); 3-111 3-501(b)(1)
323

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Former Article 3 Section 3-504(3)(b)............................. 3-504(4) ................................ 3-504(5) ................................ 3-505(1)(a)............................. 3-505(1)(b)............................. 3-505(1)(c) ............................. 3-505(1)(d)............................. 3-505(2) ................................ 3-506(1) ................................ 3-506(2) ................................ 3-507(1) ................................ 3-507(2) ................................ 3-507(3) ................................ 3-507(4) ................................ 3-508(1) ................................ 3-508(2) ................................ 3-508(3) ................................ 3-508(4) ................................ 3-508(5) ................................ 3-508(6) ................................ 3-508(7) ................................ 3-508(8) ................................ 3-509(1) ................................ 3-509(2) ................................ 3-509(3) ................................ 3-509(4) ................................ 3-509(5) ................................ 3-510(a) ................................ 3-510(b) ................................ 3-510(c) ................................ 3-511(1) ................................ 3-511(2)(a)............................. 3-511(2)(b)............................. 3-511(2)(c) ............................. 3-511(3)(a)............................. 3-511(3)(b)............................. 3-511(4) ................................ 3-511(5) ................................ 3-511(6) ................................ 3-601(1) ................................ 3-601(2) ................................ 3-601(3) ................................ 3-602 ...................................
324

Revised Article 3 or 4 Section Omitted. 3-501(b)(1) Omitted. 3-501(b)(2)(i) 3-501(b)(2)(ii) Omitted. 3-501(b)(2)(iii) Omitted. Omitted. Omitted. 3-502 Omitted. 3-501(b)(3)(i) Omitted. 3-503(b) 3-503(c) 3-503(b) Omitted. Omitted. Omitted. Omitted. 3-503(b) 3-505(b) 3-505(b) 3-505(b) Omitted. Omitted. 3-505(a)(1) 3-505(a)(2) 3-505(a)(3) Omitted. 3-504(a)(iv) 3-504(a)(ii), (iv), and (v); 3-504(b) 3-504(a)(i) 3-504(a)(ii) 3-504(a)(ii) 3-502(f) Omitted. Omitted. 3-601(a) 3-601(a) Omitted. 3-601(b)

Art. 3

Negotiable Instruments

3-102

Former Article 3 Section 3-603(1) ................................ 3-603(1)(a)............................. 3-603(1)(b)............................. 3-603(2) ................................ 3-604(1) ................................ 3-604(2) ................................ 3-604(3) ................................ 3-605(1)(a)............................. 3-605(1)(b)............................. 3-605(2) ................................ 3-606(1)(a)............................. 3-606(1)(b)............................. 3-606(2) ................................ 3-701(1) ................................ 3-701(2) ................................ 3-701(3) ................................ 3-801(1) ................................ 3-801(2) ................................ 3-801(3) ................................ 3-801(4) ................................ 3-802(1)(a)............................. 3-802(1)(b)............................. 3-802(2) ................................ 3-803 ................................... 3-804 ................................... 3-805 ...................................

Revised Article 3 or 4 Section 3-602(a) and (b) 3-602(b)(2) Omitted. See 3-206(c)(3). Omitted. 3-603(c) 3-603(b) 3-603(c) 3-604(a)(i) 3-604(a)(ii) 3-604(b) 3-605(b) and (c) 3-605(e) Omitted. Omitted. Omitted. Omitted. Omitted. Omitted. Omitted. Omitted. 3-310(a) and (c) 3-310(b) and (c) Omitted. 3-119 3-309 Omitted. See Comment 2 to 3-104.

PART 1. GENERAL PROVISIONS AND DEFINITIONS

3-101. Short Title. This Article may be cited as Uniform Commercial CodeNegotiable Instruments. 3-102. Subject Matter. (a) This Article applies to negotiable instruments. It does not apply to money, to payment orders governed by Article 4A, or to securities governed by Article 8. (b) If there is conict between this Article and Article 4 or 9, Articles 4 and 9 govern. (c) Regulations of the Board of Governors of the Federal Reserve System and operating circulars of the Federal Reserve Banks supersede any inconsistent provision of this Article to the extent of the inconsistency.
325

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Ocial Comment
1. Former Article 3 had no provision armatively stating its scope. Former Section 3-103 was a limitation on scope. In revised Article 3, Section 3-102 states that Article 3 applies to negotiable instruments, dened in Section 3-104. Section 3-104(b) also denes the term instrument as a synonym for negotiable instrument. In most places Article 3 uses the shorter term instrument. This follows the convention used in former Article 3. 2. The reference in former Section 3-103(1) to documents of title is omitted as superuous because these documents contain no promise to pay money. The denition of payment order in Section 4A-103(a)(1)(iii) excludes drafts which are governed by Article 3. Section 3-102(a) makes clear that a payment order governed by Article 4A is not governed by Article 3. Thus, Article 3 and Article 4A are mutually exclusive. Article 8 states in Section 8-102(1)(c) Section 8-103(d) that A writing that is a certicated security certicate is governed by this Article and not by Article 3, even though it also meets the requirements of that Article. Section 3-102(a) conforms to this provision. With respect to some promises or orders to pay money, there may be a question whether the promise or order is an instrument under Section 3-104(a) or a certicated security under Section 8-102(1)(a) Section 8-102(a)(4) and (15). Whether a writing is covered by Article 3 or Article 8 has important consequences. Among other things, under Section 8-207, the issuer of a certicated security may treat the registered owner as the owner for all purposes until the presentment for registration of a transfer. The issuer of a negotiable instrument, on the other hand, may discharge its obligation to pay the instrument only by paying a person entitled to enforce under Section 3-301. There are also important consequences to an indorser. An indorser of a security does not undertake the issuer's obligation or make any warranty that the issuer will honor the underlying obligation, while an indorser of a negotiable instrument becomes secondarily liable on the underlying obligation. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 4, 1995. Ordinarily the distinction between instruments and certicated securities in non-bearer form should be relatively clear. A certicated security under Article 8 must be in registered form (Section 8-102(1)(a)(i) Section 8-102(a)(13)) so that it can be registered on the issuer's records. By contrast, registration plays no part in Article 3. The distinction between an instrument and a certicated security in bearer form may be somewhat more dicult and will generally lie in the economic functions of the two writings. Ordinarily, negotiable instruments under Article 3 will be separate and distinct instruments, while certicated securities under Article 8 will be either one of a class or series or by their terms divisible into a class or series (Section 8-102(1)(a)(iii) Section 8-102(a)(15)(ii)). Thus, a promissory note in bearer form could come under either Article 3 if it were simply an individual note, or under Article 8 if it were one of a series of notes or divisible into a series. An additional distinction is whether the instrument is of the type commonly dealt in on securities exchanges or markets or commonly recognized as a medium for investment (Section 8-102(1)(a)(ii) Section 8-102(a)(15)(iii)). Thus, a check written in bearer form (i.e., a check made payable to cash) would not be a certicated security within Article 8 of the Uniform Commercial Code. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 4, 1995. Occasionally, a particular writing may t the denition of both a negotiable instrument under Article 3 and of an investment security under Article 8. In such cases, the instrument is subject exclusively to the requirements of Article 8. Section 8-102(1)(c) Section 8-103(d) and Section 3-102(a). Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 4, 1995. 3. Although the terms of Article 3 apply to transactions by Federal Reserve Banks, federal preemption would make ineective any Article 3 provision that conicts with federal law. The activities of the Federal Reserve Banks are governed by regulations of the Federal Reserve Board and by operating circulars issued by the Reserve Banks themselves. In some instances, the operating circulars are issued pursuant to a Federal Reserve Board regulation. In other cases, the Reserve Bank issues the operating circular under its own authority under the Federal Reserve Act, subject to review by the Federal Reserve Board. Section 3-102(c) states that Federal Reserve Board regulations and operating circulars of the Federal Reserve Banks supersede any inconsistent provision of Article 3 to the extent of the inconsistency. Federal Reserve Board regulations, being valid exercises of regulatory 326

Art. 3

Negotiable Instruments

3-103

authority pursuant to a federal statute, take precedence over state law if there is an inconsistency. Childs v. Federal Reserve Bank of Dallas, 719 F.2d 812 (5th Cir.1983), reh. den. 724 F.2d 127 (5th Cir.1984). Section 3-102(c) treats operating circulars as having the same eect whether issued under the Reserve Bank's own authority or under a Federal Reserve Board regulation. Federal statutes may also preempt Article 3. For example, the Expedited Funds Availability Act, 12 U.S.C. 4001 et seq., provides that the Act and the regulations issued pursuant to the Act supersede any inconsistent provisions of the UCC. 12 U.S.C. 4007(b). 4. In Cleareld Trust Co. v. United States, 318 U.S. 363 (1943), the Court held that if the United States is a party to an instrument, its rights and duties are governed by federal common law in the absence of a specic federal statute or regulation. In United States v. Kimbell Foods, Inc., 440 U.S. 715 (1979), the Court stated a three-pronged test to ascertain whether the federal common-law rule should follow the state rule. In most instances courts under the Kimbell test have shown a willingness to adopt UCC rules in formulating federal common law on the subject. In Kimbell the Court adopted the priorities rules of Article 9. 5. In 1989 the United Nations Commission on International Trade Law completed a Convention on International Bills of Exchange and International Promissory Notes. If the United States becomes a party to this Convention, the Convention will preempt state law with respect to international bills and notes governed by the Convention. Thus, an international bill of exchange or promissory note that meets the denition of instrument in Section 3-104 will not be governed by Article 3 if it is governed by the Convention. That Convention applies only to bills and notes that indicate on their face that they involve crossborder transactions. It does not apply at all to checks. Convention Articles 1(3), 2(1), 2(2). Moreover, because it applies only if the bill or note specically calls for application of the Convention, Convention Article 1, there is little chance that the Convention will apply accidentally to a transaction that the parties intended to be governed by this Article. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002.

3-103. Denitions. (a) In this Article: (1) Acceptor means a drawee who has accepted a draft. (2) Consumer account means an account established by an individual primarily for personal, family, or household purposes. (3) Consumer transaction means a transaction in which an individual incurs an obligation primarily for personal, family, or household purposes. (4) Drawee means a person ordered in a draft to make payment. (5) Drawer means a person who signs or is identied in a draft as a person ordering payment. (6) [Good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing.] (7) Maker means a person who signs or is identied in a note as a person undertaking to pay. (8) Order means a written instruction to pay money signed by the person giving the instruction. The instruction may be addressed to any person, including the person giving the instruction, or to one or more persons jointly or in the alternative but not in succession. An authorization to pay is not an order unless the person authorized to pay is also instructed to pay. (9) Ordinary care in the case of a person engaged in business means observance of reasonable commercial standards, prevailing in the area in which the person is located, with respect to the business in which the
327

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Art. 3

person is engaged. In the case of a bank that takes an instrument for processing for collection or payment by automated means, reasonable commercial standards do not require the bank to examine the instrument if the failure to examine does not violate the bank's prescribed procedures and the bank's procedures do not vary unreasonably from general banking usage not disapproved by this Article or Article 4. (10) Party means a party to an instrument. (11) Principal obligor, with respect to an instrument, means the accommodated party or any other party to the instrument against whom a secondary obligor has recourse under this article. (12) Promise means a written undertaking to pay money signed by the person undertaking to pay. An acknowledgment of an obligation by the obligor is not a promise unless the obligor also undertakes to pay the obligation. (13) Prove with respect to a fact means to meet the burden of establishing the fact (Section 1-201(b)(8)). (14) [Record means information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form.] (15) Remitter means a person who purchases an instrument from its issuer if the instrument is payable to an identied person other than the purchaser. (16) Remotely-created consumer item means an item drawn on a consumer account, which is not created by the payor bank and does not bear a handwritten signature purporting to be the signature of the drawer. (17) Secondary obligor, with respect to an instrument, means (a) an indorser or an accommodation party, (b) a drawer having the obligation described in Section 3-414(d), or (c) any other party to the instrument that has recourse against another party to the instrument pursuant to Section 3-116(b). (b) Other denitions applying to this Article and the sections in which they appear are: Acceptance Accommodated party Accommodation party Account Alteration Anomalous indorsement Blank indorsement Cashier's check Certicate of deposit Certied check Check Consideration
328

Section Section Section Section Section Section Section Section Section Section Section Section

3-409 3-419 3-419 4-104 3-407 3-205 3-205 3-104 3-104 3-409 3-104 3-303

Art. 3

Negotiable Instruments

3-103

Draft Holder in due course Incomplete instrument Indorsement Indorser Instrument Issue Issuer Negotiable instrument Negotiation Note Payable at a denite time Payable on demand Payable to bearer Payable to order Payment Person entitled to enforce Presentment Reacquisition Special indorsement Teller's check Transfer of instrument Traveler's check Value

Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section

3-104 3-302 3-115 3-204 3-204 3-104 3-105 3-105 3-104 3-201 3-104 3-108 3-108 3-109 3-109 3-602 3-301 3-501 3-207 3-205 3-104 3-203 3-104 3-303

(c) The following denitions in other Articles apply to this Article: Banking day Clearing house Collecting bank Depositary bank Documentary draft Intermediary bank Item Payor bank Suspends payments Section Section Section Section Section Section Section Section Section 4-104 4-104 4-105 4-105 4-104 4-105 4-104 4-105 4-104

(d) In addition, Article 1 contains general denitions and principles of construction and interpretation applicable throughout this Article.
Legislative Note. A jurisdiction that enacts this statute that has not yet enacted the revised version of UCC Article 1 should add to Section 3-103 the denition of good faith that appears in the ocial version of Section 1-201(b)(20) and the denition of record that appears in the ocial version of Section 1-201(b)(31). Sections 3-103(a)(6) and (14) are reserved for that purpose. A jurisdiction that already has adopted or simultaneously adopts the revised Article 1 should not add those denitions, but should leave those numbers reserved. If jurisdictions follow the numbering suggested here, the subsections will have the same 329

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numbering in all jurisdictions that have adopted these amendments (whether they have or have not adopted the revised version of UCC Article 1).

As amended in 2001 and 2002.

See Appendix I contained within revised Article 1 for material relating to changes made in text in 2001. See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
1. Subsection (a) denes some common terms used throughout the Article that were not dened by former Article 3 and adds the denitions of order and promise found in former Section 3-102(1)(b) and (c). 2. The denition of order includes an instruction given by the signer to itself. The most common example of this kind of order is a cashier's check: a draft with respect to which the drawer and drawee are the same bank or branches of the same bank. Former Section 3-118(a) treated a cashier's check as a note. It stated a draft drawn on the drawer is eective as a note. Although it is technically more correct to treat a cashier's check as a promise by the issuing bank to pay rather than an order to pay, a cashier's check is in the form of a check and it is normally referred to as a check. Thus, revised Article 3 follows banking practice in referring to a cashier's check as both a draft and a check rather than a note. Some insurance companies also follow the practice of issuing drafts in which the drawer draws on itself and makes the draft payable at or through a bank. These instruments are also treated as drafts. The obligation of the drawer of a cashier's check or other draft drawn on the drawer is stated in Section 3-412. An order may be addressed to more than one person as drawee either jointly or in the alternative. The authorization of alternative drawees follows former Section 3-102(1)(b) and recognizes the practice of drawers, such as corporations issuing dividend checks, who for commercial convenience name a number of drawees, usually in dierent parts of the country. Section 3-501(b)(1) provides that presentment may be made to any one of multiple drawees. Drawees in succession are not permitted because the holder should not be required to make more than one presentment. Dishonor by any drawee named in the draft entitles the holder to rights of recourse against the drawer or indorsers. 3. The last sentence of subsection (a)(12) is intended to make it clear that an I.O.U. or other written acknowledgment of indebtedness is not a note unless there is also an undertaking to pay the obligation. 4. This Article now uses the broadened denition of good faith in revised Article 1. The denition requires not only honesty in fact but also observance of reasonable commercial standards of fair dealing. Although fair dealing is a broad term that must be dened in context, it is clear that it is concerned with the fairness of conduct rather than the care with which an act is performed. Failure to exercise ordinary care in conducting a transaction is an entirely dierent concept than failure to deal fairly in conducting the transaction. Both fair dealing and ordinary care, which is dened in Section 3-103(a)(7), are to be judged in the light of reasonable commercial standards, but those standards in each case are directed to dierent aspects of commercial conduct. 5. Subsection (a)(9) is a denition of ordinary care which is applicable not only to Article 3 but to Article 4 as well. See Section 4-104(c). The general rule is stated in the rst sentence of subsection (a)(9) and it applies both to banks and to persons engaged in businesses other than banking. Ordinary care means observance of reasonable commercial standards of the relevant businesses prevailing in the area in which the person is located. The second sentence of subsection (a)(9) is a particular rule limited to the duty of a bank to examine an instrument taken by a bank for processing for collection or payment by automated means. This particular rule applies primarily to Section 4-406 and it is discussed in Comment 4 to that section. Nothing in Section 3-103(a)(9) is intended to prevent a customer from proving that the procedures followed by a bank are unreasonable, arbitrary, or unfair. 6. The denition of consumer account includes a joint account established by more than one individual. See Section 1-106(1).

As amended in 2001 and 2002.

See Appendix I contained within revised Article 1 for material relating to changes made in Ocial Comment in 2001.
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Art. 3

Negotiable Instruments

3-104

See Appendix Q for material relating to changes in Ocial Comment in 2002.

3-104. Negotiable Instrument. (a) Except as provided in subsections (c) and (d), negotiable instrument means an unconditional promise or order to pay a xed amount of money, with or without interest or other charges described in the promise or order, if it: (1) is payable to bearer or to order at the time it is issued or rst comes into possession of a holder; (2) is payable on demand or at a denite time; and (3) does not state any other undertaking or instruction by the person promising or ordering payment to do any act in addition to the payment of money, but the promise or order may contain (i) an undertaking or power to give, maintain, or protect collateral to secure payment, (ii) an authorization or power to the holder to confess judgment or realize on or dispose of collateral, or (iii) a waiver of the benet of any law intended for the advantage or protection of an obligor. (b) Instrument means a negotiable instrument. (c) An order that meets all of the requirements of subsection (a), except paragraph (1), and otherwise falls within the denition of check in subsection (f) is a negotiable instrument and a check. (d) A promise or order other than a check is not an instrument if, at the time it is issued or rst comes into possession of a holder, it contains a conspicuous statement, however expressed, to the eect that the promise or order is not negotiable or is not an instrument governed by this Article. (e) An instrument is a note if it is a promise and is a draft if it is an order. If an instrument falls within the denition of both note and draft, a person entitled to enforce the instrument may treat it as either. (f) Check means (i) a draft, other than a documentary draft, payable on demand and drawn on a bank or (ii) a cashier's check or teller's check. An instrument may be a check even though it is described on its face by another term, such as money order. (g) Cashier's check means a draft with respect to which the drawer and drawee are the same bank or branches of the same bank. (h) Teller's check means a draft drawn by a bank (i) on another bank, or (ii) payable at or through a bank. (i) Traveler's check means an instrument that (i) is payable on demand, (ii) is drawn on or payable at or through a bank, (iii) is designated by the term traveler's check or by a substantially similar term, and (iv) requires, as a condition to payment, a countersignature by a person whose specimen signature appears on the instrument. (j) Certicate of deposit means an instrument containing an acknowledgment by a bank that a sum of money has been received by the bank and a promise by the bank to repay the sum of money. A certicate of deposit is a note of the bank. Ocial Comment
1. The denition of negotiable instrument denes the scope of Article 3 since Section 3-102 states: This Article applies to negotiable instruments. The denition in Section 331

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3-104(a) incorporates other denitions in Article 3. An instrument is either a promise, dened in Section 3-103(a)(12), or order, dened in Section 3-103(a)(8). A promise is a written undertaking to pay money signed by the person undertaking to pay. An order is a written instruction to pay money signed by the person giving the instruction. Thus, the term negotiable instrument is limited to a signed writing that orders or promises payment of money. Money is dened in Section 1-201(24) and is not limited to United States dollars. It also includes a medium of exchange established by a foreign government or monetary units of account established by an intergovernmental organization or by agreement between two or more nations. Five other requirements are stated in Section 3-104(a): First, the promise or order must be unconditional. The quoted term is explained in Section 3-106. Second, the amount of money must be a xed amount * * * with or without interest or other charges described in the promise or order. Section 3-112(b) relates to interest. Third, the promise or order must be payable to bearer or to order. The quoted phrase is explained in Section 3-109. An exception to this requirement is stated in subsection (c). Fourth, the promise or order must be payable on demand or at a denite time. The quoted phrase is explained in Section 3-108. Fifth, the promise or order may not state any other undertaking or instruction by the person promising or ordering payment to do any act in addition to the payment of money with three exceptions. The quoted phrase is based on the rst sentence of N.I.L. Section 5 which is the precursor of no other promise, order, obligation or power given by the maker or drawer appearing in former Section 3-104(1)(b). The words instruction and undertaking are used instead of order and promise that are used in the N.I.L. formulation because the latter words are dened terms that include only orders or promises to pay money. The three exceptions stated in Section 3-104(a)(3) are based on and are intended to have the same meaning as former Section 3-112(1)(b), (c), (d), and (e), as well as N.I.L. 5(1), (2), and (3). Subsection (b) states that instrument means a negotiable instrument. This follows former Section 3-102(1)(e) which treated the two terms as synonymous. 2. Unless subsection (c) applies, the eect of subsection (a)(1) and Section 3-102(a) is to exclude from Article 3 any promise or order that is not payable to bearer or to order. There is no provision in revised Article 3 that is comparable to former Section 3-805. The comment to former Section 3-805 states that the typical example of a writing covered by that section is a check reading Pay John Doe. Such a check was governed by former Article 3 but there could not be a holder in due course of the check. Under Section 3-104(c) such a check is governed by revised Article 3 and there can be a holder in due course of the check. But subsection (c) applies only to checks. The comment to former Section 3-805 does not state any example other than the check to illustrate that section. Subsection (c) is based on the belief that it is good policy to treat checks, which are payment instruments, as negotiable instruments whether or not they contain the words to the order of. These words are almost always pre-printed on the check form. Occasionally the drawer of a check may strike out these words before issuing the check. In the past some credit unions used check forms that did not contain the quoted words. Such check forms may still be in use but they are no longer common. Absence of the quoted words can easily be overlooked and should not aect the rights of holders who may pay money or give credit for a check without being aware that it is not in the conventional form. Total exclusion from Article 3 of other promises or orders that are not payable to bearer or to order serves a useful purpose. It provides a simple device to clearly exclude a writing that does not t the pattern of typical negotiable instruments and which is not intended to be a negotiable instrument. If a writing could be an instrument despite the absence of to order or to bearer language and a dispute arises with respect to the writing, it might be argued that the writing is a negotiable instrument because the other requirements of subsection (a) are somehow met. Even if the argument is eventually found to be without merit it can be used as a litigation ploy. Words making a promise or order payable to bearer or to order are the most distinguishing feature of a negotiable instrument and such words are frequently referred to as words of negotiability. Article 3 is not meant to apply to contracts for the sale of goods or services or the sale or lease of real property or similar writings that may contain a promise to pay money. The use of words of negotiability in such contracts would be an aberration. Absence of the words precludes any argument that such contracts might be negotiable instruments. An order or promise that is excluded from Article 3 because of the requirements of Section 3-104(a) may nevertheless be similar to a negotiable instrument in many respects. 332

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Although such a writing cannot be made a negotiable instrument within Article 3 by contract or conduct of its parties, nothing in Section 3-104 or in Section 3-102 is intended to mean that in a particular case involving such a writing a court could not arrive at a result similar to the result that would follow if the writing were a negotiable instrument. For example, a court might nd that the obligor with respect to a promise that does not fall within Section 3-104(a) is precluded from asserting a defense against a bona de purchaser. The preclusion could be based on estoppel or ordinary principles of contract. It does not depend upon the law of negotiable instruments. An example is stated in the paragraph following Case # 2 in Comment 4 to Section 3-302. Moreover, consistent with the principle stated in Section 1-102(2)(b), the immediate parties to an order or promise that is not an instrument may provide by agreement that one or more of the provisions of Article 3 determine their rights and obligations under the writing. Upholding the parties' choice is not inconsistent with Article 3. Such an agreement may bind a transferee of the writing if the transferee has notice of it or the agreement arises from usage of trade and the agreement does not violate other law or public policy. An example of such an agreement is a provision that a transferee of the writing has the rights of a holder in due course stated in Article 3 if the transferee took rights under the writing in good faith, for value, and without notice of a claim or defense. Even without an agreement of the parties to an order or promise that is not an instrument, it may be appropriate, consistent with the principles stated in Section 1-102(2), for a court to apply one or more provisions of Article 3 to the writing by analogy, taking into account the expectations of the parties and the dierences between the writing and an instrument governed by Article 3. Whether such application is appropriate depends upon the facts of each case. 3. Subsection (d) allows exclusion from Article 3 of a writing that would otherwise be an instrument under subsection (a) by a statement to the eect that the writing is not negotiable or is not governed by Article 3. For example, a promissory note can be stamped with the legend NOT NEGOTIABLE. The eect under subsection (d) is not only to negate the possibility of a holder in due course, but to prevent the writing from being a negotiable instrument for any purpose. Subsection (d) does not, however, apply to a check. If a writing is excluded from Article 3 by subsection (d), a court could, nevertheless, apply Article 3 principles to it by analogy as stated in Comment 2. 4. Instruments are divided into two general categories: drafts and notes. A draft is an instrument that is an order. A note is an instrument that is a promise. Section 3-104(e). The term bill of exchange is not used in Article 3. It is generally understood to be a synonym for the term draft. Subsections (f) through (j) dene particular instruments that fall within the categories of draft and note. The term draft, dened in subsection (e), includes a check which is dened in subsection (f). Check includes a share draft drawn on a credit union payable through a bank because the denition of bank (Section 4-105) includes credit unions. However, a draft drawn on an insurance company payable through a bank is not a check because it is not drawn on a bank. Money orders are sold both by banks and non-banks. They vary in form and their form determines how they are treated in Article 3. The most common form of money order sold by banks is that of an ordinary check drawn by the purchaser except that the amount is machine impressed. That kind of money order is a check under Article 3 and is subject to a stop order by the purchaser-drawer as in the case of ordinary checks. The seller bank is the drawee and has no obligation to a holder to pay the money order. If a money order falls within the denition of a teller's check, the rules applicable to teller's checks apply. Postal money orders are subject to federal law. Teller's check is separately dened in subsection (h). A teller's check is always drawn by a bank and is usually drawn on another bank. In some cases a teller's check is drawn on a nonbank but is made payable at or through a bank. Article 3 treats both types of teller's check identically, and both are included in the denition of check. A cashier's check, dened in subsection (g), is also included in the denition of check. Traveler's checks are issued both by banks and nonbanks and may be in the form of a note or draft. Subsection (i) states the essential characteristics of a traveler's check. The requirement that the instrument be drawn on or payable at or through a bank may be satised without words on the instrument that identify a bank as drawee or paying agent so long as the instrument bears an appropriate routing number that identies a bank as paying agent. The denitions in Regulation CC 229.2 of the terms check, cashier's check, teller's check, and traveler's check are dierent from the denitions of those terms in Article 3. 333

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Certicates of deposit are treated in former Article 3 as a separate type of instrument. In revised Article 3, Section 3-104(j) treats them as notes. 5. There are some dierences between the requirements of Article 3 and the requirements included in Article 3 of the Convention on International Bills of Exchange and International Promissory Notes. Most obviously, the Convention does not include the limitation on extraneous undertakings set forth in Section 3-104(a)(3), and does not permit documents payable to bearer that would be permissible under Section 3-104(a)(1) and Section 3-109. See Convention Article 3. In most respects, however, the requirements of Section 3-104 and Article 3 of the Convention are quite similar. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002.

3-105. Issue of Instrument. (a) Issue means the rst delivery of an instrument by the maker or drawer, whether to a holder or nonholder, for the purpose of giving rights on the instrument to any person. (b) An unissued instrument, or an unissued incomplete instrument that is completed, is binding on the maker or drawer, but nonissuance is a defense. An instrument that is conditionally issued or is issued for a special purpose is binding on the maker or drawer, but failure of the condition or special purpose to be fullled is a defense. (c) Issuer applies to issued and unissued instruments and means a maker or drawer of an instrument. Ocial Comment
1. Under former Section 3-102(1)(a) issue was dened as the rst delivery to a holder or a remitter but the term remitter was neither dened nor otherwise used. In revised Article 3, Section 3-105(a) denes issue more broadly to include the rst delivery to anyone by the drawer or maker for the purpose of giving rights to anyone on the instrument. Delivery with respect to instruments is dened in Section 1-201(14) as meaning voluntary transfer of possession. 2. Subsection (b) continues the rule that nonissuance, conditional issuance or issuance for a special purpose is a defense of the maker or drawer of an instrument. Thus, the defense can be asserted against a person other than a holder in due course. The same rule applies to nonissuance of an incomplete instrument later completed. 3. Subsection (c) denes issuer to include the signer of an unissued instrument for convenience of reference in the statute.

3-106. Unconditional Promise or Order. (a) Except as provided in this section, for the purposes of Section 3-104(a), a promise or order is unconditional unless it states (i) an express condition to payment, (ii) that the promise or order is subject to or governed by another record, or (iii) that rights or obligations with respect to the promise or order are stated in another record. A reference to another record does not of itself make the promise or order conditional. (b) A promise or order is not made conditional (i) by a reference to another record for a statement of rights with respect to collateral, prepayment, or acceleration, or (ii) because payment is limited to resort to a particular fund or source. (c) If a promise or order requires, as a condition to payment, a countersignature by a person whose specimen signature appears on the promise or order, the condition does not make the promise or order conditional for the purposes of Section 3-104(a). If the person whose specimen signature appears on an instrument fails to countersign the instru334

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ment, the failure to countersign is a defense to the obligation of the issuer, but the failure does not prevent a transferee of the instrument from becoming a holder of the instrument. (d) If a promise or order at the time it is issued or rst comes into possession of a holder contains a statement, required by applicable statutory or administrative law, to the eect that the rights of a holder or transferee are subject to claims or defenses that the issuer could assert against the original payee, the promise or order is not thereby made conditional for the purposes of Section 3-104(a); but if the promise or order is an instrument, there cannot be a holder in due course of the instrument. As amended in 2002.
See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
1. This provision replaces former Section 3-105. Its purpose is to dene when a promise or order fullls the requirement in Section 3-104(a) that it be an unconditional promise or order to pay. Under Section 3-106(a) a promise or order is deemed to be unconditional unless one of the two tests of the subsection make the promise or order conditional. If the promise or order states an express condition to payment, the promise or order is not an instrument. For example, a promise states, I promise to pay $100,000 to the order of John Doe if he conveys title to Blackacre to me. The promise is not an instrument because there is an express condition to payment. However, suppose a promise states, In consideration of John Doe's promise to convey title to Blackacre I promise to pay $100,000 to the order of John Doe. That promise can be an instrument if Section 3-104 is otherwise satised. Although the recital of the executory promise of Doe to convey Blackacre might be read as an implied condition that the promise be performed, the condition is not an express condition as required by Section 3-106(a)(i). This result is consistent with former Section 3-105(1)(a) and (b). Former Section 3-105(1)(b) is not repeated in Section 3-106 because it is not necessary. It is an example of an implied condition. Former Section 3-105(1)(d), (e), and (f) and the rst clause of former Section 3-105(1)(c) are other examples of implied conditions. They are not repeated in Section 3-106 because they are not necessary. The law is not changed. Section 3-106(a)(ii) and (iii) carry forward the substance of former Section 3-105(2)(a). The only change is the use of writing instead of agreement and a broadening of the language that can result in conditionality. For example, a promissory note is not an instrument dened by Section 3-104 if it contains any of the following statements: 1. This note is subject to a contract of sale dated April 1, 1990 between the payee and maker of this note. 2. This note is subject to a loan and security agreement dated April 1, 1990 between the payee and maker of this note. 3. Rights and obligations of the parties with respect to this note are stated in an agreement dated April 1, 1990 between the payee and maker of this note. It is not relevant whether any condition to payment is or is not stated in the writing to which reference is made. The rationale is that the holder of a negotiable instrument should not be required to examine another document to determine rights with respect to payment. But subsection (b)(i) permits reference to a separate writing for information with respect to collateral, prepayment, or acceleration. Many notes issued in commercial transactions are secured by collateral, are subject to acceleration in the event of default, or are subject to prepayment. A statement of rights and obligations concerning collateral, prepayment, or acceleration does not prevent the note from being an instrument if the statement is in the note itself. See Section 3-104(a)(3) and Section 3-108(b). In some cases it may be convenient not to include a statement concerning collateral, prepayment, or acceleration in the note, but rather to refer to an accompanying loan agreement, security agreement or mortgage for that statement. Subsection (b)(i) allows a reference to the appropriate writing for a statement of these rights. For example, a note would not be made conditional by the following statement: This note is secured by a security interest in collateral described in a security agreement dated April 1, 1990 between the payee and maker of this note. Rights and obligations with respect to the collateral are [stated in] [governed by] the security agreement. The bracketed words are alterna335

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tives, either of which complies. Subsection (b)(ii) addresses the issues covered by former Section 3-105(1)(f), (g), and (h) and Section 3-105(2)(b). Under Section 3-106(a) a promise or order is not made conditional because payment is limited to payment from a particular source or fund. This reverses the result of former Section 3-105(2)(b). There is no cogent reason why the general credit of a legal entity must be pledged to have a negotiable instrument. Market forces determine the marketability of instruments of this kind. If potential buyers don't want promises or orders that are payable only from a particular source or fund, they won't take them, but Article 3 should apply. 2. Subsection (c) applies to traveler's checks or other instruments that may require a countersignature. Although the requirement of a countersignature is a condition to the obligation to pay, traveler's checks are treated in the commercial world as money substitutes and therefore should be governed by Article 3. The rst sentence of subsection (c) allows a traveler's check to meet the denition of instrument by stating that the countersignature condition does not make it conditional for the purposes of Section 3-104. The second sentence states the eect of a failure to meet the condition. Suppose a thief steals a traveler's check and cashes it by skillfully imitating the specimen signature so that the countersignature appears to be authentic. The countersignature is for the purpose of identication of the owner of the instrument. It is not an indorsement. Subsection (c) provides that the failure of the owner to countersign does not prevent a transferee from becoming a holder. Thus, the merchant or bank that cashed the traveler's check becomes a holder when the traveler's check is taken. The forged countersignature is a defense to the obligation of the issuer to pay the instrument, and is included in defenses under Section 3-305(a)(2). These defenses may not be asserted against a holder in due course. Whether a holder has notice of the defense is a factual question. If the countersignature is a very bad forgery, there may be notice. But if the merchant or bank cashed a traveler's check and the countersignature appeared to be similar to the specimen signature, there might not be notice that the countersignature was forged. Thus, the merchant or bank could be a holder in due course. 3. Subsection (d) concerns the eect of a statement to the eect that the rights of a holder or transferee are subject to claims and defenses that the issuer could assert against the original payee. The subsection applies only if the statement is required by statutory or administrative law. The prime example is the Federal Trade Commission Rule (16 C.F.R. Part 433) preserving consumers' claims and defenses in consumer credit sales. The intent of the FTC rule is to make it impossible for there to be a holder in due course of a note bearing the FTC legend and undoubtedly that is the result. But, under former Article 3, the legend may also have had the unintended eect of making the note conditional, thus excluding the note from former Article 3 altogether. Subsection (d) is designed to make it possible to preclude the possibility of a holder in due course without excluding the instrument from Article 3. Most of the provisions of Article 3 are not aected by the holder-indue-course doctrine and there is no reason why Article 3 should not apply to a note bearing the FTC legend if holder-in-due-course rights are not involved. Under subsection (d) the statement does not make the note conditional. If the note otherwise meets the requirements of Section 3-104(a) it is a negotiable instrument for all purposes except that there cannot be a holder in due course of the note. No particular form of legend or statement is required by subsection (d). The form of a particular legend or statement may be determined by the other statute or administrative law. For example, the FTC legend required in a note taken by the seller in a consumer sale of goods or services is tailored to that particular transaction and therefore uses language that is somewhat dierent from that stated in subsection (d), but the dierence in expression does not aect the essential similarity of the message conveyed. The eect of the FTC legend is to make the rights of a holder or transferee subject to claims or defenses that the issuer could assert against the original payee of the note.

3-107. Instrument Payable in Foreign Money. Unless the instrument otherwise provides, an instrument that states the amount payable in foreign money may be paid in the foreign money or in an equivalent amount in dollars calculated by using the current bankoered spot rate at the place of payment for the purchase of dollars on the day on which the instrument is paid.
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Ocial Comment
The denition of instrument in Section 3-104 requires that the promise or order be payable in money. That term is dened in Section 1-201(24) and is not limited to United States dollars. Section 3-107 states than an instrument payable in foreign money may be paid in dollars if the instrument does not prohibit it. It also states a conversion rate which applies in the absence of a dierent conversion rate stated in the instrument. The reference in former Section 3-107(1) to instruments payable in currency or current funds has been dropped as superuous.

3-108. Payable on Demand or at Denite Time. (a) A promise or order is payable on demand if it (i) states that it is payable on demand or at sight, or otherwise indicates that it is payable at the will of the holder, or (ii) does not state any time of payment. (b) A promise or order is payable at a denite time if it is payable on elapse of a denite period of time after sight or acceptance or at a xed date or dates or at a time or times readily ascertainable at the time the promise or order is issued, subject to rights of (i) prepayment, (ii) acceleration, (iii) extension at the option of the holder, or (iv) extension to a further denite time at the option of the maker or acceptor or automatically upon or after a specied act or event. (c) If an instrument, payable at a xed date, is also payable upon demand made before the xed date, the instrument is payable on demand until the xed date and, if demand for payment is not made before that date, becomes payable at a denite time on the xed date. Ocial Comment
This section is a restatement of former Section 3-108 and Section 3-109. Subsection (b) broadens former Section 3-109 somewhat by providing that a denite time includes a time readily ascertainable at the time the promise or order is issued. Subsection (b)(iii) and (iv) restates former Section 3-109(1)(d). It adopts the generally accepted rule that a clause providing for extension at the option of the holder, even without a time limit, does not affect negotiability since the holder is given only a right which the holder would have without the clause. If the extension is to be at the option of the maker or acceptor or is to be automatic, a denite time limit must be stated or the time of payment remains uncertain and the order or promise is not a negotiable instrument. If a denite time limit is stated, the eect upon certainty of time of payment is the same as if the instrument were made payable at the ultimate date with a term providing for acceleration.

3-109. Payable to Bearer or to Order. (a) A promise or order is payable to bearer if it: (1) states that it is payable to bearer or to the order of bearer or otherwise indicates that the person in possession of the promise or order is entitled to payment; (2) does not state a payee; or (3) states that it is payable to or to the order of cash or otherwise indicates that it is not payable to an identied person. (b) A promise or order that is not payable to bearer is payable to order if it is payable (i) to the order of an identied person or (ii) to an identied person or order. A promise or order that is payable to order is payable to the identied person. (c) An instrument payable to bearer may become payable to an identied person if it is specially indorsed pursuant to Section 3-205(a). An instru337

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ment payable to an identied person may become payable to bearer if it is indorsed in blank pursuant to Section 3-205(b). Ocial Comment
1. Under Section 3-104(a), a promise or order cannot be an instrument unless the instrument is payable to bearer or to order when it is issued or unless Section 3-104(c) applies. The terms payable to bearer and payable to order are dened in Section 3-109. The quoted terms are also relevant in determining how an instrument is negotiated. If the instrument is payable to bearer it can be negotiated by delivery alone. Section 3-201(b). An instrument that is payable to an identied person cannot be negotiated without the indorsement of the identied person. Section 3-201(b). An instrument payable to order is payable to an identied person. Section 3-109(b). Thus, an instrument payable to order requires the indorsement of the person to whose order the instrument is payable. 2. Subsection (a) states when an instrument is payable to bearer. An instrument is payable to bearer if it states that it is payable to bearer, but some instruments use ambiguous terms. For example, check forms usually have the words to the order of printed at the beginning of the line to be lled in for the name of the payee. If the drawer writes in the word bearer or cash, the check reads to the order of bearer or to the order of cash. In each case the check is payable to bearer. Sometimes the drawer will write the name of the payee John Doe but will add the words or bearer. In that case the check is payable to bearer. Subsection (a). Under subsection (b), if an instrument is payable to bearer it can't be payable to order. This is dierent from former Section 3-110(3). An instrument that purports to be payable both to order and bearer states contradictory terms. A transferee of the instrument should be able to rely on the bearer term and acquire rights as a holder without obtaining the indorsement of the identied payee. An instrument is also payable to bearer if it does not state a payee. Instruments that do not state a payee are in most cases incomplete instruments. In some cases the drawer of a check may deliver or mail it to the person to be paid without lling in the line for the name of the payee. Under subsection (a) the check is payable to bearer when it is sent or delivered. It is also an incomplete instrument. This case is discussed in Comment 2 to Section 3-115. Subsection (a)(3) contains the words otherwise indicates that it is not payable to an identied person. The quoted words are meant to cover uncommon cases in which an instrument indicates that it is not meant to be payable to a specic person. Such an instrument is treated like a check payable to cash. The quoted words are not meant to apply to an instrument stating that it is payable to an identied person such as ABC Corporation if ABC Corporation is a nonexistent company. Although the holder of the check cannot be the nonexistent company, the instrument is not payable to bearer. Negotiation of such an instrument is governed by Section 3-404(b).

3-110. Identication of Person to Whom Instrument Is Payable. (a) The person to whom an instrument is initially payable is determined by the intent of the person, whether or not authorized, signing as, or in the name or behalf of, the issuer of the instrument. The instrument is payable to the person intended by the signer even if that person is identied in the instrument by a name or other identication that is not that of the intended person. If more than one person signs in the name or behalf of the issuer of an instrument and all the signers do not intend the same person as payee, the instrument is payable to any person intended by one or more of the signers. (b) If the signature of the issuer of an instrument is made by automated means, such as a check-writing machine, the payee of the instrument is determined by the intent of the person who supplied the name or identication of the payee, whether or not authorized to do so. (c) A person to whom an instrument is payable may be identied in any way, including by name, identifying number, oce, or account number. For the purpose of determining the holder of an instrument, the following rules apply:
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(1) If an instrument is payable to an account and the account is identied only by number, the instrument is payable to the person to whom the account is payable. If an instrument is payable to an account identied by number and by the name of a person, the instrument is payable to the named person, whether or not that person is the owner of the account identied by number. (2) If an instrument is payable to: (i) a trust, an estate, or a person described as trustee or representative of a trust or estate, the instrument is payable to the trustee, the representative, or a successor of either, whether or not the beneciary or estate is also named; (ii) a person described as agent or similar representative of a named or identied person, the instrument is payable to the represented person, the representative, or a successor of the representative; (iii) a fund or organization that is not a legal entity, the instrument is payable to a representative of the members of the fund or organization; or (iv) n oce or to a person described as holding an oce, the instrument is payable to the named person, the incumbent of the oce, or a successor to the incumbent. (d) If an instrument is payable to two or more persons alternatively, it is payable to any of them and may be negotiated, discharged, or enforced by any or all of them in possession of the instrument. If an instrument is payable to two or more persons not alternatively, it is payable to all of them and may be negotiated, discharged, or enforced only by all of them. If an instrument payable to two or more persons is ambiguous as to whether it is payable to the persons alternatively, the instrument is payable to the persons alternatively. Ocial Comment
1. Section 3-110 states rules for determining the identity of the person to whom an instrument is initially payable if the instrument is payable to an identied person. This issue usually arises in a dispute over the validity of an indorsement in the name of the payee. Subsection (a) states the general rule that the person to whom an instrument is payable is determined by the intent of the person, whether or not authorized, signing as, or in the name or behalf of, the issuer of the instrument. Issuer means the maker or drawer of the instrument. Section 3-105(c). If X signs a check as drawer of a check on X's account, the intent of X controls. If X, as President of Corporation, signs a check as President in behalf of Corporation as drawer, the intent of X controls. If X forges Y's signature as drawer of a check, the intent of X also controls. Under Section 3-103(a)(5), Y is referred to as the drawer of the check because the signing of Y's name identies Y as the drawer. But since Y's signature was forged Y has no liability as drawer (Section 3-403(a)) unless some other provision of Article 3 or Article 4 makes Y liable. Since X, even though unauthorized, signed in the name of Y as issuer, the intent of X determines to whom the check is payable. In the case of a check payable to John Smith, since there are many people in the world named John Smith it is not possible to identify the payee of the check unless there is some further identication or the intention of the drawer is determined. Name alone is sufcient under subsection (a), but the intention of the drawer determines which John Smith is the person to whom the check is payable. The same issue is presented in cases of misdescriptions of the payee. The drawer intends to pay a person known to the drawer as John Smith. In fact that person's name is James Smith or John Jones or some other entirely dierent name. If the check identies the payee as John Smith, it is nevertheless payable to the person intended by the drawer. That person may indorse the check in either the name John Smith or the person's correct name or in both names. Section 3-204(d). The 339

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intent of the drawer is also controlling in ctitious payee cases. Section 3-404(b). The last sentence of subsection (a) refers to rare cases in which the signature of an organization requires more than one signature and the persons signing on behalf of the organization do not all intend the same person as payee. Any person intended by a signer for the organization is the payee and an indorsement by that person is an eective indorsement. Subsection (b) recognizes the fact that in a large number of cases there is no human signer of an instrument because the instrument, usually a check, is produced by automated means such as a check-writing machine. In that case, the relevant intent is that of the person who supplied the name of the payee. In most cases that person is an employee of the drawer, but in some cases the person could be an outsider who is committing a fraud by introducing names of payees of checks into the system that produces the checks. A checkwriting machine is likely to be operated by means of a computer in which is stored information as to name and address of the payee and the amount of the check. Access to the computer may allow production of fraudulent checks without knowledge of the organization that is the issuer of the check. Section 3-404(b) is also concerned with this issue. See Case # 4 in Comment 2 to Section 3-404. 2. Subsection (c) allows the payee to be identied in any way including the various ways stated. Subsection (c)(1) relates to instruments payable to bank accounts. In some cases the account might be identied by name and number, and the name and number might refer to dierent persons. For example, a check is payable to X Corporation Account No. 12345 in Bank of Podunk. Under the last sentence of subsection (c)(1), this check is payable to X Corporation and can be negotiated by X Corporation even if Account No. 12345 is some other person's account or the check is not deposited in that account. In other cases the payee is identied by an account number and the name of the owner of the account is not stated. For example, Debtor pays Creditor by issuing a check drawn on Payor Bank. The check is payable to a bank account owned by Creditor but identied only by number. Under the rst sentence of subsection (c)(1) the check is payable to Creditor and, under Section 1-201(20), Creditor becomes the holder when the check is delivered. Under Section 3-201(b), further negotiation of the check requires the indorsement of Creditor. But under Section 4-205(a), if the check is taken by a depositary bank for collection, the bank may become a holder without the indorsement. Under Section 3-102(b), provisions of Article 4 prevail over those of Article 3. The depositary bank warrants that the amount of the check was credited to the payee's account. 3. Subsection (c)(2) replaces former Section 3-117 and subsection (1)(e), (f), and (g) of former Section 3-110. This provision merely determines who can deal with an instrument as a holder. It does not determine ownership of the instrument or its proceeds. Subsection (c)(2)(i) covers trusts and estates. If the instrument is payable to the trust or estate or to the trustee or representative of the trust or estate, the instrument is payable to the trustee or representative or any successor. Under subsection (c)(2)(ii), if the instrument states that it is payable to Doe, President of X Corporation, either Doe or X Corporation can be holder of the instrument. Subsection (c)(2)(iii) concerns informal organizations that are not legal entities such as unincorporated clubs and the like. Any representative of the members of the organization can act as holder. Subsection (c)(2)(iv) applies principally to instruments payable to public oces such as a check payable to County Tax Collector. 4. Subsection (d) replaces former Section 3-116. An instrument payable to X or Y is governed by the rst sentence of subsection (d). An instrument payable to X and Y is governed by the second sentence of subsection (d). If an instrument is payable to X or Y, either is the payee and if either is in possession that person is the holder and the person entitled to enforce the instrument. Section 3-301. If an instrument is payable to X and Y, neither X nor Y acting alone is the person to whom the instrument is payable. Neither person, acting alone, can be the holder of the instrument. The instrument is payable to an identied person. The identied person is X and Y acting jointly. Section 3-109(b) and Section 1-102(5)(a). Thus, under Section 1-201(20) X or Y, acting alone, cannot be the holder or the person entitled to enforce or negotiate the instrument because neither, acting alone, is the identied person stated in the instrument. The third sentence of subsection (d) is directed to cases in which it is not clear whether an instrument is payable to multiple payees alternatively. In the case of ambiguity persons dealing with the instrument should be able to rely on the indorsement of a single payee. For example, an instrument payable to X and/or Y is treated like an instrument payable to X or Y. 340

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3-111. Place of Payment. Except as otherwise provided for items in Article 4, an instrument is payable at the place of payment stated in the instrument. If no place of payment is stated, an instrument is payable at the address of the drawee or maker stated in the instrument. If no address is stated, the place of payment is the place of business of the drawee or maker. If a drawee or maker has more than one place of business, the place of payment is any place of business of the drawee or maker chosen by the person entitled to enforce the instrument. If the drawee or maker has no place of business, the place of payment is the residence of the drawee or maker. Ocial Comment
If an instrument is payable at a bank in the United States, Section 3-501(b)(1) states that presentment must be made at the place of payment, i.e. the bank. The place of presentment of a check is governed by Regulation CC 229.36.

3-112. Interest. (a) Unless otherwise provided in the instrument, (i) an instrument is not payable with interest, and (ii) interest on an interest-bearing instrument is payable from the date of the instrument. (b) Interest may be stated in an instrument as a xed or variable amount of money or it may be expressed as a xed or variable rate or rates. The amount or rate of interest may be stated or described in the instrument in any manner and may require reference to information not contained in the instrument. If an instrument provides for interest, but the amount of interest payable cannot be ascertained from the description, interest is payable at the judgment rate in eect at the place of payment of the instrument and at the time interest rst accrues. Ocial Comment
1. Under Section 3-104(a) the requirement of a xed amount applies only to principal. The amount of interest payable is that described in the instrument. If the description of interest in the instrument does not allow for the amount of interest to be ascertained, interest is payable at the judgment rate. Hence, if an instrument calls for interest, the amount of interest will always be determinable. If a variable rate of interest is prescribed, the amount of interest is ascertainable by reference to the formula or index described or referred to in the instrument. The last sentence of subsection (b) replaces subsection (d) of former Section 3-118. 2. The purpose of subsection (b) is to clarify the meaning of interest in the introductory clause of Section 3-104(a). It is not intended to validate a provision for interest in an instrument if that provision violates other law.

3-113. Date of Instrument. (a) An instrument may be antedated or postdated. The date stated determines the time of payment if the instrument is payable at a xed period after date. Except as provided in Section 4-401(c), an instrument payable on demand is not payable before the date of the instrument. (b) If an instrument is undated, its date is the date of its issue or, in the case of an unissued instrument, the date it rst comes into possession of a holder. Ocial Comment
This section replaces former Section 3-114. Subsections (1) and (3) of former Section 3-114 are deleted as unnecessary. Section 3-113(a) is based in part on subsection (2) of for341

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mer Section 3-114. The rule that a demand instrument is not payable before the date of the instrument is subject to Section 4-401(c) which allows the payor bank to pay a postdated check unless the drawer has notied the bank of the postdating pursuant to a procedure prescribed in that subsection. With respect to an undated instrument, the date is the date of issue.

3-114. Contradictory Terms of Instrument. If an instrument contains contradictory terms, typewritten terms prevail over printed terms, handwritten terms prevail over both, and words prevail over numbers. Ocial Comment
Section 3-114 replaces subsections (b) and (c) of former Section 3-118.

3-115. Incomplete Instrument. (a) Incomplete instrument means a signed writing, whether or not issued by the signer, the contents of which show at the time of signing that it is incomplete but that the signer intended it to be completed by the addition of words or numbers. (b) Subject to subsection (c), if an incomplete instrument is an instrument under Section 3-104, it may be enforced according to its terms if it is not completed, or according to its terms as augmented by completion. If an incomplete instrument is not an instrument under Section 3-104, but, after completion, the requirements of Section 3-104 are met, the instrument may be enforced according to its terms as augmented by completion. (c) If words or numbers are added to an incomplete instrument without authority of the signer, there is an alteration of the incomplete instrument under Section 3-407. (d) The burden of establishing that words or numbers were added to an incomplete instrument without authority of the signer is on the person asserting the lack of authority. Ocial Comment
1. This section generally carries forward the rules set out in former Section 3-115. The term incomplete instrument applies both to an instrument, i.e. a writing meeting all the requirements of Section 3-104, and to a writing intended to be an instrument that is signed but lacks some element of an instrument. The test in both cases is whether the contents show that it is incomplete and that the signer intended that additional words or numbers be added. 2. If an incomplete instrument meets the requirements of Section 3-104 and is not completed it may be enforced in accordance with its terms. Suppose, in the following two cases, that a note delivered to the payee is incomplete solely because a space on the preprinted note form for the due date is not lled in: Case # 1. If the incomplete instrument is never completed, the note is payable on demand. Section 3-108(a)(ii). However, if the payee and the maker agreed to a due date, the maker may have a defense under Section 3-117 if demand for payment is made before the due date agreed to by the parties. Case # 2. If the payee completes the note by lling in the due date agreed to by the parties, the note is payable on the due date stated. However, if the due date lled in was not the date agreed to by the parties there is an alteration of the note. Section 3-407 governs the case. Suppose Debtor pays Creditor by giving Creditor a check on which the space for the name of the payee is left blank. The check is an instrument but it is incomplete. The check is enforceable in its incomplete form and it is payable to bearer because it does not state a payee. Section 3-109(a)(2). Thus, Creditor is a holder of the check. Normally in this kind of 342

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case Creditor would simply ll in the space with Creditor's name. When that occurs the check becomes payable to the Creditor. 3. In some cases the incomplete instrument does not meet the requirements of Section 3-104. An example is a check with the amount not lled in. The check cannot be enforced until the amount is lled in. If the payee lls in an amount authorized by the drawer the check meets the requirements of Section 3-104 and is enforceable as completed. If the payee lls in an unauthorized amount there is an alteration of the check and Section 3-407 applies. 4. Section 3-302(a)(1) also bears on the problem of incomplete instruments. Under that section a person cannot be a holder in due course of the instrument if it is so incomplete as to call into question its validity. Subsection (d) of Section 3-115 is based on the last clause of subsection (2) of former Section 3-115.

3-116. Joint and Several Liability; Contribution. (a) Except as otherwise provided in the instrument, two or more persons who have the same liability on an instrument as makers, drawers, acceptors, indorsers who indorse as joint payees, or anomalous indorsers are jointly and severally liable in the capacity in which they sign. (b) Except as provided in Section 3-419(f) or by agreement of the aected parties, a party having joint and several liability who pays the instrument is entitled to receive from any party having the same joint and several liability contribution in accordance with applicable law. As amended in 2002.
See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
1. Subsection (a) replaces subsection (e) of former Section 3-118. Subsection (b) states contribution rights of parties with joint and several liability by referring to applicable law. But subsection (b) is subject to Section 3-419(f). If one of the parties with joint and several liability is an accommodation party and the other is the accommodated party, Section 3-419(f) applies. Because one of the joint and several obligors may have recourse against the other joint and several obligor under subsection (b), each party that is jointly and severally liable under subsection (a) is a secondary obligor in part and a principal obligor in part, as those terms are dened in Section 3-103(a). Accordingly, Section 3-605 determines the eect of a release, an extension of time, or a modication of the obligation of one of the joint and several obligors, as well as the eect of an impairment of collateral provided by one of those obligors. 2. Indorsers normally do not have joint and several liability. Rather, an earlier indorser has liability to a later indorser. But indorsers can have joint and several liability in two cases. If an instrument is payable to two payees jointly, both payees must indorse. The indorsement is a joint indorsement and the indorsers have joint and several liability and subsection (b) applies. The other case is that of two or more anomalous indorsers. The term is dened in Section 3-205(d). An anomalous indorsement normally indicates that the indorser signed as an accommodation party. If more than one accommodation party indorses a note as an accommodation to the maker, the indorsers have joint and several liability and subsection (b) applies.

As amended in 2002.
See Appendix Q for material relating to changes in Ocial Comment in 2002.

3-117. Other Agreements Aecting Instrument. Subject to applicable law regarding exclusion of proof of contemporaneous or previous agreements, the obligation of a party to an instrument to pay the instrument may be modied, supplemented, or nullied by a separate agreement of the obligor and a person entitled to enforce the instru343

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ment, if the instrument is issued or the obligation is incurred in reliance on the agreement or as part of the same transaction giving rise to the agreement. To the extent an obligation is modied, supplemented, or nullied by an agreement under this section, the agreement is a defense to the obligation. Ocial Comment
1. The separate agreement might be a security agreement or mortgage or it might be an agreement that contradicts the terms of the instrument. For example, a person may be induced to sign an instrument under an agreement that the signer will not be liable on the instrument unless certain conditions are met. Suppose X requested credit from Creditor who is willing to give the credit only if an acceptable accommodation party will sign the note of X as co-maker. Y agrees to sign as co-maker on the condition that Creditor also obtain the signature of Z as co-maker. Creditor agrees and Y signs as co-maker with X. Creditor fails to obtain the signature of Z on the note. Under Sections 3-412 and 3-419(b), Y is obliged to pay the note, but Section 3-117 applies. In this case, the agreement modies the terms of the note by stating a condition to the obligation of Y to pay the note. This case is essentially similar to a case in which a maker of a note is induced to sign the note by fraud of the holder. Although the agreement that Y not be liable on the note unless Z also signs may not have been fraudulently made, a subsequent attempt by Creditor to require Y to pay the note in violation of the agreement is a bad faith act. Section 3-117, in treating the agreement as a defense, allows Y to assert the agreement against Creditor, but the defense would not be good against a subsequent holder in due course of the note that took it without notice of the agreement. If there cannot be a holder in due course because of Section 3-106(d), a subsequent holder that took the note in good faith, for value and without knowledge of the agreement would not be able to enforce the liability of Y. This result is consistent with the risk that a holder not in due course takes with respect to fraud in inducing issuance of an instrument. 2. The eect of merger or integration clauses to the eect that a writing is intended to be the complete and exclusive statement of the terms of the agreement or that the agreement is not subject to conditions is left to the supplementary law of the jurisdiction pursuant to Section 1-103. Thus, in the case discussed in Comment 1, whether Y is permitted to prove the condition to Y's obligation to pay the note is determined by that law. Moreover, nothing in this section is intended to validate an agreement which is fraudulent or void as against public policy, as in the case of a note given to deceive a bank examiner.

3-118. Statute of Limitations. (a) Except as provided in subsection (e), an action to enforce the obligation of a party to pay a note payable at a denite time must be commenced within six years after the due date or dates stated in the note or, if a due date is accelerated, within six years after the accelerated due date. (b) Except as provided in subsection (d) or (e), if demand for payment is made to the maker of a note payable on demand, an action to enforce the obligation of a party to pay the note must be commenced within six years after the demand. If no demand for payment is made to the maker, an action to enforce the note is barred if neither principal nor interest on the note has been paid for a continuous period of 10 years. (c) Except as provided in subsection (d), an action to enforce the obligation of a party to an unaccepted draft to pay the draft must be commenced within three years after dishonor of the draft or 10 years after the date of the draft, whichever period expires rst. (d) An action to enforce the obligation of the acceptor of a certied check or the issuer of a teller's check, cashier's check, or traveler's check must be commenced within three years after demand for payment is made to the acceptor or issuer, as the case may be.
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(e) An action to enforce the obligation of a party to a certicate of deposit to pay the instrument must be commenced within six years after demand for payment is made to the maker, but if the instrument states a due date and the maker is not required to pay before that date, the six-year period begins when a demand for payment is in eect and the due date has passed. (f) An action to enforce the obligation of a party to pay an accepted draft, other than a certied check, must be commenced (i) within six years after the due date or dates stated in the draft or acceptance if the obligation of the acceptor is payable at a denite time, or (ii) within six years after the date of the acceptance if the obligation of the acceptor is payable on demand. (g) Unless governed by other law regarding claims for indemnity or contribution, an action (i) for conversion of an instrument, for money had and received, or like action based on conversion, (ii) for breach of warranty, or (iii) to enforce an obligation, duty, or right arising under this Article and not governed by this section must be commenced within three years after the [cause of action] accrues. Ocial Comment
1. Section 3-118 diers from former Section 3-122, which states when a cause of action accrues on an instrument. Section 3-118 does not dene when a cause of action accrues. Accrual of a cause of action is stated in other sections of Article 3 such as those that state the various obligations of parties to an instrument. The only purpose of Section 3-118 is to dene the time within which an action to enforce an obligation, duty, or right arising under Article 3 must be commenced. Section 3-118 does not attempt to state all rules with respect to a statute of limitations. For example, the circumstances under which the running of a limitations period may be tolled is left to other law pursuant to Section 1-103. 2. The rst six subsections apply to actions to enforce an obligation of any party to an instrument to pay the instrument. This changes present law in that indorsers who may become liable on an instrument after issue are subject to a period of limitations running from the same date as that of the maker or drawer. Subsections (a) and (b) apply to notes. If the note is payable at a denite time, a six-year limitations period starts at the due date of the note, subject to prior acceleration. If the note is payable on demand, there are two limitations periods. Although a note payable on demand could theoretically be called a day after it was issued, the normal expectation of the parties is that the note will remain outstanding until there is some reason to call it. If the law provides that the limitations period does not start until demand is made, the cause of action to enforce it may never be barred. On the other hand, if the limitations period starts when demand for payment may be made, i.e. at any time after the note was issued, the payee of a note on which interest or portions of principal are being paid could lose the right to enforce the note even though it was treated as a continuing obligation by the parties. Some demand notes are not enforced because the payee has forgiven the debt. This is particularly true in family and other noncommercial transactions. A demand note found after the death of the payee may be presented for payment many years after it was issued. The maker may be a relative and it may be dicult to determine whether the note represents a real or a forgiven debt. Subsection (b) is designed to bar notes that no longer represent a claim to payment and to require reasonably prompt action to enforce notes on which there is default. If a demand for payment is made to the maker, a six-year limitations period starts to run when demand is made. The second sentence of subsection (b) bars an action to enforce a demand note if no demand has been made on the note and no payment of interest or principal has been made for a continuous period of 10 years. This covers the case of a note that does not bear interest or a case in which interest due on the note has not been paid. This kind of case is likely to be a family transaction in which a failure to demand payment may indicate that the holder did not intend to enforce the obligation but neglected to destroy the note. A limitations period that bars stale claims in this kind of case is appropriate if the period is 345

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relatively long. 3. Subsection (c) applies primarily to personal uncertied checks. Checks are payment instruments rather than credit instruments. The limitations period expires three years after the date of dishonor or 10 years after the date of the check, whichever is earlier. Teller's checks, cashier's checks, certied checks, and traveler's checks are treated dierently under subsection (d) because they are commonly treated as cash equivalents. A great delay in presenting a cashier's check for payment in most cases will occur because the check was mislaid during that period. The person to whom traveler's checks are issued may hold them indenitely as a safe form of cash for use in an emergency. There is no compelling reason for barring the claim of the owner of the cashier's check or traveler's check. Under subsection (d) the claim is never barred because the three-year limitations period does not start to run until demand for payment is made. The limitations period in subsection (d) in eect applies only to cases in which there is a dispute about the legitimacy of the claim of the person demanding payment. 4. Subsection (e) covers certicates of deposit. The limitations period of six years doesn't start to run until the depositor demands payment. Most certicates of deposit are payable on demand even if they state a due date. The eect of a demand for payment before maturity is usually that the bank will pay, but that a penalty will be assessed against the depositor in the form of a reduction in the amount of interest that is paid. Subsection (e) also provides for cases in which the bank has no obligation to pay until the due date. In that case the limitations period doesn't start to run until there is a demand for payment in effect and the due date has passed. 5. Subsection (f) applies to accepted drafts other than certied checks. When a draft is accepted it is in eect turned into a note of the acceptor. In almost all cases the acceptor will agree to pay at a denite time. Subsection (f) states that in that case the six-year limitations period starts to run on the due date. In the rare case in which the obligation of the acceptor is payable on demand, the six-year limitations period starts to run at the date of the acceptance. 6. Subsection (g) covers warranty and conversion cases and other actions to enforce obligations or rights arising under Article 3. A three-year period is stated and subsection (g) follows general law in stating that the period runs from the time the cause of action accrues. Since the traditional term cause of action may have been replaced in some states by claim for relief or some equivalent term, the words cause of action have been bracketed to indicate that the words may be replaced by an appropriate substitute to conform to local practice. 7. One of the most signicant dierences between this Article and the Convention on International Bills of Exchange and International Promissory Notes is that the statute of limitation under the Convention generally is only four years, rather than the six years provided by this section. See Convention Article 84. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002.

3-119. Notice of Right to Defend Action. In an action for breach of an obligation for which a third person is answerable over pursuant to this Article or Article 4, the defendant may give the third person notice of the litigation in a record, and the person notied may then give similar notice to any other person who is answerable over. If the notice states (i) that the person notied may come in and defend and (ii) that failure to do so will bind the person notied in an action later brought by the person giving the notice as to any determination of fact common to the two litigations, the person notied is so bound unless after seasonable receipt of the notice the person notied does come in and defend. As amended in 2002.
See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
This section is a restatement of former Section 3-803. 346

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PART 2. NEGOTIATION, TRANSFER, AND INDORSEMENT

3-201. Negotiation. (a) Negotiation means a transfer of possession, whether voluntary or involuntary, of an instrument by a person other than the issuer to a person who thereby becomes its holder. (b) Except for negotiation by a remitter, if an instrument is payable to an identied person, negotiation requires transfer of possession of the instrument and its indorsement by the holder. If an instrument is payable to bearer, it may be negotiated by transfer of possession alone. Ocial Comment
1. Subsections (a) and (b) are based in part on subsection (1) of former Section 3-202. A person can become holder of an instrument when the instrument is issued to that person, or the status of holder can arise as the result of an event that occurs after issuance. Negotiation is the term used in Article 3 to describe this post-issuance event. Normally, negotiation occurs as the result of a voluntary transfer of possession of an instrument by a holder to another person who becomes the holder as a result of the transfer. Negotiation always requires a change in possession of the instrument because nobody can be a holder without possessing the instrument, either directly or through an agent. But in some cases the transfer of possession is involuntary and in some cases the person transferring possession is not a holder. In dening negotiation former Section 3-202(1) used the word transfer, an undened term, and delivery, dened in Section 1-201(14) to mean voluntary change of possession. Instead, subsections (a) and (b) use the term transfer of possession and, subsection (a) states that negotiation can occur by an involuntary transfer of possession. For example, if an instrument is payable to bearer and it is stolen by Thief or is found by Finder, Thief or Finder becomes the holder of the instrument when possession is obtained. In this case there is an involuntary transfer of possession that results in negotiation to Thief or Finder. 2. In most cases negotiation occurs by a transfer of possession by a holder or remitter. Remitter transactions usually involve a cashier's or teller's check. For example, Buyer buys goods from Seller and pays for them with a cashier's check of Bank that Buyer buys from Bank. The check is issued by Bank when it is delivered to Buyer, regardless of whether the check is payable to Buyer or to Seller. Section 3-105(a). If the check is payable to Buyer, negotiation to Seller is done by delivery of the check to Seller after it is indorsed by Buyer. It is more common, however, that the check when issued will be payable to Seller. In that case Buyer is referred to as the remitter. Section 3-103(a)(15). The remitter, although not a party to the check, is the owner of the check until ownership is transferred to Seller by delivery. This transfer is a negotiation because Seller becomes the holder of the check when Seller obtains possession. In some cases Seller may have acted fraudulently in obtaining possession of the check. In those cases Buyer may be entitled to rescind the transfer to Seller because of the fraud and assert a claim of ownership to the check under Section 3-306 against Seller or a subsequent transferee of the check. Section 3-202(b) provides for rescission of negotiation, and that provision applies to rescission by a remitter as well as by a holder. 3. Other sections of Article 3 may modify the rule stated in the rst sentence of subsection (b). See for example, Sections 3-404, 3-405 and 3-406.

3-202. Negotiation Subject to Rescission. (a) Negotiation is eective even if obtained (i) from an infant, a corporation exceeding its powers, or a person without capacity, (ii) by fraud, duress, or mistake, or (iii) in breach of duty or as part of an illegal transaction. (b) To the extent permitted by other law, negotiation may be rescinded or may be subject to other remedies, but those remedies may not be as347

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serted against a subsequent holder in due course or a person paying the instrument in good faith and without knowledge of facts that are a basis for rescission or other remedy. Ocial Comment
1. This section is based on former Section 3-207. Subsection (2) of former Section 3-207 prohibited rescission of a negotiation against holders in due course. Subsection (b) of Section 3-202 extends this protection to payor banks. 2. Subsection (a) applies even though the lack of capacity or the illegality, is of a character which goes to the essence of the transaction and makes it entirely void. It is inherent in the character of negotiable instruments that any person in possession of an instrument which by its terms is payable to that person or to bearer is a holder and may be dealt with by anyone as a holder. The principle nds its most extreme application in the well settled rule that a holder in due course may take the instrument even from a thief and be protected against the claim of the rightful owner. The policy of subsection (a) is that any person to whom an instrument is negotiated is a holder until the instrument has been recovered from that person's possession. The remedy of a person with a claim to an instrument is to recover the instrument by replevin or otherwise; to impound it or to enjoin its enforcement, collection or negotiation; to recover its proceeds from the holder; or to intervene in any action brought by the holder against the obligor. As provided in Section 3-305(c), the claim of the claimant is not a defense to the obligor unless the claimant defends the action. 3. There can be no rescission or other remedy against a holder in due course or a person who pays in good faith and without notice, even though the prior negotiation may have been fraudulent or illegal in its essence and entirely void. As against any other party the claimant may have any remedy permitted by law. This section is not intended to specify what that remedy may be, or to prevent any court from imposing conditions or limitations such as prompt action or return of the consideration received. All such questions are left to the law of the particular jurisdiction. Section 3-202 gives no right that would not otherwise exist. The section is intended to mean that any remedies aorded by other law are cut o only by a holder in due course.

3-203. Transfer of Instrument; Rights Acquired by Transfer. (a) An instrument is transferred when it is delivered by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument. (b) Transfer of an instrument, whether or not the transfer is a negotiation, vests in the transferee any right of the transferor to enforce the instrument, including any right as a holder in due course, but the transferee cannot acquire rights of a holder in due course by a transfer, directly or indirectly, from a holder in due course if the transferee engaged in fraud or illegality aecting the instrument. (c) Unless otherwise agreed, if an instrument is transferred for value and the transferee does not become a holder because of lack of indorsement by the transferor, the transferee has a specically enforceable right to the unqualied indorsement of the transferor, but negotiation of the instrument does not occur until the indorsement is made. (d) If a transferor purports to transfer less than the entire instrument, negotiation of the instrument does not occur. The transferee obtains no rights under this Article and has only the rights of a partial assignee. Ocial Comment
1. Section 3-203 is based on former Section 3-201 which stated that a transferee received such rights as the transferor had. The former section was confusing because some rights of the transferor are not vested in the transferee unless the transfer is a negotiation. For example, a transferee that did not become the holder could not negotiate the instrument, a 348

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right that the transferor had. Former Section 3-201 did not dene transfer. Subsection (a) denes transfer by limiting it to cases in which possession of the instrument is delivered for the purpose of giving to the person receiving delivery the right to enforce the instrument. Although transfer of an instrument might mean in a particular case that title to the instrument passes to the transferee, that result does not follow in all cases. The right to enforce an instrument and ownership of the instrument are two dierent concepts. A thief who steals a check payable to bearer becomes the holder of the check and a person entitled to enforce it, but does not become the owner of the check. If the thief transfers the check to a purchaser the transferee obtains the right to enforce the check. If the purchaser is not a holder in due course, the owner's claim to the check may be asserted against the purchaser. Ownership rights in instruments may be determined by principles of the law of property, independent of Article 3, which do not depend upon whether the instrument was transferred under Section 3-203. Moreover, a person who has an ownership right in an instrument might not be a person entitled to enforce the instrument. For example, suppose X is the owner and holder of an instrument payable to X. X sells the instrument to Y but is unable to deliver immediate possession to Y. Instead, X signs a document conveying all of X's right, title, and interest in the instrument to Y. Although the document may be eective to give Y a claim to ownership of the instrument, Y is not a person entitled to enforce the instrument until Y obtains possession of the instrument. No transfer of the instrument occurs under Section 3-203(a) until it is delivered to Y. An instrument is a reied right to payment. The right is represented by the instrument itself. The right to payment is transferred by delivery of possession of the instrument by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument. The quoted phrase excludes issue of an instrument, dened in Section 3-105, and cases in which a delivery of possession is for some purpose other than transfer of the right to enforce. For example, if a check is presented for payment by delivering the check to the drawee, no transfer of the check to the drawee occurs because there is no intent to give the drawee the right to enforce the check. 2. Subsection (b) states that transfer vests in the transferee any right of the transferor to enforce the instrument including any right as a holder in due course. If the transferee is not a holder because the transferor did not indorse, the transferee is nevertheless a person entitled to enforce the instrument under Section 3-301 if the transferor was a holder at the time of transfer. Although the transferee is not a holder, under subsection (b) the transferee obtained the rights of the transferor as holder. Because the transferee's rights are derivative of the transferor's rights, those rights must be proved. Because the transferee is not a holder, there is no presumption under Section 3-308 that the transferee, by producing the instrument, is entitled to payment. The instrument, by its terms, is not payable to the transferee and the transferee must account for possession of the unindorsed instrument by proving the transaction through which the transferee acquired it. Proof of a transfer to the transferee by a holder is proof that the transferee has acquired the rights of a holder. At that point the transferee is entitled to the presumption under Section 3-308. Under subsection (b) a holder in due course that transfers an instrument transfers those rights as a holder in due course to the purchaser. The policy is to assure the holder in due course a free market for the instrument. There is one exception to this rule stated in the concluding clause of subsection (b). A person who is party to fraud or illegality aecting the instrument is not permitted to wash the instrument clean by passing it into the hands of a holder in due course and then repurchasing it. 3. Subsection (c) applies only to a transfer for value. It applies only if the instrument is payable to order or specially indorsed to the transferor. The transferee acquires, in the absence of a contrary agreement, the specically enforceable right to the indorsement of the transferor. Unless otherwise agreed, it is a right to the general indorsement of the transferor with full liability as indorser, rather than to an indorsement without recourse. The question may arise if the transferee has paid in advance and the indorsement is omitted fraudulently or through oversight. A transferor who is willing to indorse only without recourse or unwilling to indorse at all should make those intentions clear before transfer. The agreement of the transferee to take less than an unqualied indorsement need not be an express one, and the understanding may be implied from conduct, from past practice, or from the circumstances of the transaction. Subsection (c) provides that there is no negotiation of the instrument until the indorsement by the transferor is made. Until that time the transferee does not become a holder, and if earlier notice of a defense or claim is received, 349

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the transferee does not qualify as a holder in due course under Section 3-302. 4. The operation of Section 3-203 is illustrated by the following cases. In each case Payee, by fraud, induced Maker to issue a note to Payee. The fraud is a defense to the obligation of Maker to pay the note under Section 3-305(a)(2). Case # 1. Payee negotiated the note to X who took as a holder in due course. After the instrument became overdue X negotiated the note to Y who had notice of the fraud. Y succeeds to X's rights as a holder in due course and takes free of Maker's defense of fraud. Case # 2. Payee negotiated the note to X who took as a holder in due course. Payee then repurchased the note from X. Payee does not succeed to X's rights as a holder in due course and is subject to Maker's defense of fraud. Case # 3. Payee negotiated the note to X who took as a holder in due course. X sold the note to Purchaser who received possession. The note, however, was indorsed to X and X failed to indorse it. Purchaser is a person entitled to enforce the instrument under Section 3-301 and succeeds to the rights of X as holder in due course. Purchaser is not a holder, however, and under Section 3-308 Purchaser will have to prove the transaction with X under which the rights of X as holder in due course were acquired. Case # 4. Payee sold the note to Purchaser who took for value, in good faith and without notice of the defense of Maker. Purchaser received possession of the note but Payee neglected to indorse it. Purchaser became a person entitled to enforce the instrument but did not become the holder because of the missing indorsement. If Purchaser received notice of the defense of Maker before obtaining the indorsement of Payee, Purchaser cannot become a holder in due course because at the time notice was received the note had not been negotiated to Purchaser. If indorsement by Payee was made after Purchaser received notice, Purchaser had notice of the defense when it became the holder. 5. Subsection (d) restates former Section 3-202(3). The cause of action on an instrument cannot be split. Any indorsement which purports to convey to any party less than the entire amount of the instrument is not eective for negotiation. This is true of either Pay A one-half, or Pay A two-thirds and B one-third. Neither A nor B becomes a holder. On the other hand an indorsement reading merely Pay A and B is eective, since it transfers the entire cause of action to A and B as tenants in common. An indorsement purporting to convey less than the entire instrument does, however, operate as a partial assignment of the cause of action. Subsection (d) makes no attempt to state the legal eect of such an assignment, which is left to other law. A partial assignee of an instrument has rights only to the extent the applicable law gives rights, either at law or in equity, to a partial assignee. 6. The rules for transferring instruments set out in this section are similar to the rules in Article 13 of the Convention on International Bills of Exchange and International Promissory Notes. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002.

3-204. Indorsement. (a) Indorsement means a signature, other than that of a signer as maker, drawer, or acceptor, that alone or accompanied by other words is made on an instrument for the purpose of (i) negotiating the instrument, (ii) restricting payment of the instrument, or (iii) incurring indorser's liability on the instrument, but regardless of the intent of the signer, a signature and its accompanying words is an indorsement unless the accompanying words, terms of the instrument, place of the signature, or other circumstances unambiguously indicate that the signature was made for a purpose other than indorsement. For the purpose of determining whether a signature is made on an instrument, a paper axed to the instrument is a part of the instrument. (b) Indorser means a person who makes an indorsement. (c) For the purpose of determining whether the transferee of an instrument is a holder, an indorsement that transfers a security interest in the instrument is eective as an unqualied indorsement of the instrument.
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(d) If an instrument is payable to a holder under a name that is not the name of the holder, indorsement may be made by the holder in the name stated in the instrument or in the holder's name or both, but signature in both names may be required by a person paying or taking the instrument for value or collection. Ocial Comment
1. Subsection (a) is a denition of indorsement, a term which was not dened in former Article 3. Indorsement is dened in terms of the purpose of the signature. If a blank or special indorsement is made to give rights as a holder to a transferee the indorsement is made for the purpose of negotiating the instrument. Subsection (a)(i). If the holder of a check has an account in the drawee bank and wants to be sure that payment of the check will be made by credit to the holder's account, the holder can indorse the check by signing the holder's name with the accompanying words for deposit only before presenting the check for payment to the drawee bank. In that case the purpose of the quoted words is to restrict payment of the instrument. Subsection (a)(ii). If X wants to guarantee payment of a note signed by Y as maker, X can do so by signing X's name to the back of the note as an indorsement. This indorsement is known as an anomalous indorsement (Section 3-205(d)) and is made for the purpose of incurring indorser's liability on the note. Subsection (a)(iii). In some cases an indorsement may serve more than one purpose. For example, if the holder of a check deposits it to the holder's account in a depositary bank for collection and indorses the check by signing the holder's name with the accompanying words for deposit only the purpose of the indorsement is both to negotiate the check to the depositary bank and to restrict payment of the check. The but clause of the rst sentence of subsection (a) elaborates on former Section 3-402. In some cases it may not be clear whether a signature was meant to be that of an indorser, a party to the instrument in some other capacity such as drawer, maker or acceptor, or a person who was not signing as a party. The general rule is that a signature is an indorsement if the instrument does not indicate an unambiguous intent of the signer not to sign as an indorser. Intent may be determined by words accompanying the signature, the place of signature, or other circumstances. For example, suppose a depositary bank gives cash for a check properly indorsed by the payee. The bank requires the payee's employee to sign the back of the check as evidence that the employee received the cash. If the signature consists only of the initials of the employee it is not reasonable to assume that it was meant to be an indorsement. If there was a full signature but accompanying words indicated that it was meant as a receipt for the cash given for the check, it is not an indorsement. If the signature is not qualied in any way and appears in the place normally used for indorsements, it may be an indorsement even though the signer intended the signature to be a receipt. To take another example, suppose the drawee of a draft signs the draft on the back in the space usually used for indorsements. No words accompany the signature. Since the drawee has no reason to sign a draft unless the intent is to accept the draft, the signature is eective as an acceptance. Custom and usage may be used to determine intent. For example, by long-established custom and usage, a signature in the lower right hand corner of an instrument indicates an intent to sign as the maker of a note or the drawer of a draft. Any similar clear indication of an intent to sign in some other capacity or for some other purpose may establish that a signature is not an indorsement. For example, if the owner of a traveler's check countersigns the check in the process of negotiating it, the countersignature is not an indorsement. The countersignature is a condition to the issuer's obligation to pay and its purpose is to provide a means of verifying the identify of the person negotiating the traveler's check by allowing comparison of the specimen signature and the countersignature. The countersignature is not necessary for negotiation and the signer does not incur indorser's liability. See Comment 2 to Section 3-106. The last sentence of subsection (a) is based on subsection (2) of former Section 3-202. An indorsement on an allonge is valid even though there is sucient space on the instrument for an indorsement. 2. Assume that Payee indorses a note to Creditor as security for a debt. Under subsection (b) of Section 3-203 Creditor takes Payee's rights to enforce or transfer the instrument subject to the limitations imposed by Article 9. Subsection (c) of Section 3-204 makes clear that Payee's indorsement to Creditor, even though it mentions creation of a security inter351

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est, is an unqualied indorsement that gives to Creditor the right to enforce the note as its holder. 3. Subsection (d) is a restatement of former Section 3-203. Section 3-110(a) states that an instrument is payable to the person intended by the person signing as or in the name or behalf of the issuer even if that person is identied by a name that is not the true name of the person. In some cases the name used in the instrument is a misspelling of the correct name and in some cases the two names may be entirely dierent. The payee may indorse in the name used in the instrument, in the payee's correct name, or in both. In each case the indorsement is eective. But because an indorsement in a name dierent from that used in the instrument may raise a question about its validity and an indorsement in a name that is not the correct name of the payee may raise a problem of identifying the indorser, the accepted commercial practice is to indorse in both names. Subsection (d) allows a person paying or taking the instrument for value or collection to require indorsement in both names.

3-205. Special Indorsement; Blank Indorsement; Anomalous Indorsement. (a) If an indorsement is made by the holder of an instrument, whether payable to an identied person or payable to bearer, and the indorsement identies a person to whom it makes the instrument payable, it is a special indorsement. When specially indorsed, an instrument becomes payable to the identied person and may be negotiated only by the indorsement of that person. The principles stated in Section 3-110 apply to special indorsements. (b) If an indorsement is made by the holder of an instrument and it is not a special indorsement, it is a blank indorsement. When indorsed in blank, an instrument becomes payable to bearer and may be negotiated by transfer of possession alone until specially indorsed. (c) The holder may convert a blank indorsement that consists only of a signature into a special indorsement by writing, above the signature of the indorser, words identifying the person to whom the instrument is made payable. (d) Anomalous indorsement means an indorsement made by a person who is not the holder of the instrument. An anomalous indorsement does not aect the manner in which the instrument may be negotiated. Ocial Comment
1. Subsection (a) is based on subsection (1) of former Section 3-204. It states the test of a special indorsement to be whether the indorsement identies a person to whom the instrument is payable. Section 3-110 states rules for identifying the payee of an instrument. Section 3-205(a) incorporates the principles stated in Section 3-110 in identifying an indorsee. The language of Section 3-110 refers to language used by the issuer of the instrument. When that section is used with respect to an indorsement, Section 3-110 must be read as referring to the language used by the indorser. 2. Subsection (b) is based on subsection (2) of former Section 3-204. An indorsement made by the holder is either a special or blank indorsement. If the indorsement is made by a holder and is not a special indorsement, it is a blank indorsement. For example, the holder of an instrument, intending to make a special indorsement, writes the words Pay to the order of without completing the indorsement by writing the name of the indorsee. The holder's signature appears under the quoted words. The indorsement is not a special indorsement because it does not identify a person to whom it makes the instrument payable. Since it is not a special indorsement it is a blank indorsement and the instrument is payable to bearer. The result is analogous to that of a check in which the name of the payee is left blank by the drawer. In that case the check is payable to bearer. See the last paragraphs of Comment 2 to Section 3-115. A blank indorsement is usually the signature of the indorser on the back of the instru352

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ment without other words. Subsection (c) is based on subsection (3) of former Section 3-204. A restrictive indorsement described in Section 3-206 can be either a blank indorsement or a special indorsement. Pay to T, in trust for B is a restrictive indorsement. It is also a special indorsement because it identies T as the person to whom the instrument is payable. For deposit only followed by the signature of the payee of a check is a restrictive indorsement. It is also a blank indorsement because it does not identify the person to whom the instrument is payable. 3. The only eect of an anomalous indorsement, dened in subsection (d), is to make the signer liable on the instrument as an indorser. Such an indorsement is normally made by an accommodation party. Section 3-419. 4. Articles 14 and 16 of the Convention on International Bills of Exchange and International Promissory Notes includes similar rules for blank and special indorsements. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002.

3-206. Restrictive Indorsement. (a) An indorsement limiting payment to a particular person or otherwise prohibiting further transfer or negotiation of the instrument is not eective to prevent further transfer or negotiation of the instrument. (b) An indorsement stating a condition to the right of the indorsee to receive payment does not aect the right of the indorsee to enforce the instrument. A person paying the instrument or taking it for value or collection may disregard the condition, and the rights and liabilities of that person are not aected by whether the condition has been fullled. (c) If an instrument bears an indorsement (i) described in Section 4-201(b), or (ii) in blank or to a particular bank using the words for deposit, for collection, or other words indicating a purpose of having the instrument collected by a bank for the indorser or for a particular account, the following rules apply: (1) A person, other than a bank, who purchases the instrument when so indorsed converts the instrument unless the amount paid for the instrument is received by the indorser or applied consistently with the indorsement. (2) A depositary bank that purchases the instrument or takes it for collection when so indorsed converts the instrument unless the amount paid by the bank with respect to the instrument is received by the indorser or applied consistently with the indorsement. (3) A payor bank that is also the depositary bank or that takes the instrument for immediate payment over the counter from a person other than a collecting bank converts the instrument unless the proceeds of the instrument are received by the indorser or applied consistently with the indorsement. (4) Except as otherwise provided in paragraph (3), a payor bank or intermediary bank may disregard the indorsement and is not liable if the proceeds of the instrument are not received by the indorser or applied consistently with the indorsement. (d) Except for an indorsement covered by subsection (c), if an instrument bears an indorsement using words to the eect that payment is to be made to the indorsee as agent, trustee, or other duciary for the benet of the indorser or another person, the following rules apply: (1) Unless there is notice of breach of duciary duty as provided in
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Section 3-307, a person who purchases the instrument from the indorsee or takes the instrument from the indorsee for collection or payment may pay the proceeds of payment or the value given for the instrument to the indorsee without regard to whether the indorsee violates a duciary duty to the indorser. (2) A subsequent transferee of the instrument or person who pays the instrument is neither given notice nor otherwise aected by the restriction in the indorsement unless the transferee or payor knows that the duciary dealt with the instrument or its proceeds in breach of duciary duty. (e) The presence on an instrument of an indorsement to which this section applies does not prevent a purchaser of the instrument from becoming a holder in due course of the instrument unless the purchaser is a converter under subsection (c) or has notice or knowledge of breach of duciary duty as stated in subsection (d). (f) In an action to enforce the obligation of a party to pay the instrument, the obligor has a defense if payment would violate an indorsement to which this section applies and the payment is not permitted by this section. Ocial Comment
1. This section replaces former Sections 3-205 and 3-206 and claries the law of restrictive indorsements. 2. Subsection (a) provides that an indorsement that purports to limit further transfer or negotiation is ineective to prevent further transfer or negotiation. If a payee indorses Pay A only, A may negotiate the instrument to subsequent holders who may ignore the restriction on the indorsement. Subsection (b) provides that an indorsement that states a condition to the right of a holder to receive payment is ineective to condition payment. Thus if a payee indorses Pay A if A ships goods complying with our contract, the right of A to enforce the instrument is not aected by the condition. In the case of a note, the obligation of the maker to pay A is not aected by the indorsement. In the case of a check, the drawee can pay A without regard to the condition, and if the check is dishonored the drawer is liable to pay A. If the check was negotiated by the payee to A in return for a promise to perform a contract and the promise was not kept, the payee would have a defense or counterclaim against A if the check were dishonored and A sued the payee as indorser, but the payee would have that defense or counterclaim whether or not the condition to the right of A was expressed in the indorsement. Former Section 3-206 treated a conditional indorsement like indorsements for deposit or collection. In revised Article 3, Section 3-206(b) rejects that approach and makes the conditional indorsement ineective with respect to parties other than the indorser and indorsee. Since the indorsements referred to in subsections (a) and (b) are not eective as restrictive indorsements, they are no longer described as restrictive indorsements. 3. The great majority of restrictive indorsements are those that fall within subsection (c) which continues previous law. The depositary bank or the payor bank, if it takes the check for immediate payment over the counter, must act consistently with the indorsement, but an intermediary bank or payor bank that takes the check from a collecting bank is not affected by the indorsement. Any other person is also bound by the indorsement. For example, suppose a check is payable to X, who indorses in blank but writes above the signature the words For deposit only. The check is stolen and is cashed at a grocery store by the thief. The grocery store indorses the check and deposits it in Depositary Bank. The account of the grocery store is credited and the check is forwarded to Payor Bank which pays the check. Under subsection (c), the grocery store and Depositary Bank are converters of the check because X did not receive the amount paid for the check. Payor Bank and any intermediary bank in the collection process are not liable to X. This Article does not displace the law of waiver as it may apply to restrictive indorsements. The circumstances under which a restrictive indorsement may be waived by the person who made it is not determined by this 354

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Article. 4. Subsection (d) replaces subsection (4) of former Section 3-206. Suppose Payee indorses a check Pay to T in trust for B. T indorses in blank and delivers it to (a) Holder for value; (b) Depositary Bank for collection; or (c) Payor Bank for payment. In each case these takers can safely pay T so long as they have no notice under Section 3-307 of any breach of duciary duty that T may be committing. For example, under subsection (a) (b)* of Section 3-307 these takers have notice of a breach of trust if the check was taken in any transaction known by the taker to be for T's personal benet. Subsequent transferees of the check from Holder or Depositary Bank are not aected by the restriction unless they have knowledge that T dealt with the check in breach of trust. 5. Subsection (f) allows a restrictive indorsement to be used as a defense by a person obliged to pay the instrument if that person would be liable for paying in violation of the indorsement.

3-207. Reacquisition. Reacquisition of an instrument occurs if it is transferred to a former holder, by negotiation or otherwise. A former holder who reacquires the instrument may cancel indorsements made after the reacquirer rst became a holder of the instrument. If the cancellation causes the instrument to be payable to the reacquirer or to bearer, the reacquirer may negotiate the instrument. An indorser whose indorsement is canceled is discharged, and the discharge is eective against any subsequent holder. Ocial Comment
Section 3-207 restates former Section 3-208. Reacquisition refers to cases in which a former holder reacquires the instrument either by negotiation from the present holder or by a transfer other than negotiation. If the reacquisition is by negotiation, the former holder reacquires the status of holder. Although Section 3-207 allows the holder to cancel all indorsements made after the holder rst acquired holder status, cancellation is not necessary. Status of holder is not aected whether or not cancellation is made. But if the reacquisition is not the result of negotiation the former holder can obtain holder status only by striking the former holder's indorsement and any subsequent indorsements. The latter case is an exception to the general rule that if an instrument is payable to an identied person, the indorsement of that person is necessary to allow a subsequent transferee to obtain the status of holder. Reacquisition without indorsement by the person to whom the instrument is payable is illustrated by two examples: Case # 1. X, a former holder, buys the instrument from Y, the present holder. Y delivers the instrument to X but fails to indorse it. Negotiation does not occur because the transfer of possession did not result in X's becoming holder. Section 3-201(a). The instrument by its terms is payable to Y, not to X. But X can obtain the status of holder by striking X's indorsement and all subsequent indorsements. When these indorsements are struck, the instrument by its terms is payable either to X or to bearer, depending upon how X originally became holder. In either case X becomes holder. Section 1-201(20). Case # 2. X, the holder of an instrument payable to X, negotiates it to Y by special indorsement. The negotiation is part of an underlying transaction between X and Y. The underlying transaction is rescinded by agreement of X and Y, and Y returns the instrument without Y's indorsement. The analysis is the same as that in Case # 1. X can obtain holder status by cancelling X's indorsement to Y. In Case # 1 and Case # 2, X acquired ownership of the instrument after reacquisition, but X's title was clouded because the instrument by its terms was not payable to X. Normally, X can remedy the problem by obtaining Y's indorsement, but in some cases X may not be able to conveniently obtain that indorsement. Section 3-207 is a rule of convenience which relieves X of the burden of obtaining an indorsement that serves no substantive purpose. The eect of cancellation of any indorsement under Section 3-207 is to nullify it. Thus, the [Section 3-206] *Previous incorrect cross reference corrected by Permanent Editorial Board action November 1992. 355

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person whose indorsement is canceled is relieved of indorser's liability. Since cancellation is notice of discharge, discharge is eective even with respect to the rights of a holder in due course. Sections 3-601 and 3-604.

PART 3. ENFORCEMENT OF INSTRUMENTS

3-301. Person Entitled to Enforce Instrument. Person entitled to enforce an instrument means (i) the holder of the instrument, (ii) a nonholder in possession of the instrument who has the rights of a holder, or (iii) a person not in possession of the instrument who is entitled to enforce the instrument pursuant to Section 3-309 or 3-418(d). A person may be a person entitled to enforce the instrument even though the person is not the owner of the instrument or is in wrongful possession of the instrument. Ocial Comment
This section replaces former Section 3-301 that stated the rights of a holder. The rights stated in former Section 3-301 to transfer, negotiate, enforce, or discharge an instrument are stated in other sections of Article 3. In revised Article 3, Section 3-301 denes person entitled to enforce an instrument. The denition recognizes that enforcement is not limited to holders. The quoted phrase includes a person enforcing a lost or stolen instrument. Section 3-309. It also includes a person in possession of an instrument who is not a holder. A nonholder in possession of an instrument includes a person that acquired rights of a holder by subrogation or under Section 3-203(a). It also includes any other person who under applicable law is a successor to the holder or otherwise acquires the holder's rights. It also includes both a remitter that has received an instrument from the issuer but has not yet transferred or negotiated the instrument to another person and also any other person who under applicable law is a successor to the holder or otherwise acquires the holder's rights. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002.

3-302. Holder in Due Course. (a) Subject to subsection (c) and Section 3-106(d), holder in due course means the holder of an instrument if: (1) the instrument when issued or negotiated to the holder does not bear such apparent evidence of forgery or alteration or is not otherwise so irregular or incomplete as to call into question its authenticity; and (2) the holder took the instrument (i) for value, (ii) in good faith, (iii) without notice that the instrument is overdue or has been dishonored or that there is an uncured default with respect to payment of another instrument issued as part of the same series, (iv) without notice that the instrument contains an unauthorized signature or has been altered, (v) without notice of any claim to the instrument described in Section 3-306, and (vi) without notice that any party has a defense or claim in recoupment described in Section 3-305(a). (b) Notice of discharge of a party, other than discharge in an insolvency proceeding, is not notice of a defense under subsection (a), but discharge is eective against a person who became a holder in due course with notice of the discharge. Public ling or recording of a document does not of itself constitute notice of a defense, claim in recoupment, or claim to the instrument. (c) Except to the extent a transferor or predecessor in interest has rights as a holder in due course, a person does not acquire rights of a holder in
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due course of an instrument taken (i) by legal process or by purchase in an execution, bankruptcy, or creditor's sale or similar proceeding, (ii) by purchase as part of a bulk transaction not in ordinary course of business of the transferor, or (iii) as the successor in interest to an estate or other organization. (d) If, under Section 3-303(a)(1), the promise of performance that is the consideration for an instrument has been partially performed, the holder may assert rights as a holder in due course of the instrument only to the fraction of the amount payable under the instrument equal to the value of the partial performance divided by the value of the promised performance. (e) If (i) the person entitled to enforce an instrument has only a security interest in the instrument and (ii) the person obliged to pay the instrument has a defense, claim in recoupment, or claim to the instrument that may be asserted against the person who granted the security interest, the person entitled to enforce the instrument may assert rights as a holder in due course only to an amount payable under the instrument which, at the time of enforcement of the instrument, does not exceed the amount of the unpaid obligation secured. (f) To be eective, notice must be received at a time and in a manner that gives a reasonable opportunity to act on it. (g) This section is subject to any law limiting status as a holder in due course in particular classes of transactions. Ocial Comment
1. Subsection (a)(1) is a return to the N.I.L. rule that the taker of an irregular or incomplete instrument is not a person the law should protect against defenses of the obligor or claims of prior owners. This reects a policy choice against extending the holder in due course doctrine to an instrument that is so incomplete or irregular as to call into question its authenticity. The term authenticity is used to make it clear that the irregularity or incompleteness must indicate that the instrument may not be what it purports to be. Persons who purchase or pay such instruments should do so at their own risk. Under subsection (1) of former Section 3-304, irregularity or incompleteness gave a purchaser notice of a claim or defense. But it was not clear from that provision whether the claim or defense had to be related to the irregularity or incomplete aspect of the instrument. This ambiguity is not present in subsection (a)(1). 2. Subsection (a)(2) restates subsection (1) of former Section 3-302. Section 3-305(a) makes a distinction between defenses to the obligation to pay an instrument and claims in recoupment by the maker or drawer that may be asserted to reduce the amount payable on the instrument. Because of this distinction, which was not made in former Article 3, the reference in subsection (a)(2)(vi) is to both a defense and a claim in recoupment. Notice of forgery or alteration is stated separately because forgery and alteration are not technically defenses under subsection (a) of Section 3-305. 3. Discharge is also separately treated in the rst sentence of subsection (b). Except for discharge in an insolvency proceeding, which is specically stated to be a real defense in Section 3-305(a)(1), discharge is not expressed in Article 3 as a defense and is not included in Section 3-305(a)(2). Discharge is eective against anybody except a person having rights of a holder in due course who took the instrument without notice of the discharge. Notice of discharge does not disqualify a person from becoming a holder in due course. For example, a check certied after it is negotiated by the payee may subsequently be negotiated to a holder. If the holder had notice that the certication occurred after negotiation by the payee, the holder necessarily had notice of the discharge of the payee as indorser. Section 3-415(d). Notice of that discharge does not prevent the holder from becoming a holder in due course, but the discharge is eective against the holder. Section 3-601(b). Notice of a defense under Section 3-305(a)(1) of a maker, drawer or acceptor based on a bankruptcy discharge is dierent. There is no reason to give holder in due course status to a person 357

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with notice of that defense. The second sentence of subsection (b) is from former Section 3-304(5). 4. Professor Britton in his treatise Bills and Notes 309 (1961) stated: A substantial number of decisions before the [N.I.L.] indicates that at common law there was nothing in the position of the payee as such which made it impossible for him to be a holder in due course. The courts were divided, however, about whether the payee of an instrument could be a holder in due course under the N.I.L.. Some courts read N.I.L. 52(4) to mean that a person could be a holder in due course only if the instrument was negotiated to that person. N.I.L. 30 stated that an instrument is negotiated when it is transferred from one person to another in such manner as to constitute the transferee the holder thereof. Normally, an instrument is issued to the payee; it is not transferred to the payee. N.I.L. 191 dened issue as the rst delivery of the instrument * * * to a person who takes it as a holder. Thus, some courts concluded that the payee never could be a holder in due course. Other courts concluded that there was no evidence that the N.I.L. was intended to change the common law rule that the payee could be a holder in due course. Professor Britton states on p. 318: The typical situations which raise the [issue] are those where the defense of a maker is interposed because of fraud by a [maker who is] principal debtor * * * against a surety co-maker, or where the defense of fraud by a purchasing remitter is interposed by the drawer of the instrument against the good faith purchasing payee. Former Section 3-302(2) stated: A payee may be a holder in due course. This provision was intended to resolve the split of authority under the N.I.L.. It made clear that there was no intent to change the common-law rule that allowed a payee to become a holder in due course. See Comment 2 to former Section 3-302. But there was no need to put subsection (2) in former Section 3-302 because the split in authority under the N.I.L. was caused by the particular wording of N.I.L. 52(4). The troublesome language in that section was not repeated in former Article 3 nor is it repeated in revised Article 3. Former Section 3-302(2) has been omitted in revised Article 3 because it is surplusage and may be misleading. The payee of an instrument can be a holder in due course, but use of the holder-in-due-course doctrine by the payee of an instrument is not the normal situation. The primary importance of the concept of holder in due course is with respect to assertion of defenses or claims in recoupment (Section 3-305) and of claims to the instrument (Section 3-306). The holder-in-due-course doctrine assumes the following case as typical. Obligor issues a note or check to Obligee. Obligor is the maker of the note or drawer of the check. Obligee is the payee. Obligor has some defense to Obligor's obligation to pay the instrument. For example, Obligor issued the instrument for goods that Obligee promised to deliver. Obligee never delivered the goods. The failure of Obligee to deliver the goods is a defense. Section 3-303(b). Although Obligor has a defense against Obligee, if the instrument is negotiated to Holder and the requirements of subsection (a) are met, Holder may enforce the instrument against Obligor free of the defense. Section 3-305(b). In the typical case the holder in due course is not the payee of the instrument. Rather, the holder in due course is an immediate or remote transferee of the payee. If Obligor in our example is the only obligor on the check or note, the holder-in-due-course doctrine is irrelevant in determining rights between Obligor and Obligee with respect to the instrument. But in a small percentage of cases it is appropriate to allow the payee of an instrument to assert rights as a holder in due course. The cases are like those referred to in the quotation from Professor Britton referred to above, or other cases in which conduct of some third party is the basis of the defense of the issuer of the instrument. The following are examples: Case # 1. Buyer pays for goods bought from Seller by giving to Seller a cashier's check bought from Bank. Bank has a defense to its obligation to pay the check because Buyer bought the check from Bank with a check known to be drawn on an account with insucient funds to cover the check. If Bank issued the check to Buyer as payee and Buyer indorsed it over to Seller, it is clear that Seller can be a holder in due course taking free of the defense if Seller had no notice of the defense. Seller is a transferee of the check. There is no good reason why Seller's position should be any dierent if Bank drew the check to the order of Seller as payee. In that case, when Buyer took delivery of the check from Bank, Buyer became the owner of the check even though Buyer was not the holder. Buyer was a remitter. Section 3-103(a)(15). At that point nobody was the holder. When Buyer delivered the check to Seller, ownership of the check was transferred to Seller who also became the holder. This is a negotiation. Section 3-201. The rights of Seller should not be aected by the fact that in one case the negotiation to Seller was by 358

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a holder and in the other case the negotiation was by a remitter. Moreover, it should be irrelevant whether Bank delivered the check to Buyer and Buyer delivered it to Seller or whether Bank delivered it directly to Seller. In either case Seller can be a holder in due course that takes free of Bank's defense. Case # 2. X fraudulently induces Y to join X in a spurious venture to purchase a business. The purchase is to be nanced by a bank loan for part of the price. Bank lends money to X and Y by deposit in a joint account of X and Y who sign a note payable to Bank for the amount of the loan. X then withdraws the money from the joint account and absconds. Bank acted in good faith and without notice of the fraud of X against Y. Bank is payee of the note executed by Y, but its right to enforce the note against Y should not be aected by the fact that Y was induced to execute the note by the fraud of X. Bank can be a holder in due course that takes free of the defense of Y. Case # 2 is similar to Case # 1. In each case the payee of the instrument has given value to the person committing the fraud in exchange for the obligation of the person against whom the fraud was committed. In each case the payee was not party to the fraud and had no notice of it. Suppose in Case # 2 that the note does not meet the requirements of Section 3-104(a) and thus is not a negotiable instrument covered by Article 3. In that case, Bank cannot be a holder in due course but the result should be the same. Bank's rights are determined by general principles of contract law. Restatement Second, Contracts 164(2) governs the case. If Y is induced to enter into a contract with Bank by a fraudulent misrepresentation by X, the contract is voidable by Y unless Bank in good faith and without reason to know of the misrepresentation either gives value or relies materially on the transaction. Comment e to 164(2) states:
This is the same principle that protects an innocent person who purchases goods or commercial paper in good faith, without notice and for value from one who obtained them from the original owner by a misrepresentation. See Uniform Commercial Code 2-403(1), 3-305. In the cases that fall within [ 164(2) ], however, the innocent person deals directly with the recipient of the misrepresentation, which is made by one not a party to the contract.

The same result follows in Case # 2 if Y had been induced to sign the note as an accommodation party (Section 3-419). If Y signs as co-maker of a note for the benet of X, Y is a surety with respect to the obligation of X to pay the note but is liable as maker of the note to pay Bank. Section 3-419(b). If Bank is a holder in due course, the fraud of X cannot be asserted against Bank under Section 3-305(b). But the result is the same without resort to holder-in-due-course doctrine. If the note is not a negotiable instrument governed by Article 3, general rules of suretyship apply. Restatement, Security 119 states that the surety (Y) cannot assert a defense against the creditor (Bank) based on the fraud of the principal (X) if the creditor without knowledge of the fraud * * * extended credit to the principal on the security of the surety's promise * * *. The underlying principle of 119 is the same as that of 164(2) of Restatement Second, Contracts. Case # 3. Corporation draws a check payable to Bank. The check is given to an ocer of Corporation who is instructed to deliver it to Bank in payment of a debt owed by Corporation to Bank. Instead, the ocer, intending to defraud Corporation, delivers the check to Bank in payment of the ocer's personal debt, or the check is delivered to Bank for deposit to the ocer's personal account. If Bank obtains payment of the check, Bank has received funds of Corporation which have been used for the personal benet of the ocer. Corporation in this case will assert a claim to the proceeds of the check against Bank. If Bank was a holder in due course of the check it took the check free of Corporation's claim. Section 3-306. The issue in this case is whether Bank had notice of the claim when it took the check. If Bank knew that the ocer was a duciary with respect to the check, the issue is governed by Section 3-307. Case # 4. Employer, who owed money to X, signed a blank check and delivered it to Secretary with instructions to complete the check by typing in X's name and the amount owed to X. Secretary fraudulently completed the check by typing in the name of Y, a creditor to whom Secretary owed money. Secretary then delivered the check to Y in payment of Secretary's debt. Y obtained payment of the check. This case is similar to Case # 3. Since Secretary was authorized to complete the check, Employer is bound by Secretary's act in making the check payable to Y. The drawee bank properly paid the check. Y received funds of Employer which were used for the personal benet of Secretary. Employer asserts a claim to these funds against Y. If Y is a holder in due course, Y takes free of the claim. Whether Y is a holder in due course depends upon whether Y had notice of Employer's claim. 359

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5. Subsection (c) is based on former Section 3-302(3). Like former Section 3-302(3), subsection (c) is intended to state existing case law. It covers a few situations in which the purchaser takes an instrument under unusual circumstances. The purchaser is treated as a successor in interest to the prior holder and can acquire no better rights. But if the prior holder was a holder in due course, the purchaser obtains rights of a holder in due course. Subsection (c) applies to a purchaser in an execution sale or sale in bankruptcy. It applies equally to an attaching creditor or any other person who acquires the instrument by legal process or to a representative, such as an executor, administrator, receiver or assignee for the benet of creditors, who takes the instrument as part of an estate. Subsection (c) applies to bulk purchases lying outside of the ordinary course of business of the seller. For example, it applies to the purchase by one bank of a substantial part of the paper held by another bank which is threatened with insolvency and seeking to liquidate its assets. Subsection (c) would also apply when a new partnership takes over for value all of the assets of an old one after a new member has entered the rm, or to a reorganized or consolidated corporation taking over the assets of a predecessor. In the absence of controlling state law to the contrary, subsection (c) applies to a sale by a state bank commissioner of the assets of an insolvent bank. However, subsection (c) may be preempted by federal law if the Federal Deposit Insurance Corporation takes over an insolvent bank. Under the governing federal law, the FDIC and similar nancial institution insurers are given holder in due course status and that status is also acquired by their assignees under the shelter doctrine. 6. Subsections (d) and (e) clarify two matters not specically addressed by former Article 3: Case # 5. Payee negotiates a $1,000 note to Holder who agrees to pay $900 for it. After paying $500, Holder learns that Payee defrauded Maker in the transaction giving rise to the note. Under subsection (d) Holder may assert rights as a holder in due course to the extent of $555.55 ($500 $900 = .555 $1,000 = $555.55). This formula rewards Holder with a ratable portion of the bargained for prot. Case # 6. Payee negotiates a note of Maker for $1,000 to Holder as security for payment of Payee's debt to Holder of $600. Maker has a defense which is good against Payee but of which Holder has no notice. Subsection (e) applies. Holder may assert rights as a holder in due course only to the extent of $600. Payee does not get the benet of the holder-in-due-course status of Holder. With respect to $400 of the note, Maker may assert any rights that Maker has against Payee. A dierent result follows if the payee of a note negotiated it to a person who took it as a holder in due course and that person pledged the note as security for a debt. Because the defense cannot be asserted against the pledgor, the pledgee can assert rights as a holder in due course for the full amount of the note for the benet of both the pledgor and the pledgee. 7. There is a large body of state statutory and case law restricting the use of the holder in due course doctrine in consumer transactions as well as some business transactions that raise similar issues. Subsection (g) subordinates Article 3 to that law and any other similar law that may evolve in the future. Section 3-106(d) also relates to statutory or administrative law intended to restrict use of the holder-in-due-course doctrine. See Comment 3 to Section 3-106. 8. The status of holder in due course resembles the status of protected holder under Article 29 of the Convention on International Bills of Exchange and International Promissory Notes. The requirements for being a protected holder under Article 29 generally track those of Section 3-302. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002.

3-303. Value and Consideration. (a) An instrument is issued or transferred for value if: (1) the instrument is issued or transferred for a promise of performance, to the extent the promise has been performed; (2) the transferee acquires a security interest or other lien in the instrument other than a lien obtained by judicial proceeding; (3) the instrument is issued or transferred as payment of, or as secu360

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rity for, an antecedent claim against any person, whether or not the claim is due; (4) the instrument is issued or transferred in exchange for a negotiable instrument; or (5) the instrument is issued or transferred in exchange for the incurring of an irrevocable obligation to a third party by the person taking the instrument. (b) Consideration means any consideration sucient to support a simple contract. The drawer or maker of an instrument has a defense if the instrument is issued without consideration. If an instrument is issued for a promise of performance, the issuer has a defense to the extent performance of the promise is due and the promise has not been performed. If an instrument is issued for value as stated in subsection (a), the instrument is also issued for consideration. Ocial Comment
1. Subsection (a) is a restatement of former Section 3-303 and subsection (b) replaces former Section 3-408. The distinction between value and consideration in Article 3 is a very ne one. Whether an instrument is taken for value is relevant to the issue of whether a holder is a holder in due course. If an instrument is not issued for consideration the issuer has a defense to the obligation to pay the instrument. Consideration is dened in subsection (b) as any consideration sucient to support a simple contract. The denition of value in Section 1-201(44), which doesn't apply to Article 3, includes any consideration sufcient to support a simple contract. Thus, outside Article 3, anything that is consideration is also value. A dierent rule applies in Article 3. Subsection (b) of Section 3-303 states that if an instrument is issued for value it is also issued for consideration. Case # 1. X owes Y $1,000. The debt is not represented by a note. Later X issues a note to Y for the debt. Under subsection (a)(3) X's note is issued for value. Under subsection (b) the note is also issued for consideration whether or not, under contract law, Y is deemed to have given consideration for the note. Case # 2. X issues a check to Y in consideration of Y's promise to perform services in the future. Although the executory promise is consideration for issuance of the check it is value only to the extent the promise is performed. Subsection (a)(1). Case # 3. X issues a note to Y in consideration of Y's promise to perform services. If at the due date of the note Y's performance is not yet due, Y may enforce the note because it was issued for consideration. But if at the due date of the note, Y's performance is due and has not been performed, X has a defense. Subsection (b). 2. Subsection (a), which denes value, has primary importance in cases in which the issue is whether the holder of an instrument is a holder in due course and particularly to cases in which the issuer of the instrument has a defense to the instrument. Suppose Buyer and Seller signed a contract on April 1 for the sale of goods to be delivered on May 1. Payment of 50% of the price of the goods was due upon signing of the contract. On April 1 Buyer delivered to Seller a check in the amount due under the contract. The check was drawn by X to Buyer as payee and was indorsed to Seller. When the check was presented for payment to the drawee on April 2, it was dishonored because X had stopped payment. At that time Seller had not taken any action to perform the contract with Buyer. If X has a defense on the check, the defense can be asserted against Seller who is not a holder in due course because Seller did not give value for the check. Subsection (a)(1). The policy basis for subsection (a)(1) is that the holder who gives an executory promise of performance will not suer an out-of-pocket loss to the extent the executory promise is unperformed at the time the holder learns of dishonor of the instrument. When Seller took delivery of the check on April 1, Buyer's obligation to pay 50% of the price on that date was suspended, but when the check was dishonored on April 2 the obligation revived. Section 3-310(b). If payment for goods is due at or before delivery and the buyer fails to make the payment, the seller is excused from performing the promise to deliver the goods. Section 2-703. Thus, Seller is protected from an out-of-pocket loss even if the check is not enforceable. Holder-in-duecourse status is not necessary to protect Seller. 361

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3. Subsection (a)(2) equates value with the obtaining of a security interest or a nonjudicial lien in the instrument. The term security interest covers Article 9 cases in which an instrument is taken as collateral as well as bank collection cases in which a bank acquires a security interest under Section 4-210. The acquisition of a common-law or statutory banker's lien is also value under subsection (a)(2). An attaching creditor or other person who acquires a lien by judicial proceedings does not give value for the purposes of subsection (a)(2). 4. Subsection (a)(3) follows former Section 3-303(b) in providing that the holder takes for value if the instrument is taken in payment of or as security for an antecedent claim, even though there is no extension of time or other concession, and whether or not the claim is due. Subsection (a)(3) applies to any claim against any person; there is no requirement that the claim arise out of contract. In particular the provision is intended to apply to an instrument given in payment of or as security for the debt of a third person, even though no concession is made in return. 5. Subsection (a)(4) and (5) restate former Section 3-303(c). They state generally recognized exceptions to the rule that an executory promise is not value. A negotiable instrument is value because it carries the possibility of negotiation to a holder in due course, after which the party who gives it is obliged to pay. The same reasoning applies to any irrevocable commitment to a third person, such as a letter of credit issued when an instrument is taken. 6. The term promise in paragraph (a)(1) is used in the phrase promise of performance and for that reason does not have the specialized meaning given that term in Section 3-103(a) (12). See Section 1-201 (Changes from Former Law). No inference should be drawn from the decision to use the phrase promise of performance, although the phrase does include the word promise, which has the specialized denition set forth in Section 3-103. Indeed, that is true even though undertaking is used instead of promise in Section 3-104(a)(3). See Section 3-104 comment 1 (explaining the use of the term undertaking in Section 3-104 to avoid use of the dened term promise). Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002.

3-304. Overdue Instrument. (a) An instrument payable on demand becomes overdue at the earliest of the following times: (1) on the day after the day demand for payment is duly made; (2) if the instrument is a check, 90 days after its date; or (3) if the instrument is not a check, when the instrument has been outstanding for a period of time after its date which is unreasonably long under the circumstances of the particular case in light of the nature of the instrument and usage of the trade. (b) With respect to an instrument payable at a denite time the following rules apply: (1) If the principal is payable in installments and a due date has not been accelerated, the instrument becomes overdue upon default under the instrument for nonpayment of an installment, and the instrument remains overdue until the default is cured. (2) If the principal is not payable in installments and the due date has not been accelerated, the instrument becomes overdue on the day after the due date. (3) If a due date with respect to principal has been accelerated, the instrument becomes overdue on the day after the accelerated due date. (c) Unless the due date of principal has been accelerated, an instrument does not become overdue if there is default in payment of interest but no default in payment of principal.
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Ocial Comment
1. To be a holder in due course, one must take without notice that an instrument is overdue. Section 3-302(a)(2)(iii). Section 3-304 replaces subsection (3) of former Section 3-304. For the sake of clarity it treats demand and time instruments separately. Subsection (a) applies to demand instruments. A check becomes stale after 90 days. Under former Section 3-304(3)(c), a holder that took a demand note had notice that it was overdue if it was taken more than a reasonable length of time after its issue. In substitution for this test, subsection (a)(3) requires the trier of fact to look at both the circumstances of the particular case and the nature of the instrument and trade usage. Whether a demand note is stale may vary a great deal depending on the facts of the particular case. 2. Subsections (b) and (c) cover time instruments. They follow the distinction made under former Article 3 between defaults in payment of principal and interest. In subsection (b) installment instruments and single payment instruments are treated separately. If an installment is late, the instrument is overdue until the default is cured.

3-305. Defenses and Claims in Recoupment. (a) Except as otherwise provided in this section, the right to enforce the obligation of a party to pay an instrument is subject to the following: (1) a defense of the obligor based on (i) infancy of the obligor to the extent it is a defense to a simple contract, (ii) duress, lack of legal capacity, or illegality of the transaction which, under other law, nullies the obligation of the obligor, (iii) fraud that induced the obligor to sign the instrument with neither knowledge nor reasonable opportunity to learn of its character or its essential terms, or (iv) discharge of the obligor in insolvency proceedings; (2) a defense of the obligor stated in another section of this Article or a defense of the obligor that would be available if the person entitled to enforce the instrument were enforcing a right to payment under a simple contract; and (3) a claim in recoupment of the obligor against the original payee of the instrument if the claim arose from the transaction that gave rise to the instrument; but the claim of the obligor may be asserted against a transferee of the instrument only to reduce the amount owing on the instrument at the time the action is brought. (b) The right of a holder in due course to enforce the obligation of a party to pay the instrument is subject to defenses of the obligor stated in subsection (a)(1), but is not subject to defenses of the obligor stated in subsection (a)(2) or claims in recoupment stated in subsection (a)(3) against a person other than the holder. (c) Except as stated in subsection (d), in an action to enforce the obligation of a party to pay the instrument, the obligor may not assert against the person entitled to enforce the instrument a defense, claim in recoupment, or claim to the instrument (Section 3-306) of another person, but the other person's claim to the instrument may be asserted by the obligor if the other person is joined in the action and personally asserts the claim against the person entitled to enforce the instrument. An obligor is not obliged to pay the instrument if the person seeking enforcement of the instrument does not have rights of a holder in due course and the obligor proves that the instrument is a lost or stolen instrument. (d) In an action to enforce the obligation of an accommodation party to
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pay an instrument, the accommodation party may assert against the person entitled to enforce the instrument any defense or claim in recoupment under subsection (a) that the accommodated party could assert against the person entitled to enforce the instrument, except the defenses of discharge in insolvency proceedings, infancy, and lack of legal capacity. (e) In a consumer transaction, if law other than this article requires that an instrument include a statement to the eect that the rights of a holder or transferee are subject to a claim or defense that the issuer could assert against the original payee, and the instrument does not include such a statement: (1) the instrument has the same eect as if the instrument included such a statement; (2) the issuer may assert against the holder or transferee all claims and defenses that would have been available if the instrument included such a statement; and (3) the extent to which claims may be asserted against the holder or transferee is determined as if the instrument included such a statement. (f) This section is subject to law other than this article that establishes a dierent rule for consumer transactions.
Legislative Note: If a consumer protection law in this state addresses the same issue as subsection (g), it should be examined for consistency with subsection (g) and, if inconsistent, should be amended.

As amended in 2002.
See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
1. Subsection (a) states the defenses to the obligation of a party to pay the instrument. Subsection (a)(1) states the real defenses that may be asserted against any person entitled to enforce the instrument. Subsection (a)(1)(i) allows assertion of the defense of infancy against a holder in due course, even though the eect of the defense is to render the instrument voidable but not void. The policy is one of protection of the infant even at the expense of occasional loss to an innocent purchaser. No attempt is made to state when infancy is available as a defense or the conditions under which it may be asserted. In some jurisdictions it is held that an infant cannot rescind the transaction or set up the defense unless the holder is restored to the position held before the instrument was taken which, in the case of a holder in due course, is normally impossible. In other states an infant who has misrepresented age may be estopped to assert infancy. Such questions are left to other law, as an integral part of the policy of each state as to the protection of infants. Subsection (a)(1)(ii) covers mental incompetence, guardianship, ultra vires acts or lack of corporate capacity to do business, or any other incapacity apart from infancy. Such incapacity is largely statutory. Its existence and eect is left to the law of each state. If under the state law the eect is to render the obligation of the instrument entirely null and void, the defense may be asserted against a holder in due course. If the eect is merely to render the obligation voidable at the election of the obligor, the defense is cut o. Duress, which is also covered by subsection (a)(ii), is a matter of degree. An instrument signed at the point of a gun is void, even in the hands of a holder in due course. One signed under threat to prosecute the son of the maker for theft may be merely voidable, so that the defense is cut o. Illegality is most frequently a matter of gambling or usury, but may arise in other forms under a variety of statutes. The statutes dier in their provisions and the interpretations given them. They are primarily a matter of local concern and local policy. All such matters are therefore left to the local law. If under that law the eect of the duress or the illegality is to make the obligation entirely null and void, the defense may be asserted against a holder in due course. Otherwise it is cut o. 364

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Subsection (a)(1)(iii) refers to real or essential fraud, sometimes called fraud in the essence or fraud in the factum, as eective against a holder in due course. The common illustration is that of the maker who is tricked into signing a note in the belief that it is merely a receipt or some other document. The theory of the defense is that the signature on the instrument is ineective because the signer did not intend to sign such an instrument at all. Under this provision the defense extends to an instrument signed with knowledge that it is a negotiable instrument, but without knowledge of its essential terms. The test of the defense is that of excusable ignorance of the contents of the writing signed. The party must not only have been in ignorance, but must also have had no reasonable opportunity to obtain knowledge. In determining what is a reasonable opportunity all relevant factors are to be taken into account, including the intelligence, education, business experience, and ability to read or understand English of the signer. Also relevant is the nature of the representations that were made, whether the signer had good reason to rely on the representations or to have condence in the person making them, the presence or absence of any third person who might read or explain the instrument to the signer, or any other possibility of obtaining independent information, and the apparent necessity, or lack of it, for acting without delay. Unless the misrepresentation meets this test, the defense is cut o by a holder in due course. Subsection (a)(1)(iv) states specically that the defense of discharge in insolvency proceedings is not cut o when the instrument is purchased by a holder in due course. Insolvency proceedings is dened in Section 1-201(22) and it includes bankruptcy whether or not the debtor is insolvent. Subsection (2)(e) of former Section 3-305 is omitted. The substance of that provision is stated in Section 3-601(b). 2. Subsection (a)(2) states other defenses that, pursuant to subsection (b), are cut o by a holder in due course. These defenses comprise those specically stated in Article 3 and those based on common law contract principles. Article 3 defenses are nonissuance of the instrument, conditional issuance, and issuance for a special purpose (Section 3-105(b)); failure to countersign a traveler's check (Section 3-106(c)); modication of the obligation by a separate agreement (Section 3-117); payment that violates a restrictive indorsement (Section 3-206(f)); instruments issued without consideration or for which promised performance has not been given (Section 3-303(b)), and breach of warranty when a draft is accepted (Section 3-417(b)). The most prevalent common law defenses are fraud, misrepresentation or mistake in the issuance of the instrument. In most cases the holder in due course will be an immediate or remote transferee of the payee of the instrument. In most cases the holder-in-duecourse doctrine is irrelevant if defenses are being asserted against the payee of the instrument, but in a small number of cases the payee of the instrument may be a holder in due course. Those cases are discussed in Comment 4 to Section 3-302. Assume Buyer issues a note to Seller in payment of the price of goods that Seller fraudulently promises to deliver but which are never delivered. Seller negotiates the note to Holder who has no notice of the fraud. If Holder is a holder in due course, Holder is not subject to Buyer's defense of fraud. But in some cases an original party to the instrument is a holder in due course. For example, Buyer fraudulently induces Bank to issue a cashier's check to the order of Seller. The check is delivered by Bank to Seller, who has no notice of the fraud. Seller can be a holder in due course and can take the check free of Bank's defense of fraud. This case is discussed as Case # 1 in Comment 4 to Section 3-302. Former Section 3-305 stated that a holder in due course takes free of defenses of any party to the instrument with whom the holder has not dealt. The meaning of this language was not at all clear and if read literally could have produced the wrong result. In the hypothetical case, it could be argued that Seller dealt with Bank because Bank delivered the check to Seller. But it is clear that Seller should take free of Bank's defense against Buyer regardless of whether Seller took delivery of the check from Buyer or from Bank. The quoted language is not included in Section 3-305. It is not necessary. If Buyer issues an instrument to Seller and Buyer has a defense against Seller, that defense can obviously be asserted. Buyer and Seller are the only people involved. The holder-in-due-course doctrine has no relevance. The doctrine applies only to cases in which more than two parties are involved. Its essence is that the holder in due course does not have to suer the consequences of a defense of the obligor on the instrument that arose from an occurrence with a third party. 3. Subsection (a)(3) is concerned with claims in recoupment which can be illustrated by the following example. Buyer issues a note to the order of Seller in exchange for a promise 365

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of Seller to deliver specied equipment. If Seller fails to deliver the equipment or delivers equipment that is rightfully rejected, Buyer has a defense to the note because the performance that was the consideration for the note was not rendered. Section 3-303(b). This defense is included in Section 3-305(a)(2). That defense can always be asserted against Seller. This result is the same as that reached under former Section 3-408. But suppose Seller delivered the promised equipment and it was accepted by Buyer. The equipment, however, was defective. Buyer retained the equipment and incurred expenses with respect to its repair. In this case, Buyer does not have a defense under Section 3-303(b). Seller delivered the equipment and the equipment was accepted. Under Article 2, Buyer is obliged to pay the price of the equipment which is represented by the note. But Buyer may have a claim against Seller for breach of warranty. If Buyer has a warranty claim, the claim may be asserted against Seller as a counterclaim or as a claim in recoupment to reduce the amount owing on the note. It is not relevant whether Seller is or is not a holder in due course of the note or whether Seller knew or had notice that Buyer had the warranty claim. It is obvious that holder-in-due-course doctrine cannot be used to allow Seller to cut o a warranty claim that Buyer has against Seller. Subsection (b) specically covers this point by stating that a holder in due course is not subject to a claim in recoupment * * * against a person other than the holder. Suppose Seller negotiates the note to Holder. If Holder had notice of Buyer's warranty claim at the time the note was negotiated to Holder, Holder is not a holder in due course (Section 3-302(a)(2)(iv)) and Buyer may assert the claim against Holder (Section 3-305(a) (3)) but only as a claim in recoupment, i.e. to reduce the amount owed on the note. If the warranty claim is $1,000 and the unpaid note is $10,000, Buyer owes $9,000 to Holder. If the warranty claim is more than the unpaid amount of the note, Buyer owes nothing to Holder, but Buyer cannot recover the unpaid amount of the warranty claim from Holder. If Buyer had already partially paid the note, Buyer is not entitled to recover the amounts paid. The claim can be used only as an oset to amounts owing on the note. If Holder had no notice of Buyer's claim and otherwise qualies as a holder in due course, Buyer may not assert the claim against Holder. Section 3-305(b). The result under Section 3-305 is consistent with the result reached under former Article 3, but the rules for reaching the result are stated dierently. Under former Article 3 Buyer could assert rights against Holder only if Holder was not a holder in due course, and Holder's status depended upon whether Holder had notice of a defense by Buyer. Courts have held that Holder had that notice if Holder had notice of Buyer's warranty claim. The rationale under former Article 3 was failure of consideration. This rationale does not distinguish between cases in which the seller fails to perform and those in which the buyer accepts the performance of seller but makes a claim against the seller because the performance is faulty. The term failure of consideration is subject to varying interpretations and is not used in Article 3. The use of the term claim in recoupment in Section 3-305(a) (3) is a more precise statement of the nature of Buyer's right against Holder. The use of the term does not change the law because the treatment of a defense under subsection (a)(2) and a claim in recoupment under subsection (a)(3) is essentially the same. Under former Article 3, case law was divided on the issue of the extent to which an obligor on a note could assert against a transferee who is not a holder in due course a debt or other claim that the obligor had against the original payee of the instrument. Some courts limited claims to those that arose in the transaction that gave rise to the note. This is the approach taken in Section 3-305(a)(3). Other courts allowed the obligor on the note to use any debt or other claim, no matter how unrelated to the note, to oset the amount owed on the note. Under current judicial authority and non-UCC statutory law, there will be many cases in which a transferee of a note arising from a sale transaction will not qualify as a holder in due course. For example, applicable law may require the use of a note to which there cannot be a holder in due course. See Section 3-106(d) and Comment 3 to Section 3-106. It is reasonable to provide that the buyer should not be denied the right to assert claims arising out of the sale transaction. Subsection (a)(3) is based on the belief that it is not reasonable to require the transferee to bear the risk that wholly unrelated claims may also be asserted. The determination of whether a claim arose from the transaction that gave rise to the instrument is determined by law other than this Article and thus may vary as local law varies. 4. Subsection (c) concerns claims and defenses of a person other than the obligor on the instrument. It applies principally to cases in which an obligation is paid with the instru366

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ment of a third person. For example, Buyer buys goods from Seller and negotiates to Seller a cashier's check issued by Bank in payment of the price. Shortly after delivering the check to Seller, Buyer learns that Seller had defrauded Buyer in the sale transaction. Seller may enforce the check against Bank even though Seller is not a holder in due course. Bank has no defense to its obligation to pay the check and it may not assert defenses, claims in recoupment, or claims to the instrument of Buyer, except to the extent permitted by the but clause of the rst sentence of subsection (c). Buyer may have a claim to the instrument under Section 3-306 based on a right to rescind the negotiation to Seller because of Seller's fraud. Section 3-202(b) and Comment 2 to Section 3-201. Bank cannot assert that claim unless Buyer is joined in the action in which Seller is trying to enforce payment of the check. In that case Bank may pay the amount of the check into court and the court will decide whether that amount belongs to Buyer or Seller. The last sentence of subsection (c) allows the issuer of an instrument such as a cashier's check to refuse payment in the rare case in which the issuer can prove that the instrument is a lost or stolen instrument and the person seeking enforcement does not have rights of a holder in due course. 5. Subsection (d) applies to instruments signed for accommodation (Section 3-419) and this subsection equates the obligation of the accommodation party to that of the accommodated party. The accommodation party can assert whatever defense or claim the accommodated party had against the person enforcing the instrument. The only exceptions are discharge in bankruptcy, infancy and lack of capacity. The same rule does not apply to an indorsement by a holder of the instrument in negotiating the instrument. The indorser, as transferor, makes a warranty to the indorsee, as transferee, that no defense or claim in recoupment is good against the indorser. Section 3-416(a)(4). Thus, if the indorsee sues the indorser because of dishonor of the instrument, the indorser may not assert the defense or claim in recoupment of the maker or drawer against the indorsee. Section 3-305(d) must be read in conjunction with Section 3-605, which provides rules (usually referred to as suretyship defenses) for determining when the obligation of an accommodation party is discharged, in whole or in part, because of some act or omission of a person entitled to enforce the instrument. To the extent a rule stated in Section 3-605 is inconsistent with Section 3-305(d), the Section 3-605 rule governs. For example, Section 3-605(a) provides rules for determining when and to what extent a discharge of the accommodated party under Section 3-604 will discharge the accommodation party. As explained in Comment 2 to Section 3-605, discharge of the accommodated party is normally part of a settlement under which the holder of a note accepts partial payment from an accommodated party who is nancially unable to pay the entire amount of the note. If the holder then brings an action against the accommodation party to recover the remaining unpaid amount of the note, the accommodation party cannot use Section 3-305(d) to nullify Section 3-605(a) by asserting the discharge of the accommodated party as a defense. On the other hand, suppose the accommodated party is a buyer of goods who issued the note to the seller who took the note for the buyer's obligation to pay for the goods. Suppose the buyer has a claim for breach of warranty with respect to the goods against the seller and the warranty claim may be asserted against the holder of the note. The warranty claim is a claim in recoupment. If the holder and the accommodated party reach a settlement under which the holder accepts payment less than the amount of the note in full satisfaction of the note and the warranty claim, the accommodation party could defend an action on the note by the holder by asserting the accord and satisfaction under Section 3-305(d). There is no conict with Section 3-605(a) because that provision is not intended to apply to settlement of disputed claims. 6. Subsection (e) is added to clarify the treatment of an instrument that omits the notice currently required by the Federal Trade Commission Rule related to certain consumer credit sales and consumer purchase money loans (16 C.F.R. Part 433). This subsection adopts the view that the instrument should be treated as if the language required by the FTC Rule were present. It is based on the language describing that rule in Section 3-106(d) and the analogous provision in Section 9-404(d). 7. Subsection (f) is modeled on Sections 9-403(e) and 9-404(c). It ensures that Section 3-305 is interpreted to accommodate relevant consumer-protection laws. The absence of such a provision from other sections in Article 3 should not justify any inference about the meaning of those sections. 8. Articles 28 and 30 of the Convention on International Bills of Exchange and International Promissory Notes includes a similar dichotomy, with a narrower group of de367

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fenses available against a protected holder under Articles 28(1) and 30 than are available under Article 28(2) against a holder that is not a protected holder.

As amended in 2002.
See Appendix Q for material relating to changes in Ocial Comment in 2002.

3-306. Claims to an Instrument. A person taking an instrument, other than a person having rights of a holder in due course, is subject to a claim of a property or possessory right in the instrument or its proceeds, including a claim to rescind a negotiation and to recover the instrument or its proceeds. A person having rights of a holder in due course takes free of the claim to the instrument. Ocial Comment
This section expands on the reference to claims to the instrument mentioned in former Sections 3-305 and 3-306. Claims covered by the section include not only claims to ownership but also any other claim of a property or possessory right. It includes the claim to a lien or the claim of a person in rightful possession of an instrument who was wrongfully deprived of possession. Also included is a claim based on Section 3-202(b) for rescission of a negotiation of the instrument by the claimant. Claims to an instrument under Section 3-306 are dierent from claims in recoupment referred to in Section 3-305(a)(3). The rule of this section is similar to the rule of Article 30(2) of the Convention on International Bills of Exchange and International Promissory Notes. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002.

3-307. Notice of Breach of Fiduciary Duty. (a) In this section: (1) Fiduciary means an agent, trustee, partner, corporate ocer or director, or other representative owing a duciary duty with respect to an instrument. (2) Represented person means the principal, beneciary, partnership, corporation, or other person to whom the duty stated in paragraph (1) is owed. (b) If (i) an instrument is taken from a duciary for payment or collection or for value, (ii) the taker has knowledge of the duciary status of the duciary, and (iii) the represented person makes a claim to the instrument or its proceeds on the basis that the transaction of the duciary is a breach of duciary duty, the following rules apply: (1) Notice of breach of duciary duty by the duciary is notice of the claim of the represented person. (2) In the case of an instrument payable to the represented person or the duciary as such, the taker has notice of the breach of duciary duty if the instrument is (i) taken in payment of or as security for a debt known by the taker to be the personal debt of the duciary, (ii) taken in a transaction known by the taker to be for the personal benet of the duciary, or (iii) deposited to an account other than an account of the duciary, as such, or an account of the represented person. (3) If an instrument is issued by the represented person or the duciary as such, and made payable to the duciary personally, the taker does not have notice of the breach of duciary duty unless the taker knows of the breach of duciary duty.
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(4) If an instrument is issued by the represented person or the duciary as such, to the taker as payee, the taker has notice of the breach of duciary duty if the instrument is (i) taken in payment of or as security for a debt known by the taker to be the personal debt of the duciary, (ii) taken in a transaction known by the taker to be for the personal benet of the duciary, or (iii) deposited to an account other than an account of the duciary, as such, or an account of the represented person. Ocial Comment
1. This section states rules for determining when a person who has taken an instrument from a duciary has notice of a breach of duciary duty that occurs as a result of the transaction with the duciary. Former Section 3-304(2) and (4)(e) related to this issue, but those provisions were unclear in their meaning. Section 3-307 is intended to clarify the law by stating rules that comprehensively cover the issue of when the taker of an instrument has notice of breach of a duciary duty and thus notice of a claim to the instrument or its proceeds. 2. Subsection (a) denes the terms duciary and represented person and the introductory paragraph of subsection (b) describes the transaction to which the section applies. The basic scenario is one in which the duciary in eect embezzles money of the represented person by applying the proceeds of an instrument that belongs to the represented person to the personal use of the duciary. The person dealing with the duciary may be a depositary bank that takes the instrument for collection or a bank or other person that pays value for the instrument. The section also covers a transaction in which an instrument is presented for payment to a payor bank that pays the instrument by giving value to the duciary. Subsections (b)(2), (3), and (4) state rules for determining when the person dealing with the duciary has notice of breach of duciary duty. Subsection (b)(1) states that notice of breach of duciary duty is notice of the represented person's claim to the instrument or its proceeds. Under Section 3-306, a person taking an instrument is subject to a claim to the instrument or its proceeds, unless the taker has rights of a holder in due course. Under Section 3-302(a)(2)(v), the taker cannot be a holder in due course if the instrument was taken with notice of a claim under Section 3-306. Section 3-307 applies to cases in which a represented person is asserting a claim because a breach of duciary duty resulted in a misapplication of the proceeds of an instrument. The claim of the represented person is a claim described in Section 3-306. Section 3-307 states rules for determining when a person taking an instrument has notice of the claim which will prevent assertion of rights as a holder in due course. It also states rules for determining when a payor bank pays an instrument with notice of breach of duciary duty. Section 3-307(b) applies only if the person dealing with the duciary has knowledge of the duciary status of the duciary. Notice which does not amount to knowledge is not enough to cause Section 3-307 to apply. Knowledge is dened in Section 1-201(25). In most cases, the taker referred to in Section 3-307 will be a bank or other organization. Knowledge of an organization is determined by the rules stated in Section 1-201(27). In many cases, the individual who receives and processes an instrument on behalf of the organization that is the taker of the instrument for payment or collection or for value is a clerk who has no knowledge of any duciary status of the person from whom the instrument is received. In such cases, Section 3-307 doesn't apply because, under Section 1-201(27), knowledge of the organization is determined by the knowledge of the individual conducting that transaction, i.e. the clerk who receives and processes the instrument. Furthermore, paragraphs (2) and (4) each require that the person acting for the organization have knowledge of facts that indicate a breach of duciary duty. In the case of an instrument taken for deposit to an account, the knowledge is found in the fact that the deposit is made to an account other than that of the represented person or a duciary account for benet of that person. In other cases the person acting for the organization must know that the instrument is taken in payment or as security for a personal debt of the duciary or for the personal benet of the duciary. For example, if the instrument is being used to buy goods or services, the person acting for the organization must know that the goods or services are for the personal benet of the duciary. The requirement that the taker have knowledge rather than notice is meant to limit Section 3-307 to relatively uncommon cases 369

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in which the person who deals with the duciary knows all the relevant facts: the duciary status and that the proceeds of the instrument are being used for the personal debt or benet of the duciary or are being paid to an account that is not an account of the represented person or of the duciary, as such. Mere notice of these facts is not enough to put the taker on notice of the breach of duciary duty and does not give rise to any duty of investigation by the taker. 3. Subsection (b)(2) applies to instruments payable to the represented person or the duciary as such. For example, a check payable to Corporation is indorsed in the name of Corporation by Doe as its President. Doe gives the check to Bank as partial repayment of a personal loan that Bank had made to Doe. The check was indorsed either in blank or to Bank. Bank collects the check and applies the proceeds to reduce the amount owed on Doe's loan. If the person acting for Bank in the transaction knows that Doe is a duciary and that the check is being used to pay a personal obligation of Doe, subsection (b)(2) applies. If Corporation has a claim to the proceeds of the check because the use of the check by Doe was a breach of duciary duty, Bank has notice of the claim and did not take the check as a holder in due course. The same result follows if Doe had indorsed the check to himself before giving it to Bank. Subsection (b)(2) follows Uniform Fiduciaries Act 4 in providing that if the instrument is payable to the duciary, as such, or to the represented person, the taker has notice of a claim if the instrument is negotiated for the duciary's personal debt. If duciary funds are deposited to a personal account of the duciary or to an account that is not an account of the represented person or of the duciary, as such, there is a split of authority concerning whether the bank is on notice of a breach of duciary duty. Subsection (b)(2)(iii) states that the bank is given notice of breach of duciary duty because of the deposit. The Uniform Fiduciaries Act 9 states that the bank is not on notice unless it has knowledge of facts that makes its receipt of the deposit an act of bad faith. The rationale of subsection (b)(2) is that it is not normal for an instrument payable to the represented person or the duciary, as such, to be used for the personal benet of the duciary. It is likely that such use reects an unlawful use of the proceeds of the instrument. If the duciary is entitled to compensation from the represented person for services rendered or for expenses incurred by the duciary the normal mode of payment is by a check drawn on the duciary account to the order of the duciary. 4. Subsection (b)(3) is based on Uniform Fiduciaries Act 6 and applies when the instrument is drawn by the represented person or the duciary as such to the duciary personally. The term personally is used as it is used in the Uniform Fiduciaries Act to mean that the instrument is payable to the payee as an individual and not as a duciary. For example, Doe as President of Corporation writes a check on Corporation's account to the order of Doe personally. The check is then indorsed over to Bank as in Comment 3. In this case there is no notice of breach of duciary duty because there is nothing unusual about the transaction. Corporation may have owed Doe money for salary, reimbursement for expenses incurred for the benet of Corporation, or for any other reason. If Doe is authorized to write checks on behalf of Corporation to pay debts of Corporation, the check is a normal way of paying a debt owed to Doe. Bank may assume that Doe may use the instrument for his personal benet. 5. Subsection (b)(4) can be illustrated by a hypothetical case. Corporation draws a check payable to an organization. X, an ocer or employee of Corporation, delivers the check to a person acting for the organization. The person signing the check on behalf of Corporation is X or another person. If the person acting for the organization in the transaction knows that X is a duciary, the organization is on notice of a claim by Corporation if it takes the instrument under the same circumstances stated in subsection (b)(2). If the organization is a bank and the check is taken in repayment of a personal loan of the bank to X, the case is like the case discussed in Comment 3. It is unusual for Corporation, the represented person, to pay a personal debt of Doe by issuing a check to the bank. It is more likely that the use of the check by Doe reects an unlawful use of the proceeds of the check. The same analysis applies if the check is made payable to an organization in payment of goods or services. If the person acting for the organization knew of the duciary status of X and that the goods or services were for X's personal benet, the organization is on notice of a claim by Corporation to the proceeds of the check. See the discussion in the last paragraph of Comment 2.

3-308. Proof of Signatures and Status as Holder in Due Course. (a) In an action with respect to an instrument, the authenticity of, and
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authority to make, each signature on the instrument is admitted unless specically denied in the pleadings. If the validity of a signature is denied in the pleadings, the burden of establishing validity is on the person claiming validity, but the signature is presumed to be authentic and authorized unless the action is to enforce the liability of the purported signer and the signer is dead or incompetent at the time of trial of the issue of validity of the signature. If an action to enforce the instrument is brought against a person as the undisclosed principal of a person who signed the instrument as a party to the instrument, the plainti has the burden of establishing that the defendant is liable on the instrument as a represented person under Section 3-402(a). (b) If the validity of signatures is admitted or proved and there is compliance with subsection (a), a plainti producing the instrument is entitled to payment if the plainti proves entitlement to enforce the instrument under Section 3-301, unless the defendant proves a defense or claim in recoupment. If a defense or claim in recoupment is proved, the right to payment of the plainti is subject to the defense or claim, except to the extent the plainti proves that the plainti has rights of a holder in due course which are not subject to the defense or claim. Ocial Comment
1. Section 3-308 is a modication of former Section 3-307. The rst two sentences of subsection (a) are a restatement of former Section 3-307(1). The purpose of the requirement of a specic denial in the pleadings is to give the plainti notice of the defendant's claim of forgery or lack of authority as to the particular signature, and to aord the plainti an opportunity to investigate and obtain evidence. If local rules of pleading permit, the denial may be on information and belief, or it may be a denial of knowledge or information sufcient to form a belief. It need not be under oath unless the local statutes or rules require verication. In the absence of such specic denial the signature stands admitted, and is not in issue. Nothing in this section is intended, however, to prevent amendment of the pleading in a proper case. The question of the burden of establishing the signature arises only when it has been put in issue by specic denial. Burden of establishing is dened in Section 1-201. The burden is on the party claiming under the signature, but the signature is presumed to be authentic and authorized except as stated in the second sentence of subsection (a). Presumed is dened in Section 1-201 and means that until some evidence is introduced which would support a nding that the signature is forged or unauthorized, the plainti is not required to prove that it is valid. The presumption rests upon the fact that in ordinary experience forged or unauthorized signatures are very uncommon, and normally any evidence is within the control of, or more accessible to, the defendant. The defendant is therefore required to make some sucient showing of the grounds for the denial before the plainti is required to introduce evidence. The defendant's evidence need not be sucient to require a directed verdict, but it must be enough to support the denial by permitting a nding in the defendant's favor. Until introduction of such evidence the presumption requires a nding for the plainti. Once such evidence is introduced the burden of establishing the signature by a preponderance of the total evidence is on the plainti. The presumption does not arise if the action is to enforce the obligation of a purported signer who has died or become incompetent before the evidence is required, and so is disabled from obtaining or introducing it. Action is dened in Section 1-201 and includes a claim asserted against the estate of a deceased or an incompetent. The last sentence of subsection (a) is a new provision that is necessary to take into account Section 3-402(a) that allows an undisclosed principal to be liable on an instrument signed by an authorized representative. In that case the person enforcing the instrument must prove that the undisclosed principal is liable. 2. Subsection (b) restates former Section 3-307(2) and (3). Once signatures are proved or admitted a holder, by mere production of the instrument, proves entitlement to enforce the 371

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instrument because under Section 3-301 a holder is a person entitled to enforce the instrument. Any other person in possession of an instrument may recover only if that person has the rights of a holder. Section 3-301. That person must prove a transfer giving that person such rights under Section 3-203(b) or that such rights were obtained by subrogation or succession. If a plainti producing the instrument proves entitlement to enforce the instrument, either as a holder or a person with rights of a holder, the plainti is entitled to recovery unless the defendant proves a defense or claim in recoupment. Until proof of a defense or claim in recoupment is made, the issue as to whether the plainti has rights of a holder in due course does not arise. In the absence of a defense or claim in recoupment, any person entitled to enforce the instrument is entitled to recover. If a defense or claim in recoupment is proved, the plainti may seek to cut o the defense or claim in recoupment by proving that the plainti is a holder in due course or that the plainti has rights of a holder in due course under Section 3-203(b) or by subrogation or succession. All elements of Section 3-302(a) must be proved. Nothing in this section is intended to say that the plainti must necessarily prove rights as a holder in due course. The plainti may elect to introduce no further evidence, in which case a verdict may be directed for the plainti or the defendant, or the issue of the defense or claim in recoupment may be left to the trier of fact, according to the weight and suciency of the defendant's evidence. The plainti may elect to rebut the defense or claim in recoupment by proof to the contrary, in which case a verdict may be directed for either party or the issue may be for the trier of fact. Subsection (b) means only that if the plainti claims the rights of a holder in due course against the defense or claim in recoupment, the plainti has the burden of proof on that issue.

3-309. Enforcement of Lost, Destroyed, or Stolen Instrument. (a) A person not in possession of an instrument is entitled to enforce the instrument if: (1) the person seeking to enforce the instrument: (A) was entitled to enforce the instrument when loss of possession occurred; or (B) has directly or indirectly acquired ownership of the instrument from a person who was entitled to enforce the instrument when loss of possession occurred; (2) the loss of possession was not the result of a transfer by the person or a lawful seizure; and (3) the person cannot reasonably obtain possession of the instrument because the instrument was destroyed, its whereabouts cannot be determined, or it is in the wrongful possession of an unknown person or a person that cannot be found or is not amenable to service of process. (b) A person seeking enforcement of an instrument under subsection (a) must prove the terms of the instrument and the person's right to enforce the instrument. If that proof is made, Section 3-308 applies to the case as if the person seeking enforcement had produced the instrument. The court may not enter judgment in favor of the person seeking enforcement unless it nds that the person required to pay the instrument is adequately protected against loss that might occur by reason of a claim by another person to enforce the instrument. Adequate protection may be provided by any reasonable means. As amended in 2002.
See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
1. Section 3-309 is a modication of former Section 3-804. The rights stated are those of a person entitled to enforce the instrument at the time of loss rather than those of an 372

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owner as in former Section 3-804. Under subsection (b), judgment to enforce the instrument cannot be given unless the court nds that the defendant will be adequately protected against a claim to the instrument by a holder that may appear at some later time. The court is given discretion in determining how adequate protection is to be assured. Former Section 3-804 allowed the court to require security indemnifying the defendant against loss. Under Section 3-309 adequate protection is a exible concept. For example, there is substantial risk that a holder in due course may make a demand for payment if the instrument was payable to bearer when it was lost or stolen. On the other hand if the instrument was payable to the person who lost the instrument and that person did not indorse the instrument, no other person could be a holder of the instrument. In some cases there is risk of loss only if there is doubt about whether the facts alleged by the person who lost the instrument are true. Thus, the type of adequate protection that is reasonable in the circumstances may depend on the degree of certainty about the facts in the case. 2. Subsection (a) is intended to reject the result in Dennis Joslin Co. v. Robinson Broadcasting Corp., 977 F. Supp. 491 (D.D.C. 1997). A transferee of a lost instrument need prove only that its transferor was entitled to enforce, not that the transferee was in possession at the time the instrument was lost. The protections of subsection (a) should also be available when instruments are lost during transit, because whatever the precise status of ownership at the point of loss, either the sender or the receiver ordinarily would have been entitled to enforce the instrument during the course of transit. The amendments to subsection (a) are not intended to alter in any way the rules that apply to the preservation of checks in connection with truncation or any other expedited method of check collection or processing. 3. A security interest may attach to the right of a person not in possession of an instrument to enforce the instrument. Although the secured party may not be the owner of the instrument, the secured party may nevertheless be entitled to exercise its debtor's right to enforce the instrument by resorting to its collection rights under the circumstances described in Section 9-607. This section does not address whether the person required to pay the instrument owes any duty to a secured party that is not itself the owner of the instrument.

As amended in 2002.
See Appendix Q for material relating to changes in Ocial Comment in 2002.

3-310. Eect of Instrument on Obligation for Which Taken. (a) Unless otherwise agreed, if a certied check, cashier's check, or teller's check is taken for an obligation, the obligation is discharged to the same extent discharge would result if an amount of money equal to the amount of the instrument were taken in payment of the obligation. Discharge of the obligation does not aect any liability that the obligor may have as an indorser of the instrument. (b) Unless otherwise agreed and except as provided in subsection (a), if a note or an uncertied check is taken for an obligation, the obligation is suspended to the same extent the obligation would be discharged if an amount of money equal to the amount of the instrument were taken, and the following rules apply: (1) In the case of an uncertied check, suspension of the obligation continues until dishonor of the check or until it is paid or certied. Payment or certication of the check results in discharge of the obligation to the extent of the amount of the check. (2) In the case of a note, suspension of the obligation continues until dishonor of the note or until it is paid. Payment of the note results in discharge of the obligation to the extent of the payment. (3) Except as provided in paragraph (4), if the check or note is
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dishonored and the obligee of the obligation for which the instrument was taken is the person entitled to enforce the instrument, the obligee may enforce either the instrument or the obligation. In the case of an instrument of a third person which is negotiated to the obligee by the obligor, discharge of the obligor on the instrument also discharges the obligation. (4) If the person entitled to enforce the instrument taken for an obligation is a person other than the obligee, the obligee may not enforce the obligation to the extent the obligation is suspended. If the obligee is the person entitled to enforce the instrument but no longer has possession of it because it was lost, stolen, or destroyed, the obligation may not be enforced to the extent of the amount payable on the instrument, and to that extent the obligee's rights against the obligor are limited to enforcement of the instrument. (c) If an instrument other than one described in subsection (a) or (b) is taken for an obligation, the eect is (i) that stated in subsection (a) if the instrument is one on which a bank is liable as maker or acceptor, or (ii) that stated in subsection (b) in any other case. Ocial Comment
1. Section 3-310 is a modication of former Section 3-802. As a practical matter, application of former Section 3-802 was limited to cases in which a check or a note was given for an obligation. Subsections (a) and (b) of Section 3-310 are therefore stated in terms of checks and notes in the interests of clarity. Subsection (c) covers the rare cases in which some other instrument is given to pay an obligation. 2. Subsection (a) deals with the case in which a certied check, cashier's check or teller's check is given in payment of an obligation. In that case the obligation is discharged unless there is an agreement to the contrary. Subsection (a) drops the exception in former Section 3-802 for cases in which there is a right of recourse on the instrument against the obligor. Under former Section 3-802(1)(a) the obligation was not discharged if there was a right of recourse on the instrument against the obligor. Subsection (a) changes this result. The underlying obligation is discharged, but any right of recourse on the instrument is preserved. 3. Subsection (b) concerns cases in which an uncertied check or a note is taken for an obligation. The typical case is that in which a buyer pays for goods or services by giving the seller the buyer's personal check, or in which the buyer signs a note for the purchase price. Subsection (b) also applies to the uncommon cases in which a check or note of a third person is given in payment of the obligation. Subsection (b) preserves the rule under former Section 3-802(1)(b) that the buyer's obligation to pay the price is suspended, but subsection (b) spells out the eect more precisely. If the check or note is dishonored, the seller may sue on either the dishonored instrument or the contract of sale if the seller has possession of the instrument and is the person entitled to enforce it. If the right to enforce the instrument is held by somebody other than the seller, the seller can't enforce the right to payment of the price under the sales contract because that right is represented by the instrument which is enforceable by somebody else. Thus, if the seller sold the note or the check to a holder and has not reacquired it after dishonor, the only right that survives is the right to enforce the instrument. What that means is that even though the suspension of the obligation may end upon dishonor under paragraph (b)(1), the obligation is not revived in the circumstances described in paragraph (b)(4). Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002. The last sentence of subsection (b)(3) applies to cases in which an instrument of another person is indorsed over to the obligee in payment of the obligation. For example, Buyer delivers an uncertied personal check of X payable to the order of Buyer to Seller in payment of the price of goods. Buyer indorses the check over to Seller. Buyer is liable on the check as indorser. If Seller neglects to present the check for payment or to deposit it for collection within 30 days of the indorsement, Buyer's liability as indorser is discharged. 374

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Section 3-415(e). Under the last sentence of Section 3-310(b)(3) Buyer is also discharged on the obligation to pay for the goods. 4. There was uncertainty concerning the applicability of former Section 3-802 to the case in which the check given for the obligation was stolen from the payee, the payee's signature was forged, and the forger obtained payment. The last sentence of subsection (b)(4) addresses this issue. If the payor bank pays a holder, the drawer is discharged on the underlying obligation because the check was paid. Subsection (b)(1). If the payor bank pays a person not entitled to enforce the instrument, as in the hypothetical case, the suspension of the underlying obligation continues because the check has not been paid. Section 3-602(a). The payee's cause of action is against the depositary bank or payor bank in conversion under Section 3-420 or against the drawer under Section 3-309. In the latter case, the drawer's obligation under Section 3-414(b) is triggered by dishonor which occurs because the check is unpaid. Presentment for payment to the drawee is excused under Section 3-504(a)(i) and, under Section 3-502(e), dishonor occurs without presentment if the check is not paid. The payee cannot merely ignore the instrument and sue the drawer on the underlying contract. This would impose on the drawer the risk that the check when stolen was indorsed in blank or to bearer. A similar analysis applies with respect to lost instruments that have not been paid. If a creditor takes a check of the debtor in payment of an obligation, the obligation is suspended under the introductory paragraph of subsection (b). If the creditor then loses the check, what are the creditor's rights? The creditor can request the debtor to issue a new check and in many cases, the debtor will issue a replacement check after stopping payment on the lost check. In that case both the debtor and creditor are protected. But the debtor is not obliged to issue a new check. If the debtor refuses to issue a replacement check, the last sentence of subsection (b)(4) applies. The creditor may not enforce the obligation of debtor for which the check was taken. The creditor may assert only rights on the check. The creditor can proceed under Section 3-309 to enforce the obligation of the debtor, as drawer, to pay the check. 5. Subsection (c) deals with rare cases in which other instruments are taken for obligations. If a bank is the obligor on the instrument, subsection (a) applies and the obligation is discharged. In any other case subsection (b) applies.

3-311. Accord and Satisfaction by Use of Instrument. (a) If a person against whom a claim is asserted proves that (i) that person in good faith tendered an instrument to the claimant as full satisfaction of the claim, (ii) the amount of the claim was unliquidated or subject to a bona de dispute, and (iii) the claimant obtained payment of the instrument, the following subsections apply. (b) Unless subsection (c) applies, the claim is discharged if the person against whom the claim is asserted proves that the instrument or an accompanying written communication contained a conspicuous statement to the eect that the instrument was tendered as full satisfaction of the claim. (c) Subject to subsection (d), a claim is not discharged under subsection (b) if either of the following applies: (1) The claimant, if an organization, proves that (i) within a reasonable time before the tender, the claimant sent a conspicuous statement to the person against whom the claim is asserted that communications concerning disputed debts, including an instrument tendered as full satisfaction of a debt, are to be sent to a designated person, oce, or place, and (ii) the instrument or accompanying communication was not received by that designated person, oce, or place. (2) The claimant, whether or not an organization, proves that within 90 days after payment of the instrument, the claimant tendered repay375

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ment of the amount of the instrument to the person against whom the claim is asserted. This paragraph does not apply if the claimant is an organization that sent a statement complying with paragraph (1)(i). (d) A claim is discharged if the person against whom the claim is asserted proves that within a reasonable time before collection of the instrument was initiated, the claimant, or an agent of the claimant having direct responsibility with respect to the disputed obligation, knew that the instrument was tendered in full satisfaction of the claim. Ocial Comment
1. This section deals with an informal method of dispute resolution carried out by use of a negotiable instrument. In the typical case there is a dispute concerning the amount that is owed on a claim. Case # 1. The claim is for the price of goods or services sold to a consumer who asserts that he or she is not obliged to pay the full price for which the consumer was billed because of a defect or breach of warranty with respect to the goods or services. Case # 2. A claim is made on an insurance policy. The insurance company alleges that it is not liable under the policy for the amount of the claim. In either case the person against whom the claim is asserted may attempt an accord and satisfaction of the disputed claim by tendering a check to the claimant for some amount less than the full amount claimed by the claimant. A statement will be included on the check or in a communication accompanying the check to the eect that the check is oered as full payment or full satisfaction of the claim. Frequently, there is also a statement to the eect that obtaining payment of the check is an agreement by the claimant to a settlement of the dispute for the amount tendered. Before enactment of revised Article 3, the case law was in conict over the question of whether obtaining payment of the check had the eect of an agreement to the settlement proposed by the debtor. This issue was governed by a common law rule, but some courts hold that the common law was modied by former Section 1-207 which they interpreted as applying to full settlement checks. 2. Comment d. to Restatement of Contracts, Section 281 discusses the full satisfaction check and the applicable common law rule. In a case like Case # 1, the buyer can propose a settlement of the disputed bill by a clear notation on the check indicating that the check is tendered as full satisfaction of the bill. Under the common law rule the seller, by obtaining payment of the check accepts the oer of compromise by the buyer. The result is the same if the seller adds a notation to the check indicating that the check is accepted under protest or in only partial satisfaction of the claim. Under the common law rule the seller can refuse the check or can accept it subject to the condition stated by the buyer, but the seller can't accept the check and refuse to be bound by the condition. The rule applies only to an unliquidated claim or a claim disputed in good faith by the buyer. The dispute in the courts was whether Section 1-207 changed the common law rule. The Restatement states that section need not be read as changing this well-established rule. 3. As part of the revision of Article 3, Section 1-207 has been amended to add subsection (2) stating that Section 1-207 does not apply to an accord and satisfaction. Because of that amendment and revised Article 3, Section 3-311 governs full satisfaction checks. Section 3-311 follows the common law rule with some minor variations to reect modern business conditions. In cases covered by Section 3-311 there will often be an individual on one side of the dispute and a business organization on the other. This section is not designed to favor either the individual or the business organization. In Case # 1 the person seeking the accord and satisfaction is an individual. In Case # 2 the person seeking the accord and satisfaction is an insurance company. Section 3-311 is based on a belief that the common law rule produces a fair result and that informal dispute resolution by full satisfaction checks should be encouraged. 4. Subsection (a) states three requirements for application of Section 3-311. Good faith in subsection (a)(i) is dened in Section 3-103(a)(6) as not only honesty in fact, but the observance of reasonable commercial standards of fair dealing. The meaning of fair dealing will depend upon the facts in the particular case. For example, suppose an insurer tenders a check in settlement of a claim for personal injury in an accident clearly covered by the insurance policy. The claimant is necessitous and the amount of the check is very small in re376

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lationship to the extent of the injury and the amount recoverable under the policy. If the trier of fact determines that the insurer was taking unfair advantage of the claimant, an accord and satisfaction would not result from payment of the check because of the absence of good faith by the insurer in making the tender. Another example of lack of good faith is found in the practice of some business debtors in routinely printing full satisfaction language on their check stocks so that all or a large part of the debts of the debtor are paid by checks bearing the full satisfaction language, whether or not there is any dispute with the creditor. Under such a practice the claimant cannot be sure whether a tender in full satisfaction is or is not being made. Use of a check on which full satisfaction language was axed routinely pursuant to such a business practice may prevent an accord and satisfaction on the ground that the check was not tendered in good faith under subsection (a)(i). Section 3-311 does not apply to cases in which the debt is a liquidated amount and not subject to a bona de dispute. Subsection (a)(ii). Other law applies to cases in which a debtor is seeking discharge of such a debt by paying less than the amount owed. For the purpose of subsection (a)(iii) obtaining acceptance of a check is considered to be obtaining payment of the check. The person seeking the accord and satisfaction must prove that the requirements of subsection (a) are met. If that person also proves that the statement required by subsection (b) was given, the claim is discharged unless subsection (c) applies. Normally the statement required by subsection (b) is written on the check. Thus, the canceled check can be used to prove the statement as well as the fact that the claimant obtained payment of the check. Subsection (b) requires a conspicuous statement that the instrument was tendered in full satisfaction of the claim. Conspicuous is dened in Section 1-201(10). The statement is conspicuous if it is so written that a reasonable person against whom it is to operate ought to have noticed it. If the claimant can reasonably be expected to examine the check, almost any statement on the check should be noticed and is therefore conspicuous. In cases in which the claimant is an individual the claimant will receive the check and will normally indorse it. Since the statement concerning tender in full satisfaction normally will appear above the space provided for the claimant's indorsement of the check, the claimant ought to have noticed the statement. 5. Subsection (c)(1) is a limitation on subsection (b) in cases in which the claimant is an organization. It is designed to protect the claimant against inadvertent accord and satisfaction. If the claimant is an organization payment of the check might be obtained without notice to the personnel of the organization concerned with the disputed claim. Some business organizations have claims against very large numbers of customers. Examples are department stores, public utilities and the like. These claims are normally paid by checks sent by customers to a designated oce at which clerks employed by the claimant or a bank acting for the claimant process the checks and record the amounts paid. If the processing oce is not designed to deal with communications extraneous to recording the amount of the check and the account number of the customer, payment of a full satisfaction check can easily be obtained without knowledge by the claimant of the existence of the full satisfaction statement. This is particularly true if the statement is written on the reverse side of the check in the area in which indorsements are usually written. Normally, the clerks of the claimant have no reason to look at the reverse side of checks. Indorsement by the claimant normally is done by mechanical means or there may be no indorsement at all. Section 4-205(a). Subsection (c)(1) allows the claimant to protect itself by advising customers by a conspicuous statement that communications regarding disputed debts must be sent to a particular person, oce, or place. The statement must be given to the customer within a reasonable time before the tender is made. This requirement is designed to assure that the customer has reasonable notice that the full satisfaction check must be sent to a particular place. The reasonable time requirement could be satised by a notice on the billing statement sent to the customer. If the full satisfaction check is sent to the designated destination and the check is paid, the claim is discharged. If the claimant proves that the check was not received at the designated destination the claim is not discharged unless subsection (d) applies. 6. Subsection (c)(2) is also designed to prevent inadvertent accord and satisfaction. It can be used by a claimant other than an organization or by a claimant as an alternative to subsection (c)(1). Some organizations may be reluctant to use subsection (c)(1) because it may result in confusion of customers that causes checks to be routinely sent to the special designated person, oce, or place. Thus, much of the benet of rapid processing of checks 377

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may be lost. An organization that chooses not to send a notice complying with subsection (c)(1)(i) may prevent an inadvertent accord and satisfaction by complying with subsection (c)(2). If the claimant discovers that it has obtained payment of a full satisfaction check, it may prevent an accord and satisfaction if, within 90 days of the payment of the check, the claimant tenders repayment of the amount of the check to the person against whom the claim is asserted. 7. Subsection (c) is subject to subsection (d). If a person against whom a claim is asserted proves that the claimant obtained payment of a check known to have been tendered in full satisfaction of the claim by the claimant or an agent of the claimant having direct responsibility with respect to the disputed obligation, the claim is discharged even if (i) the check was not sent to the person, oce, or place required by a notice complying with subsection (c)(1), or (ii) the claimant tendered repayment of the amount of the check in compliance with subsection (c)(2). A claimant knows that a check was tendered in full satisfaction of a claim when the claimant has actual knowledge of that fact. Section 1-201(25). Under Section 1-201(27), if the claimant is an organization, it has knowledge that a check was tendered in full satisfaction of the claim when that fact is
brought to the attention of the individual conducting that transaction, and in any event when it would have been brought to his attention if the organization had exercised due diligence. An organization exercises due diligence if it maintains reasonable routines for communicating signicant information to the person conducting the transaction and there is reasonable compliance with the routines. Due diligence does not require an individual acting for the organization to communicate information unless such communication is part of his regular duties or unless he has reason to know of the transaction and that the transaction would be materially aected by the information.

With respect to an attempted accord and satisfaction the individual conducting that transaction is an employee or other agent of the organization having direct responsibility with respect to the dispute. For example, if the check and communication are received by a collection agency acting for the claimant to collect the disputed claim, obtaining payment of the check will result in an accord and satisfaction even if the claimant gave notice, pursuant to subsection (c)(1), that full satisfaction checks be sent to some other oce. Similarly, if a customer asserting a claim for breach of warranty with respect to defective goods purchased in a retail outlet of a large chain store delivers the full satisfaction check to the manager of the retail outlet at which the goods were purchased, obtaining payment of the check will also result in an accord and satisfaction. On the other hand, if the check is mailed to the chief executive ocer of the chain store subsection (d) would probably not be satised. The chief executive ocer of a large corporation may have general responsibility for operations of the company, but does not normally have direct responsibility for resolving a small disputed bill to a customer. A check for a relatively small amount mailed to a high executive ocer of a large organization is not likely to receive the executive's personal attention. Rather, the check would normally be routinely sent to the appropriate oce for deposit and credit to the customer's account. If the check does receive the personal attention of the high executive ocer and the ocer is aware of the full-satisfaction language, collection of the check will result in an accord and satisfaction because subsection (d) applies. In this case the ocer has assumed direct responsibility with respect to the disputed transaction. If a full satisfaction check is sent to a lock box or other oce processing checks sent to the claimant, it is irrelevant whether the clerk processing the check did or did not see the statement that the check was tendered as full satisfaction of the claim. Knowledge of the clerk is not imputed to the organization because the clerk has no responsibility with respect to an accord and satisfaction. Moreover, there is no failure of due diligence under Section 1-201(27) if the claimant does not require its clerks to look for full satisfaction statements on checks or accompanying communications. Nor is there any duty of the claimant to assign that duty to its clerks. Section 3-311(c) is intended to allow a claimant to avoid an inadvertent accord and satisfaction by complying with either subsection (c)(1) or (2) without burdening the check-processing operation with extraneous and wasteful additional duties. 8. In some cases the disputed claim may have been assigned to a nance company or bank as part of a nancing arrangement with respect to accounts receivable. If the account debtor was notied of the assignment, the claimant is the assignee of the account receivable and the agent of the claimant in subsection (d) refers to an agent of the assignee. 378

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3-312. Lost, Destroyed, or Stolen Cashier's Check, Teller's Check, or Certied Check.* (a) In this section: (1) Check means a cashier's check, teller's check, or certied check. (2) Claimant means a person who claims the right to receive the amount of a cashier's check, teller's check, or certied check that was lost, destroyed, or stolen. (3) Declaration of loss means a statement, made in a record under penalty of perjury, to the eect that (i) the declarer lost possession of a check, (ii) the declarer is the drawer or payee of the check, in the case of a certied check, or the remitter or payee of the check, in the case of a cashier's check or teller's check, (iii) the loss of possession was not the result of a transfer by the declarer or a lawful seizure, and (iv) the declarer cannot reasonably obtain possession of the check because the check was destroyed, its whereabouts cannot be determined, or it is in the wrongful possession of an unknown person or a person that cannot be found or is not amenable to service of process. (4) Obligated bank means the issuer of a cashier's check or teller's check or the acceptor of a certied check. (b) A claimant may assert a claim to the amount of a check by a communication to the obligated bank describing the check with reasonable certainty and requesting payment of the amount of the check, if (i) the claimant is the drawer or payee of a certied check or the remitter or payee of a cashier's check or teller's check, (ii) the communication contains or is accompanied by a declaration of loss of the claimant with respect to the check, (iii) the communication is received at a time and in a manner aording the bank a reasonable time to act on it before the check is paid, and (iv) the claimant provides reasonable identication if requested by the obligated bank. Delivery of a declaration of loss is a warranty of the truth of the statements made in the declaration. If a claim is asserted in compliance with this subsection, the following rules apply: (1) The claim becomes enforceable at the later of (i) the time the claim is asserted, or (ii) the 90th day following the date of the check, in the case of a cashier's check or teller's check, or the 90th day following the date of the acceptance, in the case of a certied check. (2) Until the claim becomes enforceable, it has no legal eect and the obligated bank may pay the check or, in the case of a teller's check, may permit the drawee to pay the check. Payment to a person entitled to enforce the check discharges all liability of the obligated bank with respect to the check. (3) If the claim becomes enforceable before the check is presented for payment, the obligated bank is not obliged to pay the check. (4) When the claim becomes enforceable, the obligated bank becomes
[Section 3-312] *[Section 3-312 was not adopted as part of the 1990 Ocial Text of Revised Article 3. It was ocially approved and recommended for enactment in all states in August 1991 by the National Conference of Commissioners on Uniform State Laws.]

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obliged to pay the amount of the check to the claimant if payment of the check has not been made to a person entitled to enforce the check. Subject to Section 4-302(a)(1), payment to the claimant discharges all liability of the obligated bank with respect to the check. (c) If the obligated bank pays the amount of a check to a claimant under subsection (b)(4) and the check is presented for payment by a person having rights of a holder in due course, the claimant is obliged to (i) refund the payment to the obligated bank if the check is paid, or (ii) pay the amount of the check to the person having rights of a holder in due course if the check is dishonored. (d) If a claimant has the right to assert a claim under subsection (b) and is also a person entitled to enforce a cashier's check, teller's check, or certied check which is lost, destroyed, or stolen, the claimant may assert rights with respect to the check either under this section or Section 3-309. Added in 1991 and amended in 2002.
See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
1. This section applies to cases in which a cashier's check, teller's check, or certied check is lost, destroyed, or stolen. In one typical case a customer of a bank closes his or her account and takes a cashier's check or teller's check of the bank as payment of the amount of the account. The customer may be moving to a new area and the check is to be used to open a bank account in that area. In such a case the check will normally be payable to the customer. In another typical case a cashier's check or teller's check is bought from a bank for the purpose of paying some obligation of the buyer of the check. In such a case the check may be made payable to the customer and then negotiated to the creditor by indorsement. But often, the payee of the check is the creditor. In the latter case the customer is a remitter. The section covers loss of the check by either the remitter or the payee. The section also covers loss of a certied check by either the drawer or payee. Under Section 3-309 a person seeking to enforce a lost, destroyed, or stolen cashier's check or teller's check may be required by the court to give adequate protection to the issuing bank against loss that might occur by reason of the claim by another person to enforce the check. This might require the posting of an expensive bond for the amount of the check. The purpose of Section 3-312 is to oer a person who loses such a check a means of getting refund of the amount of the check within a reasonable period of time without the expense of posting a bond and with full protection of the obligated bank. 2. A claim to the amount of a lost, destroyed, or stolen cashier's check, teller's check, or certied check may be made under subsection (b) if the following requirements of that subsection are met. First, a claim may be asserted only by the drawer or payee of a certied check or the remitter or payee of a cashier's check or teller's check. An indorsee of a check is not covered because the indorsee is not an original party to the check or a remitter. Limitation to an original party or remitter gives the obligated bank the ability to determine, at the time it becomes obligated on the check, the identity of the person or persons who can assert a claim with respect to the check. The bank is not faced with having to determine the rights of some person who was not a party to the check at that time or with whom the bank had not dealt. If a cashier's check is issued to the order of the person who purchased it from the bank and that person indorses it over to a third person who loses the check, the third person may assert rights to enforce the check under Section 3-309 but has no rights under Section 3-312. Second, the claim must be asserted by a communication to the obligated bank describing the check with reasonable certainty and requesting payment of the amount of the check. Obligated bank is dened in subsection (a)(4). Third, the communication must be received in time to allow the obligated bank to act on the claim before the check is paid, and the claimant must provide reasonable identication if requested. Subsections (b)(iii) and (iv). Fourth, the communication must contain or be accompanied by a declaration of loss described in subsection (b). This declaration is an adavit or other writing made under 380

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penalty of perjury alleging the loss, destruction, or theft of the check and stating that the declarer is a person entitled to assert a claim, i.e. the drawer or payee of a certied check or the remitter or payee of a cashier's check or teller's check. A claimant who delivers a declaration of loss makes a warranty of the truth of the statements made in the declaration. The warranty is made to the obligated bank and anybody who has a right to enforce the check. If the declaration of loss falsely alleges loss of a cashier's check that did not in fact occur, a holder of the check who was unable to obtain payment because subsection (b)(3) and (4) caused the obligated bank to dishonor the check would have a cause of action against the declarer for breach of warranty. The obligated bank may not impose additional requirements on the claimant to assert a claim under subsection (b). For example, the obligated bank may not require the posting of a bond or other form of security. Section 3-312(b) states the procedure for asserting claims covered by the section. Thus, procedures that may be stated in other law for stating claims to property do not apply and are displaced within the meaning of Section 1-103. 3. A claim asserted under subsection (b) does not have any legal eect, however, until the date it becomes enforceable, which cannot be earlier than 90 days after the date of a cashier's check or teller's check or 90 days after the date of acceptance of a certied check. Thus, if a lost check is presented for payment within the 90-day period, the bank may pay a person entitled to enforce the check without regard to the claim and is discharged of all liability with respect to the check. This ensures the continued utility of cashier's checks, teller's checks, and certied checks as cash equivalents. Virtually all such checks are presented for payment within 90 days. If the claim becomes enforceable and payment has not been made to a person entitled to enforce the check, the bank becomes obligated to pay the amount of the check to the claimant. Subsection (b)(4). When the bank becomes obligated to pay the amount of the check to the claimant, the bank is relieved of its obligation to pay the check. Subsection (b)(3). Thus, any person entitled to enforce the check, including even a holder in due course, loses the right to enforce the check after a claim under subsection (b) becomes enforceable. If the obligated bank pays the claimant under subsection (b)(4), the bank is discharged of all liability with respect to the check. The only exception is the unlikely case in which the obligated bank subsequently incurs liability under Section 4-302(a)(1) with respect to the check. For example, Obligated Bank is the issuer of a cashier's check and, after a claim becomes enforceable, it pays the claimant under subsection (b)(4). Later the check is presented to Obligated Bank for payment over the counter. Under subsection (b)(3), Obligated Bank is not obliged to pay the check and may dishonor the check by returning it to the person who presented it for payment. But the normal rules of check collection are not affected by Section 3-312. If Obligated Bank retains the check beyond midnight of the day of presentment without settling for it, it becomes accountable for the amount of the check under Section 4-302(a)(1) even though it had no obligation to pay the check. An obligated bank that pays the amount of a check to a claimant under subsection (b)(4) is discharged of all liability on the check so long as the assertion of the claim meets the requirements of subsection (b) discussed in Comment 2. This is important in cases of fraudulent declarations of loss. For example, if the claimant falsely alleges a loss that in fact did not occur, the bank, subject to Section 1-203, may rely on the declaration of loss. On the other hand, a claim may be asserted only by a person described in subsection (b)(i). Thus, the bank is discharged under subsection (a)(4) only if it pays such a person. Although it is highly unlikely, it is possible that more than one person could assert a claim under subsection (b) to the amount of a check. Such a case could occur if one of the claimants makes a false declaration of loss. The obligated bank is not required to determine whether a claimant who complies with subsection (b) is acting wrongfully. The bank may utilize procedures outside this Article, such as interpleader, under which the conicting claims may be adjudicated. Although it is unlikely that a lost check would be presented for payment after the claimant was paid by the bank under subsection (b)(4), it is possible for it to happen. Suppose the declaration of loss by the claimant fraudulently alleged a loss that in fact did not occur. If the claimant negotiated the check, presentment for payment would occur shortly after negotiation in almost all cases. Thus, a fraudulent declaration of loss is not likely to occur unless the check is negotiated after the 90-day period has already expired or shortly before expiration. In such a case the holder of the check, who may not have noticed the date of the 381

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check, is not entitled to payment from the obligated bank if the check is presented for payment after the claim becomes enforceable. Subsection (b)(3). The remedy of the holder who is denied payment in that case is an action against the claimant under subsection (c) if the holder is a holder in due course, or for breach of warranty under subsection (b). The holder would also have common law remedies against the claimant under the law of restitution or fraud. 4. The following cases illustrate the operation of Section 3-312: Case # 1. Obligated Bank (OB) certied a check drawn by its customer, Drawer (D), payable to Payee (P). Two days after the check was certied, D lost the check and then asserted a claim pursuant to subsection (b). The check had not been presented for payment when D's claim became enforceable 90 days after the check was certied. Under subsection (b)(4), at the time D's claim became enforceable OB became obliged to pay D the amount of the check. If the check is later presented for payment, OB may refuse to pay the check and has no obligation to anyone to pay the check. Any obligation owed by D to P, for which the check was intended as payment, is unaected because the check was never delivered to P. Case # 2. Obligated Bank (OB) issued a teller's check to Remitter (R) payable to Payee (P). R delivered the check to P in payment of an obligation. P lost the check and then asserted a claim pursuant to subsection (b). To carry out P's order, OB issued an order pursuant to Section 4-403(a) to the drawee of the teller's check to stop payment of the check eective on the 90th day after the date of the teller's check. The check was not presented for payment. On the 90th day after the date of the teller's check P's claim becomes enforceable and OB becomes obliged to pay P the amount of the check. As in Case # 1, OB has no further liability with respect to the check to anyone. When R delivered the check to P, R's underlying obligation to P was discharged under Section 3-310. Thus, R suered no loss. Since P received the amount of the check, P also suered no loss except with respect to the delay in receiving the amount of the check. Case # 3. Obligated Bank (OB) issued a cashier's check to its customer, Payee (P). Two days after issue, the check was stolen from P who then asserted a claim pursuant to subsection (b). Ten days after issue, the check was deposited by X in an account in Depositary Bank (DB). X had found the check and forged the indorsement of P. DB promptly presented the check to OB and obtained payment on behalf of X. On the 90th day after the date of the check P's claim becomes enforceable and P is entitled to receive the amount of the check from OB. Subsection (b)(4). Although the check was presented for payment before P's claim becomes enforceable, OB is not discharged. Because of the forged indorsement X was not a holder and neither was DB. Thus, neither is a person entitled to enforce the check (Section 3-301) and OB is not discharged under Section 3-602(a). Thus, under subsection (b)(4), because OB did not pay a person entitled to enforce the check, OB must pay P. OB's remedy is against DB for breach of warranty under Section 4-208(a)(1). As an alternative to the remedy under Section 3-312, P could recover from DB for conversion under Section 3-420(a). Case # 4. Obligated Bank (OB) issued a cashier's check to its customer, Payee (P). P made an unrestricted blank indorsement of the check and mailed the check to P's bank for deposit to P's account. The check was never received by P's bank. When P discovered the loss, P asserted a claim pursuant to subsection (b). X found the check and deposited it in X's account in Depositary Bank (DB) after indorsing the check. DB presented the check for payment before the end of the 90-day period after its date. OB paid the check. Because of the unrestricted blank indorsement by P, X became a holder of the check. DB also became a holder. Since the check was paid before P's claim became enforceable and payment was made to a person entitled to enforce the check, OB is discharged of all liability with respect to the check. Subsection (b)(2). Thus, P is not entitled to payment from OB. Subsection (b)(4) doesn't apply. Case # 5. Obligated Bank (OB) issued a cashier's check to its customer, Payee (P). P made an unrestricted blank indorsement of the check and mailed the check to P's bank for deposit to P's account. The check was never received by P's bank. When P discovered the loss, P asserted a claim pursuant to subsection (b). At the end of the 90-day period after the date of the check, OB paid the amount of the check to P under subsection (b)(4). X then found the check and deposited it to X's account in Depositary Bank (DB). DB presented the check to OB for payment. OB is not obliged to pay the check. Subsection (b)(4). If OB dishonors the check, DB's remedy is to charge back X's account. Section 382

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4-214(a). Although P, as an indorser, would normally have liability to DB under Section 3-415(a) because the check was dishonored, P is released from that liability under Section 3-415(e) because collection of the check was initiated more than 30 days after the indorsement. DB has a remedy only against X. A depositary bank that takes a cashier's check that cannot be presented for payment before expiration of the 90-day period after its date is on notice that the check might not be paid because of the possibility of a claim asserted under subsection (b) which would excuse the issuer of the check from paying the check. Thus, the depositary bank cannot safely release funds with respect to the check until it has assurance that the check has been paid. DB cannot be a holder in due course of the check because it took the check when the check was overdue. Section 3-304(a)(2). Thus, DB has no action against P under subsection (c). Case # 6. Obligated Bank (OB) issued a cashier's check payable to bearer and delivered it to its customer, Remitter (R). R held the check for 90 days and then wrongfully asserted a claim to the amount of the check under subsection (b). The declaration of loss fraudulently stated that the check was lost. R received payment from OB under subsection (b)(4). R then negotiated the check to X for value. X presented the check to OB for payment. Although OB, under subsection (b)(2), was not obliged to pay the check, OB paid X by mistake. OB's teller did not notice that the check was more than 90 days old and was not aware that OB was not obliged to pay the check. If X took the check in good faith, OB may not recover from X. Section 3-418(c). OB's remedy is to recover from R for fraud or for breach of warranty in making a false declaration of loss. Subsection (b).

PART 4. LIABILITY OF PARTIES

3-401. Signature. (a) A person is not liable on an instrument unless (i) the person signed the instrument, or (ii) the person is represented by an agent or representative who signed the instrument and the signature is binding on the represented person under Section 3-402. (b) A signature may be made (i) manually or by means of a device or machine, and (ii) by the use of any name, including a trade or assumed name, or by a word, mark, or symbol executed or adopted by a person with present intention to authenticate a writing. Ocial Comment
1. Obligation on an instrument depends on a signature that is binding on the obligor. The signature may be made by the obligor personally or by an agent authorized to act for the obligor. Signature by agents is covered by Section 3-402. It is not necessary that the name of the obligor appear on the instrument, so long as there is a signature that binds the obligor. Signature includes an indorsement. 2. A signature may be handwritten, typed, printed or made in any other manner. It need not be subscribed, and may appear in the body of the instrument, as in the case of I, John Doe, promise to pay * * * without any other signature. It may be made by mark, or even by thumbprint. It may be made in any name, including any trade name or assumed name, however false and ctitious, which is adopted for the purpose. Parol evidence is admissible to identify the signer, and when the signer is identied the signature is eective. Indorsement in a name other than that of the indorser is governed by Section 3-204(d). This section is not intended to aect any other law requiring a signature by mark to be witnessed, or any signature to be otherwise authenticated, or requiring any form of proof.

3-402. Signature by Representative. (a) If a person acting, or purporting to act, as a representative signs an instrument by signing either the name of the represented person or the name of the signer, the represented person is bound by the signature to the same extent the represented person would be bound if the signature were on a simple contract. If the represented person is bound, the signature
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of the representative is the authorized signature of the represented person and the represented person is liable on the instrument, whether or not identied in the instrument. (b) If a representative signs the name of the representative to an instrument and the signature is an authorized signature of the represented person, the following rules apply: (1) If the form of the signature shows unambiguously that the signature is made on behalf of the represented person who is identied in the instrument, the representative is not liable on the instrument. (2) Subject to subsection (c), if (i) the form of the signature does not show unambiguously that the signature is made in a representative capacity or (ii) the represented person is not identied in the instrument, the representative is liable on the instrument to a holder in due course that took the instrument without notice that the representative was not intended to be liable on the instrument. With respect to any other person, the representative is liable on the instrument unless the representative proves that the original parties did not intend the representative to be liable on the instrument. (c) If a representative signs the name of the representative as drawer of a check without indication of the representative status and the check is payable from an account of the represented person who is identied on the check, the signer is not liable on the check if the signature is an authorized signature of the represented person. Ocial Comment
1. Subsection (a) states when the represented person is bound on an instrument if the instrument is signed by a representative. If under the law of agency the represented person would be bound by the act of the representative in signing either the name of the represented person or that of the representative, the signature is the authorized signature of the represented person. Former Section 3-401(1) stated that no person is liable on an instrument unless his signature appears thereon. This was interpreted as meaning that an undisclosed principal is not liable on an instrument. This interpretation provided an exception to ordinary agency law that binds an undisclosed principal on a simple contract. It is questionable whether this exception was justied by the language of former Article 3 and there is no apparent policy justication for it. The exception is rejected by subsection (a) which returns to ordinary rules of agency. If P, the principal, authorized A, the agent, to borrow money on P's behalf and A signed A's name to a note without disclosing that the signature was on behalf of P, A is liable on the instrument. But if the person entitled to enforce the note can also prove that P authorized A to sign on P's behalf, why shouldn't P also be liable on the instrument? To recognize the liability of P takes nothing away from the utility of negotiable instruments. Furthermore, imposing liability on P has the merit of making it impossible to have an instrument on which nobody is liable even though it was authorized by P. That result could occur under former Section 3-401(1) if an authorized agent signed as agent but the note did not identify the principal. If the dispute was between the agent and the payee of the note, the agent could escape liability on the note by proving that the agent and the payee did not intend that the agent be liable on the note when the note was issued. Former Section 3-403(2)(b). Under the prevailing interpretation of former Section 3-401(1), the principal was not liable on the note under former 3-401(1) because the principal's name did not appear on the note. Thus, nobody was liable on the note even though all parties knew that the note was signed by the agent on behalf of the principal. Under Section 3-402(a) the principal would be liable on the note. 2. Subsection (b) concerns the question of when an agent who signs an instrument on behalf of a principal is bound on the instrument. The approach followed by former Section 3-403 was to specify the form of signature that imposed or avoided liability. This approach was unsatisfactory. There are many ways in which there can be ambiguity about a 384

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signature. It is better to state a general rule. Subsection (b)(1) states that if the form of the signature unambiguously shows that it is made on behalf of an identied represented person (for example, P, by A, Treasurer) the agent is not liable. This is a workable standard for a court to apply. Subsection (b)(2) partly changes former Section 3-403(2). Subsection (b)(2) relates to cases in which the agent signs on behalf of a principal but the form of the signature does not fall within subsection (b)(1). The following cases are illustrative. In each case John Doe is the authorized agent of Richard Roe and John Doe signs a note on behalf of Richard Roe. In each case the intention of the original parties to the instrument is that Roe is to be liable on the instrument but Doe is not to be liable. Case # 1. Doe signs John Doe without indicating in the note that Doe is signing as agent. The note does not identify Richard Roe as the represented person. Case # 2. Doe signs John Doe, Agent but the note does not identify Richard Roe as the represented person. Case # 3. The name Richard Roe is written on the note and immediately below that name Doe signs John Doe without indicating that Doe signed as agent. In each case Doe is liable on the instrument to a holder in due course without notice that Doe was not intended to be liable. In none of the cases does Doe's signature unambiguously show that Doe was signing as agent for an identied principal. A holder in due course should be able to resolve any ambiguity against Doe. But the situation is dierent if a holder in due course is not involved. In each case Roe is liable on the note. Subsection (a). If the original parties to the note did not intend that Doe also be liable, imposing liability on Doe is a windfall to the person enforcing the note. Under subsection (b)(2) Doe is prima facie liable because his signature appears on the note and the form of the signature does not unambiguously refute personal liability. But Doe can escape liability by proving that the original parties did not intend that he be liable on the note. This is a change from former Section 3-403(2)(a). A number of cases under former Article 3 involved situations in which an agent signed the agent's name to a note, without qualication and without naming the person represented, intending to bind the principal but not the agent. The agent attempted to prove that the other party had the same intention. Some of these cases involved mistake, and in some there was evidence that the agent may have been deceived into signing in that manner. In some of the cases the court refused to allow proof of the intention of the parties and imposed liability on the agent based on former Section 3-403(2)(a) even though both parties to the instrument may have intended that the agent not be liable. Subsection (b)(2) changes the result of those cases, and is consistent with Section 3-117 which allows oral or written agreements to modify or nullify apparent obligations on the instrument. Former Section 3-403 spoke of the represented person being named in the instrument. Section 3-402 speaks of the represented person being identied in the instrument. This change in terminology is intended to reject decisions under former Section 3-403(2) requiring that the instrument state the legal name of the represented person. 3. Subsection (c) is directed at the check cases. It states that if the check identies the represented person the agent who signs on the signature line does not have to indicate agency status. Virtually all checks used today are in personalized form which identify the person on whose account the check is drawn. In this case, nobody is deceived into thinking that the person signing the check is meant to be liable. This subsection is meant to overrule cases decided under former Article 3 such as Grin v. Ellinger, 538 S.W.2d 97 (Texas 1976).

3-403. Unauthorized Signature. (a) Unless otherwise provided in this Article or Article 4, an unauthorized signature is ineective except as the signature of the unauthorized signer in favor of a person who in good faith pays the instrument or takes it for value. An unauthorized signature may be ratied for all purposes of this Article. (b) If the signature of more than one person is required to constitute the authorized signature of an organization, the signature of the organization is unauthorized if one of the required signatures is lacking.
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(c) The civil or criminal liability of a person who makes an unauthorized signature is not aected by any provision of this Article which makes the unauthorized signature eective for the purposes of this Article. Ocial Comment
1. Unauthorized signature is dened in Section 1-201(43) as one that includes a forgery as well as a signature made by one exceeding actual or apparent authority. Former Section 3-404(1) stated that an unauthorized signature was inoperative as the signature of the person whose name was signed unless that person is precluded from denying it. Under former Section 3-406 if negligence by the person whose name was signed contributed to an unauthorized signature, that person is precluded from asserting the * * * lack of authority. Both of these sections were applied to cases in which a forged signature appeared on an instrument and the person asserting rights on the instrument alleged that the negligence of the purported signer contributed to the forgery. Since the standards for liability between the two sections dier, the overlap between the sections caused confusion. Section 3-403(a) deals with the problem by removing the preclusion language that appeared in former Section 3-404. 2. The except clause of the rst sentence of subsection (a) states the generally accepted rule that the unauthorized signature, while it is wholly inoperative as that of the person whose name is signed, is eective to impose liability upon the signer or to transfer any rights that the signer may have in the instrument. The signer's liability is not in damages for breach of warranty of authority, but is full liability on the instrument in the capacity in which the signer signed. It is, however, limited to parties who take or pay the instrument in good faith; and one who knows that the signature is unauthorized cannot recover from the signer on the instrument. 3. The last sentence of subsection (a) allows an unauthorized signature to be ratied. Ratication is a retroactive adoption of the unauthorized signature by the person whose name is signed and may be found from conduct as well as from express statements. For example, it may be found from the retention of benets received in the transaction with knowledge of the unauthorized signature. Although the forger is not an agent, ratication is governed by the rules and principles applicable to ratication of unauthorized acts of an agent. Ratication is eective for all purposes of this Article. The unauthorized signature becomes valid so far as its eect as a signature is concerned. Although the ratication may relieve the signer of liability on the instrument, it does not of itself relieve the signer of liability to the person whose name is signed. It does not in any way aect the criminal law. No policy of the criminal law prevents a person whose name is forged to assume liability to others on the instrument by ratifying the forgery, but the ratication cannot aect the rights of the state. While the ratication may be taken into account with other relevant facts in determining punishment, it does not relieve the signer of criminal liability. 4. Subsection (b) claries the meaning of unauthorized in cases in which an instrument contains less than all of the signatures that are required as authority to pay a check. Judicial authority was split on the issue whether the one-year notice period under former Section 4-406(4) (now Section 4-406(f)) barred a customer's suit against a payor bank that paid a check containing less than all of the signatures required by the customer to authorize payment of the check. Some cases took the view that if a customer required that a check contain the signatures of both A and B to authorize payment and only A signed, there was no unauthorized signature within the meaning of that term in former Section 4-406(4) because A's signature was neither unauthorized nor forged. The other cases correctly pointed out that it was the customer's signature at issue and not that of A; hence, the customer's signature was unauthorized if all signatures required to authorize payment of the check were not on the check. Subsection (b) follows the latter line of cases. The same analysis applies if A forged the signature of B. Because the forgery is not eective as a signature of B, the required signature of B is lacking. Subsection (b) refers to the authorized signature of an organization. The denition of organization in Section 1-201(28) is very broad. It covers not only commercial entities but also two or more persons having a joint or common interest. Hence subsection (b) would apply when a husband and wife are both required to sign an instrument.

3-404. Impostors; Fictitious Payees. (a) If an impostor, by use of the mails or otherwise, induces the issuer of
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an instrument to issue the instrument to the impostor, or to a person acting in concert with the impostor, by impersonating the payee of the instrument or a person authorized to act for the payee, an indorsement of the instrument by any person in the name of the payee is eective as the indorsement of the payee in favor of a person who, in good faith, pays the instrument or takes it for value or for collection. (b) If (i) a person whose intent determines to whom an instrument is payable (Section 3-110(a) or (b)) does not intend the person identied as payee to have any interest in the instrument, or (ii) the person identied as payee of an instrument is a ctitious person, the following rules apply until the instrument is negotiated by special indorsement: (1) Any person in possession of the instrument is its holder. (2) An indorsement by any person in the name of the payee stated in the instrument is eective as the indorsement of the payee in favor of a person who, in good faith, pays the instrument or takes it for value or for collection. (c) Under subsection (a) or (b), an indorsement is made in the name of a payee if (i) it is made in a name substantially similar to that of the payee or (ii) the instrument, whether or not indorsed, is deposited in a depositary bank to an account in a name substantially similar to that of the payee. (d) With respect to an instrument to which subsection (a) or (b) applies, if a person paying the instrument or taking it for value or for collection fails to exercise ordinary care in paying or taking the instrument and that failure substantially contributes to loss resulting from payment of the instrument, the person bearing the loss may recover from the person failing to exercise ordinary care to the extent the failure to exercise ordinary care contributed to the loss. Ocial Comment
1. Under former Article 3, the impostor cases were governed by former Section 3-405(1)(a) and the ctitious payee cases were governed by Section 3-405(1)(b). Section 3-404 replaces former Section 3-405(1)(a) and (b) and modies the previous law in some respects. Former Section 3-405 was read by some courts to require that the indorsement be in the exact name of the named payee. Revised Article 3 rejects this result. Section 3-404(c) requires only that the indorsement be made in a name substantially similar to that of the payee. Subsection (c) also recognizes the fact that checks may be deposited without indorsement. Section 4-205(a). Subsection (a) changes the former law in a case in which the impostor is impersonating an agent. Under former Section 3-405(1)(a), if Impostor impersonated Smith and induced the drawer to draw a check to the order of Smith, Impostor could negotiate the check. If Impostor impersonated Smith, the president of Smith Corporation, and the check was payable to the order of Smith Corporation, the section did not apply. See the last paragraph of Comment 2 to former Section 3-405. In revised Article 3, Section 3-404(a) gives Impostor the power to negotiate the check in both cases. 2. Subsection (b) is based in part on former Section 3-405(1)(b) and in part on N.I.L. 9(3). It covers cases in which an instrument is payable to a ctitious or nonexisting person and to cases in which the payee is a real person but the drawer or maker does not intend the payee to have any interest in the instrument. Subsection (b) applies to any instrument, but its primary importance is with respect to checks of corporations and other organizations. It also applies to forged check cases. The following cases illustrate subsection (b): Case # 1. Treasurer is authorized to draw checks in behalf of Corporation. Treasurer fraudulently draws a check of Corporation payable to Supplier Co., a non-existent company. Subsection (b) applies because Supplier Co. is a ctitious person and because 387

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Treasurer did not intend Supplier Co. to have any interest in the check. Under subsection (b)(1) Treasurer, as the person in possession of the check, becomes the holder of the check. Treasurer indorses the check in the name Supplier Co. and deposits it in Depositary Bank. Under subsection (b)(2) and (c)(i), the indorsement is eective to make Depositary Bank the holder and therefore a person entitled to enforce the instrument. Section 3-301. Case # 2. Same facts as Case # 1 except that Supplier Co. is an actual company that does business with Corporation. If Treasurer intended to steal the check when the check was drawn, the result in Case # 2 is the same as the result in Case # 1. Subsection (b) applies because Treasurer did not intend Supplier Co. to have any interest in the check. It does not make any dierence whether Supplier Co. was or was not a creditor of Corporation when the check was drawn. If Treasurer did not decide to steal the check until after the check was drawn, the case is covered by Section 3-405 rather than Section 3-404(b), but the result is the same. See Case # 6 in Comment 3 to Section 3-405. Case # 3. Checks of Corporation must be signed by two ocers. President and Treasurer both sign a check of Corporation payable to Supplier Co., a company that does business with Corporation from time to time but to which Corporation does not owe any money. Treasurer knows that no money is owed to Supplier Co. and does not intend that Supplier Co. have any interest in the check. President believes that money is owed to Supplier Co. Treasurer obtains possession of the check after it is signed. Subsection (b) applies because Treasurer is a person whose intent determines to whom an instrument is payable and Treasurer does not intend Supplier Co. to have any interest in the check. Treasurer becomes the holder of the check and may negotiate it by indorsing it in the name Supplier Co. Case # 4. Checks of Corporation are signed by a check-writing machine. Names of payees of checks produced by the machine are determined by information entered into the computer that operates the machine. Thief, a person who is not an employee or other agent of Corporation, obtains access to the computer and causes the check-writing machine to produce a check payable to Supplier Co., a non-existent company. Subsection (b)(ii) applies. Thief then obtains possession of the check. At that point Thief becomes the holder of the check because Thief is the person in possession of the instrument. Subsection (b)(1). Under Section 3-301 Thief, as holder, is the person entitled to enforce the instrument even though Thief does not have title to the check and is in wrongful possession of it. Thief indorses the check in the name Supplier Co. and deposits it in an account in Depositary Bank which Thief opened in the name Supplier Co. Depositary Bank takes the check in good faith and credits the Supplier Co. account. Under subsection (b)(2) and (c)(i), the indorsement is eective. Depositary Bank becomes the holder and the person entitled to enforce the check. The check is presented to the drawee bank for payment and payment is made. Thief then withdraws the credit to the account. Although the check was issued without authority given by Corporation, the drawee bank is entitled to pay the check and charge Corporation's account if there was an agreement with Corporation allowing the bank to debit Corporation's account for payment of checks produced by the check-writing machine whether or not authorized. The indorsement is also eective if Supplier Co. is a real person. In that case subsection (b)(i) applies. Under Section 3-110(b) Thief is the person whose intent determines to whom the check is payable, and Thief did not intend Supplier Co. to have any interest in the check. When the drawee bank pays the check, there is no breach of warranty under Section 3-417(a)(1) or 4-208(a)(1) because Depositary Bank was a person entitled to enforce the check when it was forwarded for payment. Case # 5. Thief, who is not an employee or agent of Corporation, steals check forms of Corporation. John Doe is president of Corporation and is authorized to sign checks on behalf of Corporation as drawer. Thief draws a check in the name of Corporation as drawer by forging the signature of Doe. Thief makes the check payable to the order of Supplier Co. with the intention of stealing it. Whether Supplier Co. is a ctitious person or a real person, Thief becomes the holder of the check and the person entitled to enforce it. The analysis is the same as that in Case # 4. Thief deposits the check in an account in Depositary Bank which Thief opened in the name Supplier Co. Thief either indorses the check in a name other than Supplier Co. or does not indorse the check at all. Under Section 4-205(a) a depositary bank may become holder of a check deposited to the account of a customer if the customer was a holder, whether or not the customer indorses. 388

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Subsection (c)(ii) treats deposit to an account in a name substantially similar to that of the payee as the equivalent of indorsement in the name of the payee. Thus, the deposit is an eective indorsement of the check. Depositary Bank becomes the holder of the check and the person entitled to enforce the check. If the check is paid by the drawee bank, there is no breach of warranty under Section 3-417(a)(1) or 4-208(a)(1) because Depositary Bank was a person entitled to enforce the check when it was forwarded for payment and, unless Depositary Bank knew about the forgery of Doe's signature, there is no breach of warranty under Section 3-417(a)(3) or 4-208(a)(3). Because the check was a forged check the drawee bank is not entitled to charge Corporation's account unless Section 3-406 or Section 4-406 applies. 3. In cases governed by subsection (a) the dispute will normally be between the drawer of the check that was obtained by the impostor and the drawee bank that paid it. The drawer is precluded from obtaining recredit of the drawer's account by arguing that the check was paid on a forged indorsement so long as the drawee bank acted in good faith in paying the check. Cases governed by subsection (b) are illustrated by Cases # 1 through # 5 in Comment 2. In Cases # 1, # 2, and # 3 there is no forgery of the check, thus the drawer of the check takes the loss if there is no lack of good faith by the banks involved. Cases # 4 and # 5 are forged check cases. Depositary Bank is entitled to retain the proceeds of the check if it didn't know about the forgery. Under Section 3-418 the drawee bank is not entitled to recover from Depositary Bank on the basis of payment by mistake because Depositary Bank took the check in good faith and gave value for the check when the credit given for the check was withdrawn. And there is no breach of warranty under Section 3-417(a)(1) or (3) or 4-208(a)(1) or (3). Unless Section 3-406 applies the loss is taken by the drawee bank if a forged check is paid, and that is the result in Case # 5. In Case # 4 the loss is taken by Corporation, the drawer, because an agreement between Corporation and the drawee bank allowed the bank to debit Corporation's account despite the unauthorized use of the checkwriting machine. If a check payable to an impostor, ctitious payee, or payee not intended to have an interest in the check is paid, the eect of subsections (a) and (b) is to place the loss on the drawer of the check rather than on the drawee or the depositary bank that took the check for collection. Cases governed by subsection (a) always involve fraud, and fraud is almost always involved in cases governed by subsection (b). The drawer is in the best position to avoid the fraud and thus should take the loss. This is true in Case # 1, Case # 2, and Case # 3. But in some cases the person taking the check might have detected the fraud and thus have prevented the loss by the exercise of ordinary care. In those cases, if that person failed to exercise ordinary care, it is reasonable that that person bear loss to the extent the failure contributed to the loss. Subsection (d) is intended to reach that result. It allows the person who suers loss as a result of payment of the check to recover from the person who failed to exercise ordinary care. In Case # 1, Case # 2, and Case # 3, the person suering the loss is Corporation, the drawer of the check. In each case the most likely defendant is the depositary bank that took the check and failed to exercise ordinary care. In those cases, the drawer has a cause of action against the oending bank to recover a portion of the loss. The amount of loss to be allocated to each party is left to the trier of fact. Ordinary care is dened in Section 3-103(a)(9). An example of the type of conduct by a depositary bank that could give rise to recovery under subsection (d) is discussed in Comment 4 to Section 3-405. That comment addresses the last sentence of Section 3-405(b) which is similar to Section 3-404(d). In Case # 1, Case # 2, and Case # 3, there was no forgery of the drawer's signature. But cases involving checks payable to a ctitious payee or a payee not intended to have an interest in the check are often forged check cases as well. Examples are Case # 4 and Case # 5. Normally, the loss in forged check cases is on the drawee bank that paid the check. Case # 5 is an example. In Case # 4 the risk with respect to the forgery is shifted to the drawer because of the agreement between the drawer and the drawee bank. The doctrine that prevents a drawee bank from recovering payment with respect to a forged check if the payment was made to a person who took the check for value and in good faith is incorporated into Section 3-418 and Sections 3-417(a)(3) and 4-208(a)(3). This doctrine is based on the assumption that the depositary bank normally has no way of detecting the forgery because the drawer is not that bank's customer. On the other hand, the drawee bank, at least in some cases, may be able to detect the forgery by comparing the signature on the check with the specimen signature that the drawee has on le. But in some forged 389

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check cases the depositary bank is in a position to detect the fraud. Those cases typically involve a check payable to a ctitious payee or a payee not intended to have an interest in the check. Subsection (d) applies to those cases. If the depositary bank failed to exercise ordinary care and the failure substantially contributed to the loss, the drawer in Case # 4 or the drawee bank in Case # 5 has a cause of action against the depositary bank under subsection (d). Comment 4 to Section 3-405 can be used as a guide to the type of conduct that could give rise to recovery under Section 3-404(d).

3-405. Employer's Responsibility for Fraudulent Indorsement by Employee. (a) In this section: (1) Employee includes an independent contractor and employee of an independent contractor retained by the employer. (2) Fraudulent indorsement means (i) in the case of an instrument payable to the employer, a forged indorsement purporting to be that of the employer, or (ii) in the case of an instrument with respect to which the employer is the issuer, a forged indorsement purporting to be that of the person identied as payee. (3) Responsibility with respect to instruments means authority (i) to sign or indorse instruments on behalf of the employer, (ii) to process instruments received by the employer for bookkeeping purposes, for deposit to an account, or for other disposition, (iii) to prepare or process instruments for issue in the name of the employer, (iv) to supply information determining the names or addresses of payees of instruments to be issued in the name of the employer, (v) to control the disposition of instruments to be issued in the name of the employer, or (vi) to act otherwise with respect to instruments in a responsible capacity. Responsibility does not include authority that merely allows an employee to have access to instruments or blank or incomplete instrument forms that are being stored or transported or are part of incoming or outgoing mail, or similar access. (b) For the purpose of determining the rights and liabilities of a person who, in good faith, pays an instrument or takes it for value or for collection, if an employer entrusted an employee with responsibility with respect to the instrument and the employee or a person acting in concert with the employee makes a fraudulent indorsement of the instrument, the indorsement is eective as the indorsement of the person to whom the instrument is payable if it is made in the name of that person. If the person paying the instrument or taking it for value or for collection fails to exercise ordinary care in paying or taking the instrument and that failure substantially contributes to loss resulting from the fraud, the person bearing the loss may recover from the person failing to exercise ordinary care to the extent the failure to exercise ordinary care contributed to the loss. (c) Under subsection (b), an indorsement is made in the name of the person to whom an instrument is payable if (i) it is made in a name substantially similar to the name of that person or (ii) the instrument, whether or not indorsed, is deposited in a depositary bank to an account in a name substantially similar to the name of that person. Ocial Comment
1. Section 3-405 is addressed to fraudulent indorsements made by an employee with respect to instruments with respect to which the employer has given responsibility to the 390

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employee. It covers two categories of fraudulent indorsements: indorsements made in the name of the employer to instruments payable to the employer and indorsements made in the name of payees of instruments issued by the employer. This section applies to instruments generally but normally the instrument will be a check. Section 3-405 adopts the principle that the risk of loss for fraudulent indorsements by employees who are entrusted with responsibility with respect to checks should fall on the employer rather than the bank that takes the check or pays it, if the bank was not negligent in the transaction. Section 3-405 is based on the belief that the employer is in a far better position to avoid the loss by care in choosing employees, in supervising them, and in adopting other measures to prevent forged indorsements on instruments payable to the employer or fraud in the issuance of instruments in the name of the employer. If the bank failed to exercise ordinary care, subsection (b) allows the employer to shift loss to the bank to the extent the bank's failure to exercise ordinary care contributed to the loss. Ordinary care is dened in Section 3-103(a)(9). The provision applies regardless of whether the employer is negligent. The rst category of cases governed by Section 3-405 are those involving indorsements made in the name of payees of instruments issued by the employer. In this category, Section 3-405 includes cases that were covered by former Section 3-405(1)(c). The scope of Section 3-405 in revised Article 3 is, however, somewhat wider. It covers some cases not covered by former Section 3-405(1)(c) in which the entrusted employee makes a forged indorsement to a check drawn by the employer. An example is Case # 6 in Comment 3. Moreover, a larger group of employees is included in revised Section 3-405. The key provision is the denition of responsibility in subsection (a)(1) which identies the kind of responsibility delegated to an employee which will cause the employer to take responsibility for the fraudulent acts of that employee. An employer can insure this risk by employee delity bonds. The second category of cases governed by Section 3-405fraudulent indorsements of the name of the employer to instruments payable to the employerwere covered in former Article 3 by Section 3-406. Under former Section 3-406, the employer took the loss only if negligence of the employer could be proved. Under revised Article 3, Section 3-406 need not be used with respect to forgeries of the employer's indorsement. Section 3-405 imposes the loss on the employer without proof of negligence. 2. With respect to cases governed by former Section 3-405(1)(c), Section 3-405 is more favorable to employers in one respect. The bank was entitled to the preclusion provided by former Section 3-405(1)(c) if it took the check in good faith. The fact that the bank acted negligently did not shift the loss to the bank so long as the bank acted in good faith. Under revised Section 3-405 the loss may be recovered from the bank to the extent the failure of the bank to exercise ordinary care contributed to the loss. 3. Section 3-404(b) and Section 3-405 both apply to cases of employee fraud. Section 3-404(b) is not limited to cases of employee fraud, but most of the cases to which it applies will be cases of employee fraud. The following cases illustrate the application of Section 3-405. In each case it is assumed that the bank that took the check acted in good faith and was not negligent. Case # 1. Janitor, an employee of Employer, steals a check for a very large amount payable to Employer after nding it on a desk in one of Employer's oces. Janitor forges Employer's indorsement on the check and obtains payment. Since Janitor was not entrusted with responsibility with respect to the check, Section 3-405 does not apply. Section 3-406 might apply to this case. The issue would be whether Employer was negligent in safeguarding the check. If not, Employer could assert that the indorsement was forged and bring an action for conversion against the depositary or payor bank under Section 3-420. Case # 2. X is Treasurer of Corporation and is authorized to write checks on behalf of Corporation by signing X's name as Treasurer. X draws a check in the name of Corporation and signs X's name as Treasurer. The check is made payable to X. X then indorses the check and obtains payment. Assume that Corporation did not owe any money to X and did not authorize X to write the check. Although the writing of the check was not authorized, Corporation is bound as drawer of the check because X had authority to sign checks on behalf of Corporation. This result follows from agency law and Section 3-402(a). Section 3-405 does not apply in this case because there is no forged indorsement. X was payee of the check so the indorsement is valid. Section 3-110(a). Case # 3. The duties of Employee, a bookkeeper, include posting the amounts of 391

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checks payable to Employer to the accounts of the drawers of the checks. Employee steals a check payable to Employer which was entrusted to Employee and forges Employer's indorsement. The check is deposited by Employee to an account in Depositary Bank which Employee opened in the same name as Employer, and the check is honored by the drawee bank. The indorsement is eective as Employer's indorsement because Employee's duties include processing checks for bookkeeping purposes. Thus, Employee is entrusted with responsibility with respect to the check. Neither Depositary Bank nor the drawee bank is liable to Employer for conversion of the check. The same result follows if Employee deposited the check in the account in Depositary Bank without indorsement. Section 4-205(a). Under subsection (c) deposit in a depositary bank in an account in a name substantially similar to that of Employer is the equivalent of an indorsement in the name of Employer. Case # 4. Employee's duties include stamping Employer's unrestricted blank indorsement on checks received by Employer and depositing them in Employer's bank account. After stamping Employer's unrestricted blank indorsement on a check, Employee steals the check and deposits it in Employee's personal bank account. Section 3-405 doesn't apply because there is no forged indorsement. Employee is authorized by Employer to indorse Employer's checks. The fraud by Employee is not the indorsement but rather the theft of the indorsed check. Whether Employer has a cause of action against the bank in which the check was deposited is determined by whether the bank had notice of the breach of duciary duty by Employee. The issue is determined under Section 3-307. Case # 5. The computer that controls Employer's check-writing machine was programmed to cause a check to be issued to Supplier Co. to which money was owed by Employer. The address of Supplier Co. was included in the information in the computer. Employee is an accounts payable clerk whose duties include entering information into the computer. Employee fraudulently changed the address of Supplier Co. in the computer data bank to an address of Employee. The check was subsequently produced by the check-writing machine and mailed to the address that Employee had entered into the computer. Employee obtained possession of the check, indorsed it in the name of Supplier Co, and deposited it to an account in Depositary Bank which Employee opened in the name Supplier Co. The check was honored by the drawee bank. The indorsement is effective under Section 3-405(b) because Employee's duties allowed Employee to supply information determining the address of the payee of the check. An employee that is entrusted with duties that enable the employee to determine the address to which a check is to be sent controls the disposition of the check and facilitates forgery of the indorsement. The employer is held responsible. The drawee may debit the account of Employer for the amount of the check. There is no breach of warranty by Depositary Bank under Section 3-417(a)(1) or 4-208(a)(1). Case # 6. Treasurer is authorized to draw checks in behalf of Corporation. Treasurer draws a check of Corporation payable to Supplier Co., a company that sold goods to Corporation. The check was issued to pay the price of these goods. At the time the check was signed Treasurer had no intention of stealing the check. Later, Treasurer stole the check, indorsed it in the name Supplier Co. and obtained payment by depositing it to an account in Depositary Bank which Treasurer opened in the name Supplier Co.. The indorsement is eective under Section 3-405(b). Section 3-404(b) does not apply to this case. Case # 7. Checks of Corporation are signed by Treasurer in behalf of Corporation as drawer. Clerk's duties include the preparation of checks for issue by Corporation. Clerk prepares a check payable to the order of Supplier Co. for Treasurer's signature. Clerk fraudulently informs Treasurer that the check is needed to pay a debt owed to Supplier Co, a company that does business with Corporation. No money is owed to Supplier Co. and Clerk intends to steal the check. Treasurer signs it and returns it to Clerk for mailing. Clerk does not indorse the check but deposits it to an account in Depositary Bank which Clerk opened in the name Supplier Co.. The check is honored by the drawee bank. Section 3-404(b)(i) does not apply to this case because Clerk, under Section 3-110(a), is not the person whose intent determines to whom the check is payable. But Section 3-405 does apply and it treats the deposit by Clerk as an eective indorsement by Clerk because Clerk was entrusted with responsibility with respect to the check. If Supplier Co. is a ctitious person Section 3-404(b)(ii) applies. But the result is the same. Clerk's deposit is treated as an eective indorsement of the check whether Supplier Co. 392

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is a ctitious or a real person or whether money was or was not owing to Supplier Co. The drawee bank may debit the account of Corporation for the amount of the check and there is no breach of warranty by Depositary Bank under Section 3-417(1)(a). 4. The last sentence of subsection (b) is similar to subsection (d) of Section 3-404 which is discussed in Comment 3 to Section 3-404. In Case # 5, Case # 6, or Case # 7 the depositary bank may have failed to exercise ordinary care when it allowed the employee to open an account in the name Supplier Co., to deposit checks payable to Supplier Co. in that account, or to withdraw funds from that account that were proceeds of checks payable to Supplier Co. Failure to exercise ordinary care is to be determined in the context of all the facts relating to the bank's conduct with respect to the bank's collection of the check. If the trier of fact nds that there was such a failure and that the failure substantially contributed to loss, it could nd the depositary bank liable to the extent the failure contributed to the loss. The last sentence of subsection (b) can be illustrated by an example. Suppose in Case # 5 that the check is not payable to an obscure Supplier Co. but rather to a well-known national corporation. In addition, the check is for a very large amount of money. Before depositing the check, Employee opens an account in Depositary Bank in the name of the corporation and states to the person conducting the transaction for the bank that Employee is manager of a new oce being opened by the corporation. Depositary Bank opens the account without requiring Employee to produce any resolutions of the corporation's board of directors or other evidence of authorization of Employee to act for the corporation. A few days later, the check is deposited, the account is credited, and the check is presented for payment. After Depositary Bank receives payment, it allows Employee to withdraw the credit by a wire transfer to an account in a bank in a foreign country. The trier of fact could nd that Depositary Bank did not exercise ordinary care and that the failure to exercise ordinary care contributed to the loss suered by Employer. The trier of fact could allow recovery by Employer from Depositary Bank for all or part of the loss suered by Employer.

As amended in 2005.
See Appendix V for material relating to changes made in Ocial Comment in 2005.

3-406. Negligence Contributing to Forged Signature or Alteration of Instrument. (a) A person whose failure to exercise ordinary care substantially contributes to an alteration of an instrument or to the making of a forged signature on an instrument is precluded from asserting the alteration or the forgery against a person who, in good faith, pays the instrument or takes it for value or for collection. (b) Under subsection (a), if the person asserting the preclusion fails to exercise ordinary care in paying or taking the instrument and that failure substantially contributes to loss, the loss is allocated between the person precluded and the person asserting the preclusion according to the extent to which the failure of each to exercise ordinary care contributed to the loss. (c) Under subsection (a), the burden of proving failure to exercise ordinary care is on the person asserting the preclusion. Under subsection (b), the burden of proving failure to exercise ordinary care is on the person precluded. Ocial Comment
1. Section 3-406(a) is based on former Section 3-406. With respect to alteration, Section 3-406 adopts the doctrine of Young v. Grote, 4 Bing. 253 (1827), which held that a drawer who so negligently draws an instrument as to facilitate its material alteration is liable to a drawee who pays the altered instrument in good faith. Under Section 3-406 the doctrine is expanded to apply not only to drafts but to all instruments. It includes in the protected class any person who, in good faith, pays the instrument or takes it for value or for 393

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collection. Section 3-406 rejects decisions holding that the maker of a note owes no duty of care to the holder because at the time the instrument is issued there is no contract between them. By issuing the instrument and setting it aoat upon a sea of strangers the maker or drawer voluntarily enters into a relation with later holders which justies imposition of a duty of care. In this respect an instrument so negligently drawn as to facilitate alteration does not dier in principle from an instrument containing blanks which may be lled. Under Section 3-407 a person paying an altered instrument or taking it for value, in good faith and without notice of the alteration may enforce rights with respect to the instrument according to its original terms. If negligence of the obligor substantially contributes to an alteration, this section gives the holder or the payor the alternative right to treat the altered instrument as though it had been issued in the altered form. No attempt is made to dene particular conduct that will constitute failure to exercise ordinary care [that] substantially contributes to an alteration. Rather, ordinary care is dened in Section 3-103(a)(9) in general terms. The question is left to the court or the jury for decision in the light of the circumstances in the particular case including reasonable commercial standards that may apply. Section 3-406 does not make the negligent party liable in tort for damages resulting from the alteration. If the negligent party is estopped from asserting the alteration the person taking the instrument is fully protected because the taker can treat the instrument as having been issued in the altered form. 2. Section 3-406 applies equally to a failure to exercise ordinary care that substantially contributes to the making of a forged signature on an instrument. Section 3-406 refers to forged signature rather than unauthorized signature that appeared in former Section 3-406 because it more accurately describes the scope of the provision. Unauthorized signature is a broader concept that includes not only forgery but also the signature of an agent which does not bind the principal under the law of agency. The agency cases are resolved independently under agency law. Section 3-406 is not necessary in those cases. The substantially contributes test of former Section 3-406 is continued in this section in preference to a direct and proximate cause test. The substantially contributes test is meant to be less stringent than a direct and proximate cause test. Under the less stringent test the preclusion should be easier to establish. Conduct substantially contributes to a material alteration or forged signature if it is a contributing cause of the alteration or signature and a substantial factor in bringing it about. The analysis of substantially contributes in former Section 3-406 by the court in Thompson Maple Products v. Citizens National Bank of Corry, 234 A.2d 32 (Pa.Super.Ct.1967), states what is intended by the use of the same words in revised Section 3-406(b). Since Section 3-404(d) and Section 3-405(b) also use the words substantially contributes the analysis of these words also applies to those provisions. 3. The following cases illustrate the kind of conduct that can be the basis of a preclusion under Section 3-406(a): Case # 1. Employer signs checks drawn on Employer's account by use of a rubber stamp of Employer's signature. Employer keeps the rubber stamp along with Employer's personalized blank check forms in an unlocked desk drawer. An unauthorized person fraudulently uses the check forms to write checks on Employer's account. The checks are signed by use of the rubber stamp. If Employer demands that Employer's account in the drawee bank be recredited because the forged check was not properly payable, the drawee bank may defend by asserting that Employer is precluded from asserting the forgery. The trier of fact could nd that Employer failed to exercise ordinary care to safeguard the rubber stamp and the check forms and that the failure substantially contributed to the forgery of Employer's signature by the unauthorized use of the rubber stamp. Case # 2. An insurance company draws a check to the order of Sarah Smith in payment of a claim of a policyholder, Sarah Smith, who lives in Alabama. The insurance company also has a policyholder with the same name who lives in Illinois. By mistake, the insurance company mails the check to the Illinois Sarah Smith who indorses the check and obtains payment. Because the payee of the check is the Alabama Sarah Smith, the indorsement by the Illinois Sarah Smith is a forged indorsement. Section 3-110(a). The trier of fact could nd that the insurance company failed to exercise ordinary care when it mailed the check to the wrong person and that the failure substantially contributed to the making of the forged indorsement. In that event the insurance company 394

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could be precluded from asserting the forged indorsement against the drawee bank that honored the check. Case # 3. A company writes a check for $10. The gure 10 and the word ten are typewritten in the appropriate spaces on the check form. A large blank space is left after the gure and the word. The payee of the check, using a typewriter with a typeface similar to that used on the check, writes the word thousand after the word ten and a comma and three zeros after the gure 10. The drawee bank in good faith pays $10,000 when the check is presented for payment and debits the account of the drawer in that amount. The trier of fact could nd that the drawer failed to exercise ordinary care in writing the check and that the failure substantially contributed to the alteration. In that case the drawer is precluded from asserting the alteration against the drawee if the check was paid in good faith. 4. Subsection (b) diers from former Section 3-406 in that it adopts a concept of comparative negligence. If the person precluded under subsection (a) proves that the person asserting the preclusion failed to exercise ordinary care and that failure substantially contributed to the loss, the loss may be allocated between the two parties on a comparative negligence basis. In the case of a forged indorsement the litigation is usually between the payee of the check and the depositary bank that took the check for collection. An example is a case like Case # 1 of Comment 3 to Section 3-405. If the trier of fact nds that Employer failed to exercise ordinary care in safeguarding the check and that the failure substantially contributed to the making of the forged indorsement, subsection (a) of Section 3-406 applies. If Employer brings an action for conversion against the depositary bank that took the checks from the forger, the depositary bank could assert the preclusion under subsection (a). But suppose the forger opened an account in the depositary bank in a name identical to that of Employer, the payee of the check, and then deposited the check in the account. Subsection (b) may apply. There may be an issue whether the depositary bank should have been alerted to possible fraud when a new account was opened for a corporation shortly before a very large check payable to a payee with the same name is deposited. Circumstances surrounding the opening of the account may have suggested that the corporation to which the check was payable may not be the same as the corporation for which the account was opened. If the trier of fact nds that collecting the check under these circumstances was a failure to exercise ordinary care, it could allocate the loss between the depositary bank and Employer, the payee.

3-407. Alteration. (a) Alteration means (i) an unauthorized change in an instrument that purports to modify in any respect the obligation of a party, or (ii) an unauthorized addition of words or numbers or other change to an incomplete instrument relating to the obligation of a party. (b) Except as provided in subsection (c), an alteration fraudulently made discharges a party whose obligation is aected by the alteration unless that party assents or is precluded from asserting the alteration. No other alteration discharges a party, and the instrument may be enforced according to its original terms. (c) A payor bank or drawee paying a fraudulently altered instrument or a person taking it for value, in good faith and without notice of the alteration, may enforce rights with respect to the instrument (i) according to its original terms, or (ii) in the case of an incomplete instrument altered by unauthorized completion, according to its terms as completed. Ocial Comment
1. This provision restates former Section 3-407. Former Section 3-407 dened a material alteration as any alteration that changes the contract of the parties in any respect. Revised Section 3-407 refers to such a change as an alteration. As under subsection (2) of former Section 3-407, discharge because of alteration occurs only in the case of an alteration fraudulently made. There is no discharge if a blank is lled in the honest belief that it is authorized or if a change is made with a benevolent motive such as a desire to give the 395

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obligor the benet of a lower interest rate. Changes favorable to the obligor are unlikely to be made with any fraudulent intent, but if such an intent is found the alteration may operate as a discharge. Discharge is a personal defense of the party whose obligation is modied and anyone whose obligation is not aected is not discharged. But if an alteration discharges a party there is also discharge of any party having a right of recourse against the discharged party because the obligation of the party with the right of recourse is aected by the alteration. Assent to the alteration given before or after it is made will prevent the party from asserting the discharge. The phrase or is precluded from asserting the alteration in subsection (b) recognizes the possibility of an estoppel or other ground barring the defense which does not rest on assent. 2. Under subsection (c) a person paying a fraudulently altered instrument or taking it for value, in good faith and without notice of the alteration, is not aected by a discharge under subsection (b). The person paying or taking the instrument may assert rights with respect to the instrument according to its original terms or, in the case of an incomplete instrument that is altered by unauthorized completion, according to its terms as completed. If blanks are lled or an incomplete instrument is otherwise completed, subsection (c) places the loss upon the party who left the instrument incomplete by permitting enforcement in its completed form. This result is intended even though the instrument was stolen from the issuer and completed after the theft.

3-408. Drawee Not Liable on Unaccepted Draft. A check or other draft does not of itself operate as an assignment of funds in the hands of the drawee available for its payment, and the drawee is not liable on the instrument until the drawee accepts it. Ocial Comment
1. This section is a restatement of former Section 3-409(1). Subsection (2) of former Section 3-409 is deleted as misleading and superuous. Comment 3 says of subsection (2): It is intended to make it clear that this section does not in any way aect any liability which may arise apart from the instrument. In reality subsection (2) did not make anything clear and was a source of confusion. If all it meant was that a bank that has not certied a check may engage in other conduct that might make it liable to a holder, it stated the obvious and was superuous. Section 1-103 is adequate to cover those cases. 2. Liability with respect to drafts may arise under other law. For example, Section 4-302 imposes liability on a payor bank for late return of an item.

3-409. Acceptance of Draft; Certied Check. (a) Acceptance means the drawee's signed agreement to pay a draft as presented. It must be written on the draft and may consist of the drawee's signature alone. Acceptance may be made at any time and becomes eective when notication pursuant to instructions is given or the accepted draft is delivered for the purpose of giving rights on the acceptance to any person. (b) A draft may be accepted although it has not been signed by the drawer, is otherwise incomplete, is overdue, or has been dishonored. (c) If a draft is payable at a xed period after sight and the acceptor fails to date the acceptance, the holder may complete the acceptance by supplying a date in good faith. (d) Certied check means a check accepted by the bank on which it is drawn. Acceptance may be made as stated in subsection (a) or by a writing on the check which indicates that the check is certied. The drawee of a check has no obligation to certify the check, and refusal to certify is not dishonor of the check.
396

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Ocial Comment
1. The rst three subsections of Section 3-409 are a restatement of former Section 3-410. Subsection (d) adds a denition of certied check which is a type of accepted draft. 2. Subsection (a) states the generally recognized rule that the mere signature of the drawee on the instrument is a sucient acceptance. Customarily the signature is written vertically across the face of the instrument, but since the drawee has no reason to sign for any other purpose a signature in any other place, even on the back of the instrument, is sucient. It need not be accompanied by such words as Accepted, Certied, or Good. It must not, however, bear any words indicating an intent to refuse to honor the draft. The last sentence of subsection (a) states the generally recognized rule that an acceptance written on the draft takes eect when the drawee noties the holder or gives notice according to instructions. 3. The purpose of subsection (c) is to provide a denite date of payment if none appears on the instrument. An undated acceptance of a draft payable thirty days after sight is incomplete. Unless the acceptor writes in a dierent date the holder is authorized to complete the acceptance according to the terms of the draft by supplying a date of acceptance. Any date supplied by the holder is eective if made in good faith. 4. The last sentence of subsection (d) states the generally recognized rule that in the absence of agreement a bank is under no obligation to certify a check. A check is a demand instrument calling for payment rather than acceptance. The bank may be liable for breach of any agreement with the drawer, the holder, or any other person by which it undertakes to certify. Its liability is not on the instrument, since the drawee is not so liable until acceptance. Section 3-408. Any liability is for breach of the separate agreement.

3-410. Acceptance Varying Draft. (a) If the terms of a drawee's acceptance vary from the terms of the draft as presented, the holder may refuse the acceptance and treat the draft as dishonored. In that case, the drawee may cancel the acceptance. (b) The terms of a draft are not varied by an acceptance to pay at a particular bank or place in the United States, unless the acceptance states that the draft is to be paid only at that bank or place. (c) If the holder assents to an acceptance varying the terms of a draft, the obligation of each drawer and indorser that does not expressly assent to the acceptance is discharged. Ocial Comment
1. This section is a restatement of former Section 3-412. It applies to conditional acceptances, acceptances for part of the amount, acceptances to pay at a dierent time from that required by the draft, or to the acceptance of less than all of the drawees. It applies to any other engagement changing the essential terms of the draft. If the drawee makes a varied acceptance the holder may either reject it or assent to it. The holder may reject by insisting on acceptance of the draft as presented. Refusal by the drawee to accept the draft as presented is dishonor. In that event the drawee is not bound by the varied acceptance and is entitled to have it canceled. If the holder assents to the varied acceptance, the drawee's obligation as acceptor is according to the terms of the varied acceptance. Under subsection (c) the eect of the holder's assent is to discharge any drawer or indorser who does not also assent. The assent of the drawer or indorser must be armatively expressed. Mere failure to object within a reasonable time is not assent which will prevent the discharge. 2. Under subsection (b) an acceptance does not vary from the terms of the draft if it provides for payment at any particular bank or place in the United States unless the acceptance states that the draft is to be paid only at such bank or place. Section 3-501(b)(1) states that if an instrument is payable at a bank in the United States presentment must be made at the place of payment (Section 3-111) which in this case is at the designated bank.

3-411. Refusal to Pay Cashier's Checks, Teller's Checks, and Certied Checks. (a) In this section, obligated bank means the acceptor of a certied
397

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Art. 3

check or the issuer of a cashier's check or teller's check bought from the issuer. (b) If the obligated bank wrongfully (i) refuses to pay a cashier's check or certied check, (ii) stops payment of a teller's check, or (iii) refuses to pay a dishonored teller's check, the person asserting the right to enforce the check is entitled to compensation for expenses and loss of interest resulting from the nonpayment and may recover consequential damages if the obligated bank refuses to pay after receiving notice of particular circumstances giving rise to the damages. (c) Expenses or consequential damages under subsection (b) are not recoverable if the refusal of the obligated bank to pay occurs because (i) the bank suspends payments, (ii) the obligated bank asserts a claim or defense of the bank that it has reasonable grounds to believe is available against the person entitled to enforce the instrument, (iii) the obligated bank has a reasonable doubt whether the person demanding payment is the person entitled to enforce the instrument, or (iv) payment is prohibited by law. Ocial Comment
1. In some cases a creditor may require that the debt be paid by an obligation of a bank. The debtor may comply by obtaining certication of the debtor's check, but more frequently the debtor buys from a bank a cashier's check or teller's check payable to the creditor. The check is taken by the creditor as a cash equivalent on the assumption that the bank will pay the check. Sometimes, the debtor wants to retract payment by inducing the obligated bank not to pay. The typical case involves a dispute between the parties to the transaction in which the check is given in payment. In the case of a certied check or cashier's check, the bank can safely pay the holder of the check despite notice that there may be an adverse claim to the check (Section 3-602). It is also clear that the bank that sells a teller's check has no duty to order the bank on which it is drawn not to pay it. A debtor using any of these types of checks has no right to stop payment. Nevertheless, some banks will refuse payment as an accommodation to a customer. Section 3-411 is designed to discourage this practice. 2. The term obligated bank refers to the issuer of the cashier's check or teller's check and the acceptor of the certied check. If the obligated bank wrongfully refuses to pay, it is liable to pay for expenses and loss of interest resulting from the refusal to pay. There is no express provision for attorney's fees, but attorney's fees are not meant to be necessarily excluded. They could be granted because they t within the language expenses * * * resulting from the nonpayment. In addition the bank may be liable to pay consequential damages if it has notice of the particular circumstances giving rise to the damages. 3. Subsection (c) provides that expenses or consequential damages are not recoverable if the refusal to pay is because of the reasons stated. The purpose is to limit that recovery to cases in which the bank refuses to pay even though its obligation to pay is clear and it is able to pay. Subsection (b) applies only if the refusal to honor the check is wrongful. If the bank is not obliged to pay there is no recovery. The bank may assert any claim or defense that it has, but normally the bank would not have a claim or defense. In the usual case it is a remitter that is asserting a claim to the check on the basis of a rescission of negotiation to the payee under Section 3-202. See Comment 2 to Section 3-201. The bank can assert that claim if there is compliance with Section 3-305(c), but the bank is not protected from damages under subsection (b) if the claim of the remitter is not upheld. In that case, the bank is insulated from damages only if payment is enjoined under Section 3-602(b)(1). Subsection (c)(iii) refers to cases in which the bank may have a reasonable doubt about the identity of the person demanding payment. For example, a cashier's check is payable to Supplier Co. The person in possession of the check presents it for payment over the counter and claims to be an ocer of Supplier Co. The bank may refuse payment until it has been given adequate proof that the presentment in fact is being made for Supplier Co., the person entitled to enforce the check.

3-412. Obligation of Issuer of Note or Cashier's Check. The issuer of a note or cashier's check or other draft drawn on the drawer
398

Art. 3

Negotiable Instruments

3-413

is obliged to pay the instrument (i) according to its terms at the time it was issued or, if not issued, at the time it rst came into possession of a holder, or (ii) if the issuer signed an incomplete instrument, according to its terms when completed, to the extent stated in Sections 3-115 and 3-407. The obligation is owed to a person entitled to enforce the instrument or to an indorser who paid the instrument under Section 3-415. Ocial Comment
1. The obligations of the maker, acceptor, drawer, and indorser are stated in four separate sections. Section 3-412 states the obligation of the maker of a note and is consistent with former Section 3-413(1). Section 3-412 also applies to the issuer of a cashier's check or other draft drawn on the drawer. Under former Section 3-118(a), since a cashier's check or other draft drawn on the drawer was eective as a note, the drawer was liable under former Section 3-413(1) as a maker. Under Sections 3-103(a)(8) and 3-104(f) a cashier's check or other draft drawn on the drawer is treated as a draft to reect common commercial usage, but the liability of the drawer is stated by Section 3-412 as being the same as that of the maker of a note rather than that of the drawer of a draft. Thus, Section 3-412 does not in substance change former law. 2. Under Section 3-105(b) nonissuance of either a complete or incomplete instrument is a defense by a maker or drawer against a person that is not a holder in due course. 3. The obligation of the maker may be modied in the case of alteration if, under Section 3-406, the maker is precluded from asserting the alteration. 4. The rule of this section is similar to the rule of Article 39 of the Convention on International Bills of Exchange and International Promissory Notes. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002.

3-413. Obligation of Acceptor. (a) The acceptor of a draft is obliged to pay the draft (i) according to its terms at the time it was accepted, even though the acceptance states that the draft is payable as originally drawn or equivalent terms, (ii) if the acceptance varies the terms of the draft, according to the terms of the draft as varied, or (iii) if the acceptance is of a draft that is an incomplete instrument, according to its terms when completed, to the extent stated in Sections 3-115 and 3-407. The obligation is owed to a person entitled to enforce the draft or to the drawer or an indorser who paid the draft under Section 3-414 or 3-415. (b) If the certication of a check or other acceptance of a draft states the amount certied or accepted, the obligation of the acceptor is that amount. If (i) the certication or acceptance does not state an amount, (ii) the amount of the instrument is subsequently raised, and (iii) the instrument is then negotiated to a holder in due course, the obligation of the acceptor is the amount of the instrument at the time it was taken by the holder in due course. Ocial Comment
Subsection (a) is consistent with former Section 3-413(1). Subsection (b) has primary importance with respect to certied checks. It protects the holder in due course of a certied check that was altered after certication and before negotiation to the holder in due course. A bank can avoid liability for the altered amount by stating on the check the amount the bank agrees to pay. The subsection applies to other accepted drafts as well. The rule of this section is similar to the rule of Articles 41 of the Convention on International Bills of Exchange and International Promissory Notes. Articles 42 and 43 of the Convention include more detailed rules that in many respects do not have parallels in this Article. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002. 399

 3-414

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Art. 3

3-414. Obligation of Drawer. (a) This section does not apply to cashier's checks or other drafts drawn on the drawer. (b) If an unaccepted draft is dishonored, the drawer is obliged to pay the draft (i) according to its terms at the time it was issued or, if not issued, at the time it rst came into possession of a holder, or (ii) if the drawer signed an incomplete instrument, according to its terms when completed, to the extent stated in Sections 3-115 and 3-407. The obligation is owed to a person entitled to enforce the draft or to an indorser who paid the draft under Section 3-415. (c) If a draft is accepted by a bank, the drawer is discharged, regardless of when or by whom acceptance was obtained. (d) If a draft is accepted and the acceptor is not a bank, the obligation of the drawer to pay the draft if the draft is dishonored by the acceptor is the same as the obligation of an indorser under Section 3-415(a) and (c). (e) If a draft states that it is drawn without recourse or otherwise disclaims liability of the drawer to pay the draft, the drawer is not liable under subsection (b) to pay the draft if the draft is not a check. A disclaimer of the liability stated in subsection (b) is not eective if the draft is a check. (f) If (i) a check is not presented for payment or given to a depositary bank for collection within 30 days after its date, (ii) the drawee suspends payments after expiration of the 30-day period without paying the check, and (iii) because of the suspension of payments, the drawer is deprived of funds maintained with the drawee to cover payment of the check, the drawer to the extent deprived of funds may discharge its obligation to pay the check by assigning to the person entitled to enforce the check the rights of the drawer against the drawee with respect to the funds. Ocial Comment
1. Subsection (a) excludes cashier's checks because the obligation of the issuer of a cashier's check is stated in Section 3-412. 2. Subsection (b) states the obligation of the drawer on an unaccepted draft. It replaces former Section 3-413(2). The requirement under former Article 3 of notice of dishonor or protest has been eliminated. Under revised Article 3, notice of dishonor is necessary only with respect to indorser's liability. The liability of the drawer of an unaccepted draft is treated as a primary liability. Under former Section 3-102(1)(d) the term secondary party was used to refer to a drawer or indorser. The quoted term is not used in revised Article 3. The eect of a draft drawn without recourse is stated in subsection (e). 3. Under subsection (c) the drawer is discharged of liability on a draft accepted by a bank regardless of when acceptance was obtained. This changes former Section 3-411(1) which provided that the drawer is discharged only if the holder obtains acceptance. Holders that have a bank obligation do not normally rely on the drawer to guarantee the bank's solvency. A holder can obtain protection against the insolvency of a bank acceptor by a specic guaranty of payment by the drawer or by obtaining an indorsement by the drawer. Section 3-205(d). 4. Subsection (d) states the liability of the drawer if a draft is accepted by a drawee other than a bank and the acceptor dishonors. The drawer of an unaccepted draft is the only party liable on the instrument. The drawee has no liability on the draft. Section 3-408. When the draft is accepted, the obligations change. The drawee, as acceptor, becomes primarily liable and the drawer's liability is that of a person secondarily liable as a guarantor of payment. The drawer's liability is identical to that of an indorser, and subsection (d) states the drawer's liability that way. The drawer is liable to pay the person entitled to 400

Art. 3

Negotiable Instruments

3-415

enforce the draft or any indorser that pays pursuant to Section 3-415. The drawer in this case is discharged if notice of dishonor is required by Section 3-503 and is not given in compliance with that section. A drawer that pays has a right of recourse against the acceptor. Section 3-413(a). 5. Subsection (e) does not permit the drawer of a check to avoid liability under subsection (b) by drawing the check without recourse. There is no legitimate purpose served by issuing a check on which nobody is liable. Drawing without recourse is eective to disclaim liability of the drawer if the draft is not a check. Suppose, in a documentary sale, Seller draws a draft on Buyer for the price of goods shipped to Buyer. The draft is payable upon delivery to the drawee of an order bill of lading covering the goods. Seller delivers the draft with the bill of lading to Finance Company that is named as payee of the draft. If Seller draws without recourse Finance Company takes the risk that Buyer will dishonor. If Buyer dishonors, Finance Company has no recourse against Seller but it can obtain reimbursement by selling the goods which it controls through the bill of lading. 6. Subsection (f) is derived from former Section 3-502(1)(b). It is designed to protect the drawer of a check against loss resulting from suspension of payments by the drawee bank when the holder of the check delays collection of the check. For example, X writes a check payable to Y for $1,000. The check is covered by funds in X's account in the drawee bank. Y delays initiation of collection of the check for more than 30 days after the date of the check. The drawee bank suspends payments after the 30-day period and before the check is presented for payment. If the $1,000 of funds in X's account have not been withdrawn, X has a claim for those funds against the drawee bank and, if subsection (e) were not in eect, X would be liable to Y on the check because the check was dishonored. Section 3-502(e). If the suspension of payments by the drawee bank will result in payment to X of less than the full amount of the $1,000 in the account or if there is a signicant delay in payment to X, X will suer a loss which would not have been suered if Y had promptly initiated collection of the check. In most cases, X will not suer any loss because of the existence of federal bank deposit insurance that covers accounts up to $100,000. Thus, subsection (e) has relatively little importance. There might be some cases, however, in which the account is not fully insured because it exceeds $100,000 or because the account doesn't qualify for deposit insurance. Subsection (f) retains the phrase deprived of funds maintained with the drawee appearing in former Section 3-502(1)(b). The quoted phrase applies if the suspension of payments by the drawee prevents the drawer from receiving the benet of funds which would have paid the check if the holder had been timely in initiating collection. Thus, any signicant delay in obtaining full payment of the funds is a deprivation of funds. The drawer can discharge drawer's liability by assigning rights against the drawee with respect to the funds to the holder. 7. The obligation of the drawer under this section is similar to the obligation of the drawer under Article 38 of the Convention on International Bills of Exchange and International Promissory Notes. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002.

3-415. Obligation of Indorser. (a) Subject to subsections (b), (c), (d), (e) and to Section 3-419(d), if an instrument is dishonored, an indorser is obliged to pay the amount due on the instrument (i) according to the terms of the instrument at the time it was indorsed, or (ii) if the indorser indorsed an incomplete instrument, according to its terms when completed, to the extent stated in Sections 3-115 and 3-407. The obligation of the indorser is owed to a person entitled to enforce the instrument or to a subsequent indorser who paid the instrument under this section. (b) If an indorsement states that it is made without recourse or otherwise disclaims liability of the indorser, the indorser is not liable under subsection (a) to pay the instrument. (c) If notice of dishonor of an instrument is required by Section 3-503 and notice of dishonor complying with that section is not given to an indorser, the liability of the indorser under subsection (a) is discharged.
401

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Art. 3

(d) If a draft is accepted by a bank after an indorsement is made, the liability of the indorser under subsection (a) is discharged. (e) If an indorser of a check is liable under subsection (a) and the check is not presented for payment, or given to a depositary bank for collection, within 30 days after the day the indorsement was made, the liability of the indorser under subsection (a) is discharged. As amended in 1993. Ocial Comment
1. Subsections (a) and (b) restate the substance of former Section 3-414(1). Subsection (2) of former Section 3-414 has been dropped because it is superuous. Although notice of dishonor is not mentioned in subsection (a), it must be given in some cases to charge an indorser. It is covered in subsection (c). Regulation CC 229.35(b) provides that a bank handling a check for collection or return is liable to a bank that subsequently handles the check to the extent the latter bank does not receive payment for the check. This liability applies whether or not the bank incurring the liability indorsed the check. 2. Section 3-503 states when notice of dishonor is required and how it must be given. If required notice of dishonor is not given in compliance with Section 3-503, subsection (c) of Section 3-415 states that the eect is to discharge the indorser's obligation. 3. Subsection (d) is similar in eect to Section 3-414(c) if the draft is accepted by a bank after the indorsement is made. See Comment 3 to Section 3-414. If a draft is accepted by a bank before the indorsement is made, the indorser incurs the obligation stated in subsection (a). 4. Subsection (e) modies former Sections 3-503(2)(b) and 3-502(1)(a) by stating a 30-day rather than a seven-day period, and stating it as an absolute rather than a presumptive period. 5. As stated in subsection (a), the obligation of an indorser to pay the amount due on the instrument is generally owed not only to a person entitled to enforce the instrument but also to a subsequent indorser who paid the instrument. But if the prior indorser and the subsequent indorser are both anomalous indorsers, this rule does not apply. In that case, Section 3-116 applies. Under Section 3-116(a), the anomalous indorsers are jointly and severally liable and if either pays the instrument the indorser who pays has a right of contribution against the other. Section 3-116(b). The right to contribution in Section 3-116(b) is subject to agreement of the aected parties. Suppose the subsequent indorser can prove an agreement with the prior indorser under which the prior indorser agreed to treat the subsequent indorser as a guarantor of the obligation of the prior indorser. Rights of the two indorsers between themselves would be governed by the agreement. Under suretyship law, the subsequent indorser under such an agreement is referred to as a sub-surety. Under the agreement, if the subsequent indorser pays the instrument there is a right to reimbursement from the prior indorser; if the prior indorser pays the instrument, there is no right of recourse against the subsequent indorser. See PEB Commentary No. 11, dated February 10, 1994 [Appendix A, infra]. 6. The rule of this section is similar to the rule of Article 44 of the Convention on International Bills of Exchange and International Promissory Notes. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002.

3-416. Transfer Warranties. (a) A person who transfers an instrument for consideration warrants to the transferee and, if the transfer is by indorsement, to any subsequent transferee that: (1) the warrantor is a person entitled to enforce the instrument; (2) all signatures on the instrument are authentic and authorized; (3) the instrument has not been altered; (4) the instrument is not subject to a defense or claim in recoupment of any party which can be asserted against the warrantor;
402

Art. 3

Negotiable Instruments

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(5) the warrantor has no knowledge of any insolvency proceeding commenced with respect to the maker or acceptor or, in the case of an unaccepted draft, the drawer; and (6) with respect to a remotely-created consumer item, that the person on whose account the item is drawn authorized the issuance of the item in the amount for which the item is drawn. (b) A person to whom the warranties under subsection (a) are made and who took the instrument in good faith may recover from the warrantor as damages for breach of warranty an amount equal to the loss suered as a result of the breach, but not more than the amount of the instrument plus expenses and loss of interest incurred as a result of the breach. (c) The warranties stated in subsection (a) cannot be disclaimed with respect to checks. Unless notice of a claim for breach of warranty is given to the warrantor within 30 days after the claimant has reason to know of the breach and the identity of the warrantor, the liability of the warrantor under subsection (b) is discharged to the extent of any loss caused by the delay in giving notice of the claim. (d) A [cause of action] for breach of warranty under this section accrues when the claimant has reason to know of the breach. As amended in 2002.
See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
1. Subsection (a) is taken from subsection (2) of former Section 3-417. Subsections (3) and (4) of former Section 3-417 are deleted. Warranties under subsection (a) in favor of the immediate transferee apply to all persons who transfer an instrument for consideration whether or not the transfer is accompanied by indorsement. Any consideration sucient to support a simple contract will support those warranties. If there is an indorsement the warranty runs with the instrument and the remote holder may sue the indorser-warrantor directly and thus avoid a multiplicity of suits. 2. Since the purpose of transfer (Section 3-203(a)) is to give the transferee the right to enforce the instrument, subsection (a)(1) is a warranty that the transferor is a person entitled to enforce the instrument (Section 3-301). Under Section 3-203(b) transfer gives the transferee any right of the transferor to enforce the instrument. Subsection (a)(1) is in eect a warranty that there are no unauthorized or missing indorsements that prevent the transferor from making the transferee a person entitled to enforce the instrument. 3. The rationale of subsection (a)(4) is that the transferee does not undertake to buy an instrument that is not enforceable in whole or in part, unless there is a contrary agreement. Even if the transferee takes as a holder in due course who takes free of the defense or claim in recoupment, the warranty gives the transferee the option of proceeding against the transferor rather than litigating with the obligor on the instrument the issue of the holderin-due-course status of the transferee. Subsection (3) of former Section 3-417 which limits this warranty is deleted. The rationale is that while the purpose of a no recourse indorsement is to avoid a guaranty of payment, the indorsement does not clearly indicate an intent to disclaim warranties. 4. Under subsection (a)(5) the transferor does not warrant against diculties of collection, impairment of the credit of the obligor or even insolvency. The transferee is expected to determine such questions before taking the obligation. If insolvency proceedings as dened in Section 1-201(22) have been instituted against the party who is expected to pay and the transferor knows it, the concealment of that fact amounts to a fraud upon the transferee, and the warranty against knowledge of such proceedings is provided accordingly. 5. Transfer warranties may be disclaimed with respect to any instrument except a check. Between the immediate parties disclaimer may be made by agreement. In the case of an indorser, disclaimer of transferor's liability, to be eective, must appear in the indorsement with words such as without warranties or some other specic reference to warranties. But 403

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in the case of a check, subsection (c) of Section 3-416 provides that transfer warranties cannot be disclaimed at all. In the check collection process the banking system relies on these warranties. 6. Subsection (b) states the measure of damages for breach of warranty. There is no express provision for attorney's fees, but attorney's fees are not meant to be necessarily excluded. They could be granted because they t within the phrase expenses * * * incurred as a result of the breach. The intention is to leave to other state law the issue as to when attorney's fees are recoverable. 7. Since the traditional term cause of action may have been replaced in some states by claim for relief or some equivalent term, the words cause of action in subsection (d) have been bracketed to indicate that the words may be replaced by an appropriate substitute to conform to local practice. 8. Subsection (a)(6) is based on a number of nonuniform amendments designed to address concerns about certain kinds of check fraud. The provision implements a limited rejection of Price v. Neal, 97 Eng. Rep. 871 (K.B. 1762), so that in certain circumstances (those involving remotely-created consumer items) the payor bank can use a warranty claim to absolve itself of responsibility for honoring an unauthorized item. The provision rests on the premise that monitoring by depositary banks can control this type of fraud more eectively than any practices readily available to payor banks. The provision expressly includes both the case in which the consumer does not authorize the item at all and also the case in which the consumer authorizes the item but in an amount dierent from the amount in which the item is drawn. Similar provisions appear in Sections 3-417, 4-207, and 4-208. The provision supplements applicable federal law, which requires telemarketers who submit instruments for payment to obtain the customer's express veriable authorization, which may be either in writing or tape recorded and must be made available upon request to the customer's bank. Federal Trade Commission's Telemarketing Sales Rule, 16 C.F.R. 310.3(a)(3), implementing the Telemarketing and Consumer Fraud and Abuse Prevention Act, 15 U.S.C. 61016108. Some states also have consumer-protection laws governing authorization of instruments in telemarketing transactions. See, e.g., 9 Vt. Stat. Ann. 2464. 9. Article 45 of the Convention on International Bills of Exchange and International Promissory Notes includes warranties that are similar (except for the warranty in subsection (a)(6)).

As amended in 2002.
See Appendix Q for material relating to changes in Ocial Comment in 2002.

3-417. Presentment Warranties. (a) If an unaccepted draft is presented to the drawee for payment or acceptance and the drawee pays or accepts the draft, (i) the person obtaining payment or acceptance, at the time of presentment, and (ii) a previous transferor of the draft, at the time of transfer, warrant to the drawee making payment or accepting the draft in good faith that: (1) the warrantor is, or was, at the time the warrantor transferred the draft, a person entitled to enforce the draft or authorized to obtain payment or acceptance of the draft on behalf of a person entitled to enforce the draft; (2) the draft has not been altered; (3) the warrantor has no knowledge that the signature of the drawer of the draft is unauthorized; and (4) with respect to any remotely-created consumer item, that the person on whose account the item is drawn authorized the issuance of the item in the amount for which the item is drawn.
404

Art. 3

Negotiable Instruments

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(b) A drawee making payment may recover from any warrantor damages for breach of warranty equal to the amount paid by the drawee less the amount the drawee received or is entitled to receive from the drawer because of the payment. In addition, the drawee is entitled to compensation for expenses and loss of interest resulting from the breach. The right of the drawee to recover damages under this subsection is not aected by any failure of the drawee to exercise ordinary care in making payment. If the drawee accepts the draft, breach of warranty is a defense to the obligation of the acceptor. If the acceptor makes payment with respect to the draft, the acceptor is entitled to recover from any warrantor for breach of warranty the amounts stated in this subsection. (c) If a drawee asserts a claim for breach of warranty under subsection (a) based on an unauthorized indorsement of the draft or an alteration of the draft, the warrantor may defend by proving that the indorsement is effective under Section 3-404 or 3-405 or the drawer is precluded under Section 3-406 or 4-406 from asserting against the drawee the unauthorized indorsement or alteration. (d) If (i) a dishonored draft is presented for payment to the drawer or an indorser or (ii) any other instrument is presented for payment to a party obliged to pay the instrument, and (iii) payment is received, the following rules apply: (1) The person obtaining payment and a prior transferor of the instrument warrant to the person making payment in good faith that the warrantor is, or was, at the time the warrantor transferred the instrument, a person entitled to enforce the instrument or authorized to obtain payment on behalf of a person entitled to enforce the instrument. (2) The person making payment may recover from any warrantor for breach of warranty an amount equal to the amount paid plus expenses and loss of interest resulting from the breach. (e) The warranties stated in subsections (a) and (d) cannot be disclaimed with respect to checks. Unless notice of a claim for breach of warranty is given to the warrantor within 30 days after the claimant has reason to know of the breach and the identity of the warrantor, the liability of the warrantor under subsection (b) or (d) is discharged to the extent of any loss caused by the delay in giving notice of the claim. (f) A [cause of action] for breach of warranty under this section accrues when the claimant has reason to know of the breach. As amended in 2002.
See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
1. This section replaces subsection (1) of former Section 3-417. The former provision was dicult to understand because it purported to state in one subsection all warranties given to any person paying any instrument. The result was a provision replete with exceptions that could not be readily understood except after close scrutiny of the language. In revised Section 3-417, presentment warranties made to drawees of uncertied checks and other unaccepted drafts are stated in subsection (a). All other presentment warranties are stated in subsection (d). 2. Subsection (a) states three warranties. Subsection (a)(1) in eect is a warranty that there are no unauthorized or missing indorsements. Person entitled to enforce is dened in Section 3-301. Subsection (a)(2) is a warranty that there is no alteration. Subsection 405

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(a)(3) is a warranty of no knowledge that there is a forged drawer's signature. Subsection (a) states that the warranties are made to the drawee and subsections (b) and (c) identify the drawee as the person entitled to recover for breach of warranty. There is no warranty made to the drawer under subsection (a) when presentment is made to the drawee. Warranty to the drawer is governed by subsection (d) and that applies only when presentment for payment is made to the drawer with respect to a dishonored draft. In Sun N Sand, Inc. v. United California Bank, 582 P.2d 920 (Cal.1978), the court held that under former Section 3-417(1) a warranty was made to the drawer of a check when the check was presented to the drawee for payment. The result in that case is rejected. 3. Subsection (a)(1) retains the rule that the drawee does not admit the authenticity of indorsements and subsection (a)(3) retains the rule of Price v. Neal, 3 Burr. 1354 (1762), that the drawee takes the risk that the drawer's signature is unauthorized unless the person presenting the draft has knowledge that the drawer's signature is unauthorized. Under subsection (a)(3) the warranty of no knowledge that the drawer's signature is unauthorized is also given by prior transferors of the draft. 4. Subsection (d) applies to presentment for payment in all cases not covered by subsection (a). It applies to presentment of notes and accepted drafts to any party obliged to pay the instrument, including an indorser, and to presentment of dishonored drafts if made to the drawer or an indorser. In cases covered by subsection (d), there is only one warranty and it is the same as that stated in subsection (a)(1). There are no warranties comparable to subsections (a)(2) and (a)(3) because they are appropriate only in the case of presentment to the drawee of an unaccepted draft. With respect to presentment of an accepted draft to the acceptor, there is no warranty with respect to alteration or knowledge that the signature of the drawer is unauthorized. Those warranties were made to the drawee when the draft was presented for acceptance (Section 3-417(a)(2) and (3)) and breach of that warranty is a defense to the obligation of the drawee as acceptor to pay the draft. If the drawee pays the accepted draft the drawee may recover the payment from any warrantor who was in breach of warranty when the draft was accepted. Section 3-417(b). Thus, there is no necessity for these warranties to be repeated when the accepted draft is presented for payment. Former Section 3-417(1)(b)(iii) and (c)(iii) are not included in revised Section 3-417 because they are unnecessary. Former Section 3-417(1)(c)(iv) is not included because it is also unnecessary. The acceptor should know what the terms of the draft were at the time acceptance was made. If presentment is made to the drawer or maker, there is no necessity for a warranty concerning the signature of that person or with respect to alteration. If presentment is made to an indorser, the indorser had itself warranted authenticity of signatures and that the instrument was not altered. Section 3-416(a)(2) and (3). 5. The measure of damages for breach of warranty under subsection (a) is stated in subsection (b). There is no express provision for attorney's fees, but attorney's fees are not meant to be necessarily excluded. They could be granted because they t within the language expenses * * * resulting from the breach. Subsection (b) provides that the right of the drawee to recover for breach of warranty is not aected by a failure of the drawee to exercise ordinary care in paying the draft. This provision follows the result reached under former Article 3 in Hartford Accident & Indemnity Co. v. First Pennsylvania Bank, 859 F.2d 295 (3d Cir.1988). 6. Subsection (c) applies to checks and other unaccepted drafts. It gives to the warrantor the benet of rights that the drawee has against the drawer under Section 3-404, 3-405, 3-406, or 4-406. If the drawer's conduct contributed to a loss from forgery or alteration, the drawee should not be allowed to shift the loss from the drawer to the warrantor. 7. The rst sentence of subsection (e) recognizes that checks are normally paid by automated means and that payor banks rely on warranties in making payment. Thus, it is not appropriate to allow disclaimer or warranties appearing on checks that normally will not be examined by the payor bank. The second sentence requires a breach of warranty claim to be asserted within 30 days after the drawee learns of the breach and the identity of the warrantor. 8. Since the traditional term cause of action may have been replaced in some states by claim for relief or some equivalent term, the words cause of action in subsection (f) have been bracketed to indicate that the words may be replaced by an appropriate substitute to conform to local practice. 406

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9. For discussion of subsection (a)(4), see Comment 8 to Section 3-416.

As amended in 2002.
See Appendix Q for material relating to changes in Ocial Comment in 2002.

3-418. Payment or Acceptance by Mistake. (a) Except as provided in subsection (c), if the drawee of a draft pays or accepts the draft and the drawee acted on the mistaken belief that (i) payment of the draft had not been stopped pursuant to Section 4-403 or (ii) the signature of the drawer of the draft was authorized, the drawee may recover the amount of the draft from the person to whom or for whose benet payment was made or, in the case of acceptance, may revoke the acceptance. Rights of the drawee under this subsection are not aected by failure of the drawee to exercise ordinary care in paying or accepting the draft. (b) Except as provided in subsection (c), if an instrument has been paid or accepted by mistake and the case is not covered by subsection (a), the person paying or accepting may, to the extent permitted by the law governing mistake and restitution, (i) recover the payment from the person to whom or for whose benet payment was made or (ii) in the case of acceptance, may revoke the acceptance. (c) The remedies provided by subsection (a) or (b) may not be asserted against a person who took the instrument in good faith and for value or who in good faith changed position in reliance on the payment or acceptance. This subsection does not limit remedies provided by Section 3-417 or 4-407. (d) Notwithstanding Section 4-215, if an instrument is paid or accepted by mistake and the payor or acceptor recovers payment or revokes acceptance under subsection (a) or (b), the instrument is deemed not to have been paid or accepted and is treated as dishonored, and the person from whom payment is recovered has rights as a person entitled to enforce the dishonored instrument. Ocial Comment
1. This section covers payment or acceptance by mistake and replaces former Section 3-418. Under former Article 3, the remedy of a drawee that paid or accepted a draft by mistake was based on the law of mistake and restitution, but that remedy was not specically stated. It was provided by Section 1-103. Former Section 3-418 was simply a limitation on the unstated remedy under the law of mistake and restitution. Under revised Article 3, Section 3-418 specically states the right of restitution in subsections (a) and (b). Subsection (a) allows restitution in the two most common cases in which the problem is presented: payment or acceptance of forged checks and checks on which the drawer has stopped payment. If the drawee acted under a mistaken belief that the check was not forged or had not been stopped, the drawee is entitled to recover the funds paid or to revoke the acceptance whether or not the drawee acted negligently. But in each case, by virtue of subsection (c), the drawee loses the remedy if the person receiving payment or acceptance was a person who took the check in good faith and for value or who in good faith changed position in reliance on the payment or acceptance. Subsections (a) and (c) are consistent with former Section 3-418 and the rule of Price v. Neal. The result in the two cases covered by subsection (a) is that the drawee in most cases will not have a remedy against the person paid because there is usually a person who took the check in good faith and for value or who in good faith changed position in reliance on the payment or acceptance. 2. If a check has been paid by mistake and the payee receiving payment did not give 407

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value for the check or did not change position in reliance on the payment, the drawee bank is entitled to recover the amount of the check under subsection (a) regardless of how the check was paid. The drawee bank normally pays a check by a credit to an account of the collecting bank that presents the check for payment. The payee of the check normally receives the payment by a credit to the payee's account in the depositary bank. But in some cases the payee of the check may have received payment directly from the drawee bank by presenting the check for payment over the counter. In those cases the payee is entitled to receive cash, but the payee may prefer another form of payment such as a cashier's check or teller's check issued by the drawee bank. Suppose Seller contracted to sell goods to Buyer. The contract provided for immediate payment by Buyer and delivery of the goods 20 days after payment. Buyer paid by mailing a check for $10,000 drawn on Bank payable to Seller. The next day Buyer gave a stop payment order to Bank with respect to the check Buyer had mailed to Seller. A few days later Seller presented Buyer's check to Bank for payment over the counter and requested a cashier's check as payment. Bank issued and delivered a cashier's check for $10,000 payable to Seller. The teller failed to discover Buyer's stop order. The next day Bank discovered the mistake and immediately advised Seller of the facts. Seller refused to return the cashier's check and did not deliver any goods to Buyer. Under Section 4-215, Buyer's check was paid by Bank at the time it delivered its cashier's check to Seller. See Comment 3 to Section 4-215. Bank is obliged to pay the cashier's check and has no defense to that obligation. The cashier's check was issued for consideration because it was issued in payment of Buyer's check. Although Bank has no defense on its cashier's check it may have a right to recover $10,000, the amount of Buyer's check, from Seller under Section 3-418(a). Bank paid Buyer's check by mistake. Seller did not give value for Buyer's check because the promise to deliver goods to Buyer was never performed. Section 3-303(a)(1). And, on these facts, Seller did not change position in reliance on the payment of Buyer's check. Thus, the rst sentence of Section 3-418(c) does not apply and Seller is obliged to return $10,000 to Bank. Bank is obliged to pay the cashier's check but it has a counterclaim against Seller based on its rights under Section 3-418(a). This claim can be asserted against Seller, but it cannot be asserted against some other person with rights of a holder in due course of the cashier's check. A person without rights of a holder in due course of the cashier's check would take subject to Bank's claim against Seller because it is a claim in recoupment. Section 3-305(a)(3). If Bank recovers from Seller under Section 3-418(a), the payment of Buyer's check is treated as unpaid and dishonored. Section 3-418(d). One consequence is that Seller may enforce Buyer's obligation as drawer to pay the check. Section 3-414. Another consequence is that Seller's rights against Buyer on the contract of sale are also preserved. Under Section 3-310(b) Buyer's obligation to pay for the goods was suspended when Seller took Buyer's check and remains suspended until the check is either dishonored or paid. Under Section 3-310(b)(2) 3-310(b)(1)* the obligation is discharged when the check is paid. Since Section 3-418(d) treats Buyer's check as unpaid and dishonored, Buyer's obligation is not discharged and suspension of the obligation terminates. Under Section 3-310(b)(3), Seller may enforce either the contract of sale or the check subject to defenses and claims of Buyer. If Seller had released the goods to Buyer before learning about the stop order, Bank would have no recovery against Seller under Section 3-418(a) because Seller in that case gave value for Buyer's check. Section 3-418(c). In this case Bank's sole remedy is under Section 4-407 by subrogation. 3. Subsection (b) covers cases of payment or acceptance by mistake that are not covered by subsection (a). It directs courts to deal with those cases under the law governing mistake and restitution. Perhaps the most important class of cases that falls under subsection (b), because it is not covered by subsection (a), is that of payment by the drawee bank of a check with respect to which the bank has no duty to the drawer to pay either because the drawer has no account with the bank or because available funds in the drawer's account are not sucient to cover the amount of the check. With respect to such a case, under Restatement of Restitution 29, if the bank paid because of a mistaken belief that there [Section 3-418] *Previous incorrect cross reference cor408 rected by Permanent Editorial Board action November 1992.

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were available funds in the drawer's account sucient to cover the amount of the check, the bank is entitled to restitution. But 29 is subject to Restatement of Restitution 33 which denies restitution if the holder of the check receiving payment paid value in good faith for the check and had no reason to know that the check was paid by mistake when payment was received. The result in some cases is clear. For example, suppose Father gives Daughter a check for $10,000 as a birthday gift. The check is drawn on Bank in which both Father and Daughter have accounts. Daughter deposits the check in her account in Bank. An employee of Bank, acting under the belief that there were available funds in Father's account to cover the check, caused Daughter's account to be credited for $10,000. In fact, Father's account was overdrawn and Father did not have overdraft privileges. Since Daughter received the check gratuitously there is clear unjust enrichment if she is allowed to keep the $10,000 and Bank is unable to obtain reimbursement from Father. Thus, Bank should be permitted to reverse the credit to Daughter's account. But this case is not typical. In most cases the remedy of restitution will not be available because the person receiving payment of the check will have given value for it in good faith. In some cases, however, it may not be clear whether a drawee bank should have a right of restitution. For example, a check-kiting scheme may involve a large number of checks drawn on a number of dierent banks in which the drawer's credit balances are based on uncollected funds represented by fraudulently drawn checks. No attempt is made in Section 3-418 to state rules for determining the conicting claims of the various banks that may be victimized by such a scheme. Rather, such cases are better resolved on the basis of general principles of law and the particular facts presented in the litigation. 4. The right of the drawee to recover a payment or to revoke an acceptance under Section 3-418 is not aected by the rules under Article 4 that determine when an item is paid. Even though a payor bank may have paid an item under Section 4-215, it may have a right to recover the payment under Section 3-418. National Savings & Trust Co. v. Park Corp., 722 F.2d 1303 (6th Cir.1983), cert. denied, 466 U.S. 939 (1984), correctly states the law on the issue under former Article 3. Revised Article 3 does not change the previous law.

3-419. Instruments Signed for Accommodation. (a) If an instrument is issued for value given for the benet of a party to the instrument (accommodated party) and another party to the instrument (accommodation party) signs the instrument for the purpose of incurring liability on the instrument without being a direct beneciary of the value given for the instrument, the instrument is signed by the accommodation party for accommodation. (b) An accommodation party may sign the instrument as maker, drawer, acceptor, or indorser and, subject to subsection (d), is obliged to pay the instrument in the capacity in which the accommodation party signs. The obligation of an accommodation party may be enforced notwithstanding any statute of frauds and whether or not the accommodation party receives consideration for the accommodation. (c) A person signing an instrument is presumed to be an accommodation party and there is notice that the instrument is signed for accommodation if the signature is an anomalous indorsement or is accompanied by words indicating that the signer is acting as surety or guarantor with respect to the obligation of another party to the instrument. Except as provided in Section 3-605, the obligation of an accommodation party to pay the instrument is not aected by the fact that the person enforcing the obligation had notice when the instrument was taken by that person that the accommodation party signed the instrument for accommodation. (d) If the signature of a party to an instrument is accompanied by words indicating unambiguously that the party is guaranteeing collection rather
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than payment of the obligation of another party to the instrument, the signer is obliged to pay the amount due on the instrument to a person entitled to enforce the instrument only if (i) execution of judgment against the other party has been returned unsatised, (ii) the other party is insolvent or in an insolvency proceeding, (iii) the other party cannot be served with process, or (iv) it is otherwise apparent that payment cannot be obtained from the other party. (e) If the signature of a party to an instrument is accompanied by words indicating that the party guarantees payment or the signer signs the instrument as an accommodation party in some other manner that does not unambiguously indicate an intention to guarantee collection rather than payment, the signer is obliged to pay the amount due on the instrument to a person entitled to enforce the instrument in the same circumstances as the accommodated party would be obliged, without prior resort to the accommodated party by the person entitled to enforce the instrument. (f) An accommodation party who pays the instrument is entitled to reimbursement from the accommodated party and is entitled to enforce the instrument against the accommodated party. In proper circumstances, an accommodation party may obtain relief that requires the accommodated party to perform its obligations on the instrument. An accommodated party that pays the instrument has no right of recourse against, and is not entitled to contribution from, an accommodation party. As amended in 2002.
See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
1. Section 3-419 replaces former Section 3-415 and 3-416. An accommodation party is a person who signs an instrument to benet the accommodated party either by signing at the time value is obtained by the accommodated party or later, and who is not a direct beneciary of the value obtained. An accommodation party will usually be a co-maker or anomalous indorser. Subsection (a) distinguishes between direct and indirect benet. For example, if X cosigns a note of Corporation that is given for a loan to Corporation, X is an accommodation party if no part of the loan was paid to X or for X's direct benet. This is true even though X may receive indirect benet from the loan because X is employed by Corporation or is a stockholder of Corporation, or even if X is the sole stockholder so long as Corporation and X are recognized as separate entities. 2. It does not matter whether an accommodation party signs gratuitously either at the time the instrument is issued or after the instrument is in the possession of a holder. Subsection (b) of Section 3-419 takes the view stated in Comment 3 to former Section 3-415 that there need be no consideration running to the accommodation party: The obligation of the accommodation party is supported by any consideration for which the instrument is taken before it is due. Subsection (2) is intended to change occasional decisions holding that there is no sucient consideration where an accommodation party signs a note after it is in the hands of a holder who has given value. The [accommodation] party is liable to the holder in such a case even though there is no extension of time or other concession. 3. As stated in Comment 1, whether a person is an accommodation party is a question of fact. But it is almost always the case that a co-maker who signs with words of guaranty after the signature is an accommodation party. The same is true of an anomalous indorser. In either case a person taking the instrument is put on notice of the accommodation status of the co-maker or indorser. This is relevant to Section 3-605(e). But, under subsection (c), signing with words of guaranty or as an anomalous indorser also creates a presumption that the signer is an accommodation party. A party challenging accommodation party status would have to rebut this presumption by producing evidence that the signer was in 410

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fact a direct beneciary of the value given for the instrument. An accommodation party is always a surety. A surety who is not a party to the instrument, however, is not an accommodation party. For example, if M issues a note payable to the order of P, and S signs a separate contract in which S agrees to pay P the amount of the instrument if it is dishonored, S is a surety but is not an accommodation party. In such a case, S's rights and duties are determined under the general law of suretyship. In unusual cases two parties to an instrument may have a surety relationship that is not governed by Article 3 because the requirements of Section 3-419(a) are not met. In those cases the general law of suretyship applies to the relationship. See PEB Commentary No. 11, dated February 10, 1994 [Appendix A, infra]. 4. Subsection (b) states that an accommodation party is liable on the instrument in the capacity in which the party signed the instrument. In most cases that capacity will be either that of a maker or indorser of a note. But subsection (d) provides a limitation on subsection (b). If the signature of the accommodation party is accompanied by words indicating unambiguously that the party is guaranteeing collection rather than payment of the instrument, liability is limited to that stated in subsection (d), which is based on former Section 3-416(2). Former Article 3 was confusing because the obligation of a guarantor was covered both in Section 3-415 and in Section 3-416. The latter section suggested that a signature accompanied by words of guaranty created an obligation distinct from that of an accommodation party. Revised Article 3 eliminates that confusion by stating in Section 3-419 the obligation of a person who uses words of guaranty. Portions of former Section 3-416 are preserved. Former Section 3-416(2) is reected in Section 3-419(d) and former Section 3-416(4) is reected in Section 3-419(c). Words added to an anomalous indorsement indicating that payment of the instrument is guaranteed by the indorser do not change the liability of the indorser as stated in Section 3-415. This is a change from former Section 3-416(5). See PEB Commentary No. 11, supra. 5. Subsection (e) like former Section 3-415(5), provides that an accommodation party that pays the instrument is entitled to enforce the instrument against the accommodated party. Since the accommodation party that pays the instrument is entitled to enforce the instrument against the accommodated party, the accommodation party also obtains rights to any security interest or other collateral that secures payment of the instrument. Subsection (e) also provides that an accommodation party that pays the instrument is entitled to reimbursement from the accommodated party. See PEB Commentary No. 11, supra. 6. In occasional cases, the accommodation party might pay the instrument even though the accommodated party had a defense to its obligation that was available to the accommodation party under Section 3-305(d). In such cases, the accommodation party's right to reimbursement may conict with the accommodated party's right to raise its defense. For example, suppose the accommodation party pays the instrument without being aware of the defense. In that case the accommodation party should be entitled to reimbursement. Suppose the accommodation party paid the instrument with knowledge of the defense. In that case, to the extent of the defense, reimbursement ordinarily would not be justied, but under some circumstances reimbursement may be justied depending upon the facts of the case. The resolution of this conict is left to the general law of suretyship. Section 1-103. See PEB Commentary No. 11, supra. 7. Section 3-419, along with Section 3-116(a) and (b), Section 3-305(d) and Section 3-605, provides rules governing the rights of accommodation parties. In addition, except to the extent that it is displaced by provisions of this Article, the general law of suretyship also applies to the rights of accommodation parties. Section 1-103. See PEB Commentary No. 11, supra.

As amended in 2002.
See Appendix Q for material relating to changes in Ocial Comment in 2002.

3-420. Conversion of Instrument. (a) The law applicable to conversion of personal property applies to instruments. An instrument is also converted if it is taken by transfer, other than a negotiation, from a person not entitled to enforce the instru411

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ment or a bank makes or obtains payment with respect to the instrument for a person not entitled to enforce the instrument or receive payment. An action for conversion of an instrument may not be brought by (i) the issuer or acceptor of the instrument or (ii) a payee or indorsee who did not receive delivery of the instrument either directly or through delivery to an agent or a co-payee. (b) In an action under subsection (a), the measure of liability is presumed to be the amount payable on the instrument, but recovery may not exceed the amount of the plainti's interest in the instrument. (c) A representative, other than a depositary bank, who has in good faith dealt with an instrument or its proceeds on behalf of one who was not the person entitled to enforce the instrument is not liable in conversion to that person beyond the amount of any proceeds that it has not paid out. Ocial Comment
1. Section 3-420 is a modication of former Section 3-419. The rst sentence of Section 3-420(a) states a general rule that the law of conversion applicable to personal property also applies to instruments. Paragraphs (a) and (b) of former Section 3-419(1) are deleted as inappropriate in cases of noncash items that may be delivered for acceptance or payment in collection letters that contain varying instructions as to what to do in the event of nonpayment on the day of delivery. It is better to allow such cases to be governed by the general law of conversion that would address the issue of when, under the circumstances prevailing, the presenter's right to possession has been denied. The second sentence of Section 3-420(a) states that an instrument is converted if it is taken by transfer other than a negotiation from a person not entitled to enforce the instrument or taken for collection or payment from a person not entitled to enforce the instrument or receive payment. This covers cases in which a depositary or payor bank takes an instrument bearing a forged indorsement. It also covers cases in which an instrument is payable to two persons and the two persons are not alternative payees, e.g. a check payable to John and Jane Doe. Under Section 3-110(d) the check can be negotiated or enforced only by both persons acting jointly. Thus, neither payee acting without the consent of the other, is a person entitled to enforce the instrument. If John indorses the check and Jane does not, the indorsement is not eective to allow negotiation of the check. If Depositary Bank takes the check for deposit to John's account, Depositary Bank is liable to Jane for conversion of the check if she did not consent to the transaction. John, acting alone, is not the person entitled to enforce the check because John is not the holder of the check. Section 3-110(d) and Comment 4 to Section 3-110. Depositary Bank does not get any greater rights under Section 4-205(1). If it acted for John as its customer, it did not become holder of the check under that provision because John, its customer, was not a holder. Under former Article 3, the cases were divided on the issue of whether the drawer of a check with a forged indorsement can assert rights against a depositary bank that took the check. The last sentence of Section 3-420(a) resolves the conict by following the rule stated in Stone & Webster Engineering Corp. v. First National Bank & Trust Co., 184 N.E.2d 358 (Mass.1962). There is no reason why a drawer should have an action in conversion. The check represents an obligation of the drawer rather than property of the drawer. The drawer has an adequate remedy against the payor bank for recredit of the drawer's account for unauthorized payment of the check. There was also a split of authority under former Article 3 on the issue of whether a payee who never received the instrument is a proper plainti in a conversion action. The typical case was one in which a check was stolen from the drawer or in which the check was mailed to an address dierent from that of the payee and was stolen after it arrived at that address. The thief forged the indorsement of the payee and obtained payment by depositing the check to an account in a depositary bank. The issue was whether the payee could bring an action in conversion against the depositary bank or the drawee bank. In revised Article 3, under the last sentence of Section 3-420(a), the payee has no conversion action because the check was never delivered to the payee. Until delivery, the payee does not have any interest in the check. The payee never became the holder of the check nor a person entitled 412

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to enforce the check. Section 3-301. Nor is the payee injured by the fraud. Normally the drawer of a check intends to pay an obligation owed to the payee. But if the check is never delivered to the payee, the obligation owed to the payee is not aected. If the check falls into the hands of a thief who obtains payment after forging the signature of the payee as an indorsement, the obligation owed to the payee continues to exist after the thief receives payment. Since the payee's right to enforce the underlying obligation is unaected by the fraud of the thief, there is no reason to give any additional remedy to the payee. The drawer of the check has no conversion remedy, but the drawee is not entitled to charge the drawer's account when the drawee wrongfully honored the check. The remedy of the drawee is against the depositary bank for breach of warranty under Section 3-417(a)(1) or 4-208(a) (1). The loss will fall on the person who gave value to the thief for the check. The situation is dierent if the check is delivered to the payee. If the check is taken for an obligation owed to the payee, the last sentence of Section 3-310(b)(4) provides that the obligation may not be enforced to the extent of the amount of the check. The payee's rights are restricted to enforcement of the payee's rights in the instrument. In this event the payee is injured by the theft and has a cause of action for conversion. The payee receives delivery when the check comes into the payee's possession, as for example when it is put into the payee's mailbox. Delivery to an agent is delivery to the payee. If a check is payable to more than one payee, delivery to one of the payees is deemed to be delivery to all of the payees. Occasionally, the person asserting a conversion cause of action is an indorsee rather than the original payee. If the check is stolen before the check can be delivered to the indorsee and the indorsee's indorsement is forged, the analysis is similar. For example, a check is payable to the order of A. A indorses it to B and puts it into an envelope addressed to B. The envelope is never delivered to B. Rather, Thief steals the envelope, forges B's indorsement to the check and obtains payment. Because the check was never delivered to B, the indorsee, B has no cause of action for conversion, but A does have such an action. A is the owner of the check. B never obtained rights in the check. If A intended to negotiate the check to B in payment of an obligation, that obligation was not aected by the conduct of Thief. B can enforce that obligation. Thief stole A's property not B's. 2. Subsection (2) of former Section 3-419 is amended because it is not clear why the former law distinguished between the liability of the drawee and that of other converters. Why should there be a conclusive presumption that the liability is face amount if a drawee refuses to pay or return an instrument or makes payment on a forged indorsement, while the liability of a maker who does the same thing is only presumed to be the face amount? Moreover, it was not clear under former Section 3-419(2) what face amount meant. If a note for $10,000 is payable in a year at 10% interest, it is common to refer to $10,000 as the face amount, but if the note is converted the loss to the owner also includes the loss of interest. In revised Article 3, Section 3-420(b), by referring to amount payable on the instrument, allows the full amount due under the instrument to be recovered. The but clause in subsection (b) addresses the problem of conversion actions in multiple payee checks. Section 3-110(d) states that an instrument cannot be enforced unless all payees join in the action. But an action for conversion might be brought by a payee having no interest or a limited interest in the proceeds of the check. This clause prevents such a plainti from receiving a windfall. An example is a check payable to a building contractor and a supplier of building material. The check is not payable to the payees alternatively. Section 3-110(d). The check is delivered to the contractor by the owner of the building. Suppose the contractor forges supplier's signature as an indorsement of the check and receives the entire proceeds of the check. The supplier should not, without qualication, be able to recover the entire amount of the check from the bank that converted the check. Depending upon the contract between the contractor and the supplier, the amount of the check may be due entirely to the contractor, in which case there should be no recovery, entirely to the supplier, in which case recovery should be for the entire amount, or part may be due to one and the rest to the other, in which case recovery should be limited to the amount due to the supplier. 3. Subsection (3) of former Section 3-419 drew criticism from the courts, that saw no reason why a depositary bank should have the defense stated in the subsection. See Knesz v. Central Jersey Bank & Trust Co., 477 A.2d 806 (N.J.1984). The depositary bank is ultimately liable in the case of a forged indorsement check because of its warranty to the payor bank under Section 4-208(a)(1) and it is usually the most convenient defendant in 413

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cases involving multiple checks drawn on dierent banks. There is no basis for requiring the owner of the check to bring multiple actions against the various payor banks and to require those banks to assert warranty rights against the depositary bank. In revised Article 3, the defense provided by Section 3-420(c) is limited to collecting banks other than the depositary bank. If suit is brought against both the payor bank and the depositary bank, the owner, of course, is entitled to but one recovery.

PART 5. DISHONOR
3-501. Presentment. (a) Presentment means a demand made by or on behalf of a person entitled to enforce an instrument (i) to pay the instrument made to the drawee or a party obliged to pay the instrument or, in the case of a note or accepted draft payable at a bank, to the bank, or (ii) to accept a draft made to the drawee. (b) The following rules are subject to Article 4, agreement of the parties, and clearing-house rules and the like: (1) Presentment may be made at the place of payment of the instrument and must be made at the place of payment if the instrument is payable at a bank in the United States; may be made by any commercially reasonable means, including an oral, written, or electronic communication; is eective when the demand for payment or acceptance is received by the person to whom presentment is made; and is eective if made to any one of two or more makers, acceptors, drawees, or other payors. (2) Upon demand of the person to whom presentment is made, the person making presentment must (i) exhibit the instrument, (ii) give reasonable identication and, if presentment is made on behalf of another person, reasonable evidence of authority to do so, and (iii) sign a receipt on the instrument for any payment made or surrender the instrument if full payment is made. (3) Without dishonoring the instrument, the party to whom presentment is made may (i) return the instrument for lack of a necessary indorsement, or (ii) refuse payment or acceptance for failure of the presentment to comply with the terms of the instrument, an agreement of the parties, or other applicable law or rule. (4) The party to whom presentment is made may treat presentment as occurring on the next business day after the day of presentment if the party to whom presentment is made has established a cut-o hour not earlier than 2 p.m. for the receipt and processing of instruments presented for payment or acceptance and presentment is made after the cut-o hour. Ocial Comment
Subsection (a) denes presentment. Subsection (b)(1) states the place and manner of presentment. Electronic presentment is authorized. The communication of the demand for payment or acceptance is eective when received. Subsection (b)(2) restates former Section 3-505. Subsection (b)(2)(i) allows the person to whom presentment is made to require exhibition of the instrument, unless the parties have agreed otherwise as in an electronic presentment agreement. Former Section 3-507(3) is the antecedent of subsection (b)(3)(i). Since a payor must decide whether to pay or accept on the day of presentment, subsection (b)(4) allows the payor to set a cut-o hour for receipt of instruments presented. 414

Art. 3

Negotiable Instruments

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3-502. Dishonor. (a) Dishonor of a note is governed by the following rules: (1) If the note is payable on demand, the note is dishonored if presentment is duly made to the maker and the note is not paid on the day of presentment. (2) If the note is not payable on demand and is payable at or through a bank or the terms of the note require presentment, the note is dishonored if presentment is duly made and the note is not paid on the day it becomes payable or the day of presentment, whichever is later. (3) If the note is not payable on demand and paragraph (2) does not apply, the note is dishonored if it is not paid on the day it becomes payable. (b) Dishonor of an unaccepted draft other than a documentary draft is governed by the following rules: (1) If a check is duly presented for payment to the payor bank otherwise than for immediate payment over the counter, the check is dishonored if the payor bank makes timely return of the check or sends timely notice of dishonor or nonpayment under Section 4-301 or 4-302, or becomes accountable for the amount of the check under Section 4-302. (2) If a draft is payable on demand and paragraph (1) does not apply, the draft is dishonored if presentment for payment is duly made to the drawee and the draft is not paid on the day of presentment. (3) If a draft is payable on a date stated in the draft, the draft is dishonored if (i) presentment for payment is duly made to the drawee and payment is not made on the day the draft becomes payable or the day of presentment, whichever is later, or (ii) presentment for acceptance is duly made before the day the draft becomes payable and the draft is not accepted on the day of presentment. (4) If a draft is payable on elapse of a period of time after sight or acceptance, the draft is dishonored if presentment for acceptance is duly made and the draft is not accepted on the day of presentment. (c) Dishonor of an unaccepted documentary draft occurs according to the rules stated in subsection (b)(2), (3), and (4), except that payment or acceptance may be delayed without dishonor until no later than the close of the third business day of the drawee following the day on which payment or acceptance is required by those paragraphs. (d) Dishonor of an accepted draft is governed by the following rules: (1) If the draft is payable on demand, the draft is dishonored if presentment for payment is duly made to the acceptor and the draft is not paid on the day of presentment. (2) If the draft is not payable on demand, the draft is dishonored if presentment for payment is duly made to the acceptor and payment is not made on the day it becomes payable or the day of presentment, whichever is later. (e) In any case in which presentment is otherwise required for dishonor under this section and presentment is excused under Section 3-504, dishonor occurs without presentment if the instrument is not duly accepted or paid.
415

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(f) If a draft is dishonored because timely acceptance of the draft was not made and the person entitled to demand acceptance consents to a late acceptance, from the time of acceptance the draft is treated as never having been dishonored. Ocial Comment
1. Section 3-415 provides that an indorser is obliged to pay an instrument if the instrument is dishonored and is discharged if the indorser is entitled to notice of dishonor and notice is not given. Under Section 3-414, the drawer is obliged to pay an unaccepted draft if it is dishonored. The drawer, however, is not entitled to notice of dishonor except to the extent required in a case governed by Section 3-414(d). Part 5 tells when an instrument is dishonored (Section 3-502) and what it means to give notice of dishonor (Section 3-503). Often dishonor does not occur until presentment (Section 3-501), and frequently presentment and notice of dishonor are excused (Section 3-504). 2. In the great majority of cases presentment and notice of dishonor are waived with respect to notes. In most cases a formal demand for payment to the maker of the note is not contemplated. Rather, the maker is expected to send payment to the holder of the note on the date or dates on which payment is due. If payment is not made when due, the holder usually makes a demand for payment, but in the normal case in which presentment is waived, demand is irrelevant and the holder can proceed against indorsers when payment is not received. Under former Article 3, in the small minority of cases in which presentment and dishonor were not waived with respect to notes, the indorser was discharged from liability (former Section 3-502(1)(a)) unless the holder made presentment to the maker on the exact day the note was due (former Section 3-503(1)(c)) and gave notice of dishonor to the indorser before midnight of the third business day after dishonor (former Section 3-508(2)). These provisions are omitted from Revised Article 3 as inconsistent with practice which seldom involves face-to-face dealings. 3. Subsection (a) applies to notes. Subsection (a)(1) applies to notes payable on demand. Dishonor requires presentment, and dishonor occurs if payment is not made on the day of presentment. There is no change from previous Article 3. Subsection (a)(2) applies to notes payable at a denite time if the note is payable at or through a bank or, by its terms, presentment is required. Dishonor requires presentment, and dishonor occurs if payment is not made on the due date or the day of presentment if presentment is made after the due date. Subsection (a)(3) applies to all other notes. If the note is not paid on its due date it is dishonored. This allows holders to collect notes in ways that make sense commercially without having to be concerned about a formal presentment on a given day. 4. Subsection (b) applies to unaccepted drafts other than documentary drafts. Subsection (b)(1) applies to checks. Except for checks presented for immediate payment over the counter, which are covered by subsection (b)(2), dishonor occurs according to rules stated in Article 4. When a check is presented for payment through the check-collection system, the drawee bank normally makes settlement for the amount of the check to the presenting bank. Under Section 4-301 the drawee bank may recover this settlement if it returns the check within its midnight deadline (Section 4-104). In that case the check is not paid and dishonor occurs under Section 3-502(b)(1). If the drawee bank does not return the check or give notice of dishonor or nonpayment within the midnight deadline, the settlement becomes nal payment of the check. Section 4-215. Thus, no dishonor occurs regardless of whether the check is retained or is returned after the midnight deadline. In some cases the drawee bank might not settle for the check when it is received. Under Section 4-302 if the drawee bank is not also the depositary bank and retains the check without settling for it beyond midnight of the day it is presented for payment, the bank becomes accountable for the amount of the check, i.e. it is obliged to pay the amount of the check. If the drawee bank is also the depositary bank, the bank is accountable for the amount of the check if the bank does not pay the check or return it or send notice of dishonor within the midnight deadline. In all cases in which the drawee bank becomes accountable, the check has not been paid and, under Section 3-502(b)(1), the check is dishonored. The fact that the bank is obliged to pay the check does not mean that the check has been paid. When a check is presented for payment, the person presenting the check is entitled to payment not just the obligation of the drawee to pay. Until that payment is made, the check is dishonored. To say that the drawee bank is obliged to pay the check necessarily means that the check has 416

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not been paid. If the check is eventually paid, the drawee bank no longer is accountable. 4. Subsection (b) applies to unaccepted drafts other than documentary drafts. Subsection (b)(1) applies to checks. Except for checks presented for immediate payment over the counter, which are covered by subsection (b)(2), dishonor occurs according to rules stated in Article 4. Those rules contemplate four separate situations that warrant discussion. The rst two situations arise in the normal course of aairs, in which the drawee bank makes settlement for the amount of the check to the presenting bank. In the rst situation, the drawee bank under Section 4-301 recovers this settlement if it returns the check by its midnight deadline (Section 4-104). In that case the check is not paid and dishonor occurs under Section 3-502(b) (1). The second situation arises if the drawee bank has made such a settlement and does not return the check or give notice of dishonor or nonpayment within the midnight deadline. In that case, the settlement becomes nal payment of the check under Section 4-215. Because the drawee bank already has paid such an item, it cannot be accountable for the item under the terms of Section 4-302(a)(1). Thus, no dishonor occurs regardless of whether the drawee bank retains the check indenitely or for some reason returns the check after its midnight deadline. The third and fourth situations arise less commonly, in cases in which the drawee bank does not settle for the check when it is received. Under Section 4-302 if the drawee bank is not also the depositary bank and retains the check without settling for it beyond midnight of the day it is presented for payment, the bank at that point becomes accountable for the amount of the check, i.e., it is obliged to pay the amount of the check. If the drawee bank is also the depositary bank, the bank becomes accountable for the amount of the check if the bank does not pay the check or return it or send notice of dishonor by its midnight deadline. Hence, if the drawee bank is also the depositary bank and does not either settle for the check when it is received (a settlement that would ripen into nal payment if the drawee bank failed to take action to recover the settlement by its midnight deadline) or return the check or an appropriate notice by its midnight deadline, the drawee bank will become accountable for the amount of the check under Section 4-302. Thus, in all cases in which the drawee bank becomes accountable under Section 4-302, the check has not been paid (either by a settlement that became unrecoverable or otherwise) and thus, under Section 3-502(b)(1), the check is dishonored. The fact that a bank that is accountable for the amount of the check under Section 4-302 is obliged to pay the check does not mean that the check has been paid. Indeed, because each of the paragraphs of Section 4-302(b) is limited by its terms to situations in which a bank has not paid the item, a drawee bank will be accountable under Section 4-302 only in situations in which it has not previously paid the check. Section 3-502(b)(1) reects the view that a person presenting a check is entitled to payment, not just the ability to hold the drawee accountable under Section 4-302. If that payment is not made in a timely manner, the check is dishonored. Regulation CC Section 229.36(d) provides that settlement between banks for the forward collection of checks is nal. The relationship of that section to Articles 3 and 4 is discussed in the Commentary to that section. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002. Subsection (b)(2) applies to demand drafts other than those governed by subsection (b)(1). It covers checks presented for immediate payment over the counter and demand drafts other than checks. Dishonor occurs if presentment for payment is made and payment is not made on the day of presentment. Subsection (b)(3) and (4) applies to time drafts. An unaccepted time draft diers from a time note. The maker of a note knows that the note has been issued, but the drawee of a draft may not know that a draft has been drawn on it. Thus, with respect to drafts, presentment for payment or acceptance is required. Subsection (b)(3) applies to drafts payable on a date stated in the draft. Dishonor occurs if presentment for payment is made and payment is not made on the day the draft becomes payable or the day of presentment if presentment is made after the due date. The holder of an unaccepted draft payable on a stated date has the option of presenting the draft for acceptance before the day the draft becomes payable to establish whether the drawee is willing to assume liability by accepting. Under subsection (b)(3)(ii) dishonor occurs when the draft is presented and not accepted. Subsection (b)(4) applies to unaccepted drafts payable on elapse of a period of time after sight or acceptance. If the draft is payable 30 days after sight, the draft must be presented for acceptance to start the running of the 30-day period. Dishonor occurs if it is not accepted. The 417

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rules in subsection (b)(3) and (4) follow former Section 3-501(1)(a). 5. Subsection (c) gives drawees an extended period to pay documentary drafts because of the time that may be needed to examine the documents. The period prescribed is that given by Section 5-112 in cases in which a letter of credit is involved. 6. Subsection (d) governs accepted drafts. If the acceptor's obligation is to pay on demand the rule, stated in subsection (d)(1), is the same as for that of a demand note stated in subsection (a)(1). If the acceptor's obligation is to pay at a denite time the rule, stated in subsection (d)(2), is the same as that of a time note payable at a bank stated in subsection (b)(2). 7. Subsection (e) is a limitation on subsection (a)(1) and (2), subsection (b), subsection (c), and subsection (d). Each of those provisions states dishonor as occurring after presentment. If presentment is excused under Section 3-504, dishonor occurs under those provisions without presentment if the instrument is not duly accepted or paid. 8. Under subsection (b)(3)(ii) and (4) if a draft is presented for acceptance and the draft is not accepted on the day of presentment, there is dishonor. But after dishonor, the holder may consent to late acceptance. In that case, under subsection (f), the late acceptance cures the dishonor. The draft is treated as never having been dishonored. If the draft is subsequently presented for payment and payment is refused dishonor occurs at that time.

3-503. Notice of Dishonor. (a) The obligation of an indorser stated in Section 3-415(a) and the obligation of a drawer stated in Section 3-414(d) may not be enforced unless (i) the indorser or drawer is given notice of dishonor of the instrument complying with this section or (ii) notice of dishonor is excused under Section 3-504(b). (b) Notice of dishonor may be given by any person; may be given by any commercially reasonable means, including an oral, written, or electronic communication; and is sucient if it reasonably identies the instrument and indicates that the instrument has been dishonored or has not been paid or accepted. Return of an instrument given to a bank for collection is sucient notice of dishonor. (c) Subject to Section 3-504(c), with respect to an instrument taken for collection by a collecting bank, notice of dishonor must be given (i) by the bank before midnight of the next banking day following the banking day on which the bank receives notice of dishonor of the instrument, or (ii) by any other person within 30 days following the day on which the person receives notice of dishonor. With respect to any other instrument, notice of dishonor must be given within 30 days following the day on which dishonor occurs. Ocial Comment
1. Subsection (a) is consistent with former Section 3-501(2)(a), but notice of dishonor is no longer relevant to the liability of a drawer except for the case of a draft accepted by an acceptor other than a bank. Comments 2 and 4 to Section 3-414. There is no reason why drawers should be discharged on instruments they draw until payment or acceptance. They are entitled to have the instrument presented to the drawee and dishonored (Section 3-414(b)) before they are liable to pay, but no notice of dishonor need be made to them as a condition of liability. Subsection (b), which states how notice of dishonor is given, is based on former Section 3-508(3). 2. Subsection (c) replaces former Section 3-508(2). It diers from that section in that it provides a 30-day period for a person other than a collecting bank to give notice of dishonor rather than the three-day period allowed in former Article 3. Delay in giving notice of dishonor may be excused under Section 3-504(c).

3-504. Excused Presentment and Notice of Dishonor. (a) Presentment for payment or acceptance of an instrument is excused
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if (i) the person entitled to present the instrument cannot with reasonable diligence make presentment, (ii) the maker or acceptor has repudiated an obligation to pay the instrument or is dead or in insolvency proceedings, (iii) by the terms of the instrument presentment is not necessary to enforce the obligation of indorsers or the drawer, (iv) the drawer or indorser whose obligation is being enforced has waived presentment or otherwise has no reason to expect or right to require that the instrument be paid or accepted, or (v) the drawer instructed the drawee not to pay or accept the draft or the drawee was not obligated to the drawer to pay the draft. (b) Notice of dishonor is excused if (i) by the terms of the instrument notice of dishonor is not necessary to enforce the obligation of a party to pay the instrument, or (ii) the party whose obligation is being enforced waived notice of dishonor. A waiver of presentment is also a waiver of notice of dishonor. (c) Delay in giving notice of dishonor is excused if the delay was caused by circumstances beyond the control of the person giving the notice and the person giving the notice exercised reasonable diligence after the cause of the delay ceased to operate. Ocial Comment
Section 3-504 is largely a restatement of former Section 3-511. Subsection (4) of former Section 3-511 is replaced by Section 3-502(f).

3-505. Evidence of Dishonor. (a) The following are admissible as evidence and create a presumption of dishonor and of any notice of dishonor stated: (1) a document regular in form as provided in subsection (b) which purports to be a protest; (2) a purported stamp or writing of the drawee, payor bank, or presenting bank on or accompanying the instrument stating that acceptance or payment has been refused unless reasons for the refusal are stated and the reasons are not consistent with dishonor; (3) a book or record of the drawee, payor bank, or collecting bank, kept in the usual course of business which shows dishonor, even if there is no evidence of who made the entry. (b) A protest is a certicate of dishonor made by a United States consul or vice consul, or a notary public or other person authorized to administer oaths by the law of the place where dishonor occurs. It may be made upon information satisfactory to that person. The protest must identify the instrument and certify either that presentment has been made or, if not made, the reason why it was not made, and that the instrument has been dishonored by nonacceptance or nonpayment. The protest may also certify that notice of dishonor has been given to some or all parties. Ocial Comment
Protest is no longer mandatory and must be requested by the holder. Even if requested, protest is not a condition to the liability of indorsers or drawers. Protest is a service provided by the banking system to establish that dishonor has occurred. Like other services provided by the banking system, it will be available if market incentives, inter-bank agreements, or governmental regulations require it, but liabilities of parties no longer rest on it. Protest may be a requirement for liability on international drafts governed by foreign law which this Article cannot aect. 419

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PART 6. DISCHARGE AND PAYMENT

3-601. Discharge and Eect of Discharge. (a) The obligation of a party to pay the instrument is discharged as stated in this Article or by an act or agreement with the party which would discharge an obligation to pay money under a simple contract. (b) Discharge of the obligation of a party is not eective against a person acquiring rights of a holder in due course of the instrument without notice of the discharge. Ocial Comment
Subsection (a) replaces subsections (1) and (2) of former Section 3-601. Subsection (b) restates former Section 3-602. Notice of discharge is not treated as notice of a defense that prevents holder in due course status. Section 3-302(b). Discharge is eective against a holder in due course only if the holder had notice of the discharge when holder in due course status was acquired. For example, if an instrument bearing a canceled indorsement is taken by a holder, the holder has notice that the indorser has been discharged. Thus, the discharge is eective against the holder even if the holder is a holder in due course.

3-602. Payment. (a) Subject to subsection (e), an instrument is paid to the extent payment is made by or on behalf of a party obliged to pay the instrument, and to a person entitled to enforce the instrument. To the extent of the payment, the obligation of the party obliged to pay the instrument is discharged even though payment is made with knowledge of a claim to the instrument under Section 3-306 by another person. (b) Subject to subsection (e), a note is paid to the extent payment is made by or on behalf of a party obliged to pay the note to a person that formerly was entitled to enforce the note only if at the time of the payment the party obliged to pay has not received adequate notication that the note has been transferred and that payment is to be made to the transferee. A notication is adequate only if it is signed by the transferor or the transferee; reasonably identies the transferred note; and provides an address at which payments subsequently are to be made. Upon request, a transferee shall seasonably furnish reasonable proof that the note has been transferred. Unless the transferee complies with the request, a payment to the person that formerly was entitled to enforce the note is eective for purposes of subsection (c) even if the party obliged to pay the note has received a notication under this paragraph. (c) Subject to subsection (e), to the extent of a payment under subsections (a) and (b), the obligation of the party obliged to pay the instrument is discharged even though payment is made with knowledge of a claim to the instrument under Section 3-306 by another person. (d) Subject to subsection (e), a transferee, or any party that has acquired rights in the instrument directly or indirectly from a transferee, including any such party that has rights as a holder in due course, is deemed to have notice of any payment that is made under subsection (b) after the date that the note is transferred to the transferee but before the party obliged to pay the note receives adequate notication of the transfer. (e) The obligation of a party to pay the instrument is not discharged under subsections (a) through (d) if:
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(1) a claim to the instrument under Section 3-306 is enforceable against the party receiving payment and (i) payment is made with knowledge by the payor that payment is prohibited by injunction or similar process of a court of competent jurisdiction, or (ii) in the case of an instrument other than a cashier's check, teller's check, or certied check, the party making payment accepted, from the person having a claim to the instrument, indemnity against loss resulting from refusal to pay the person entitled to enforce the instrument; or (2) the person making payment knows that the instrument is a stolen instrument and pays a person it knows is in wrongful possession of the instrument. (f) As used in this section, signed, with respect to a record that is not a writing, includes the attachment to or logical association with the record of an electronic symbol, sound, or process with the present intent to adopt or accept the record. As amended in 2002.
See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
1. This section replaces former Section 3-603(1). The phrase claim to the instrument in subsection (a) means, by reference to Section 3-306, a claim of ownership or possession and not a claim in recoupment. Subsection (e)(1)(ii) is added to conform to Section 3-411. Section 3-411 is intended to discourage an obligated bank from refusing payment of a cashier's check, certied check or dishonored teller's check at the request of a claimant to the check who provided the bank with indemnity against loss. See Comment 1 to Section 3-411. An obligated bank that refuses payment under those circumstances not only remains liable on the check but may also be liable to the holder of the check for consequential damages. Section 3-602(e)(1)(ii) and Section 3-411, read together, change the rule of former Section 3-603(1) with respect to the obligation of the obligated bank on the check. Payment to the holder of a cashier's check, teller's check, or certied check discharges the obligation of the obligated bank on the check to both the holder and the claimant even though indemnity has been given by the person asserting the claim. If the obligated bank pays the check in violation of an agreement with the claimant in connection with the indemnity agreement, any liability that the bank may have for violation of the agreement is not governed by Article 3, but is left to other law. This section continues the rule that the obligor is not discharged on the instrument if payment is made in violation of an injunction against payment. See Section 3-411(c)(iv). 2. Subsection (a) covers payments made in a traditional manner, to the person entitled to enforce the instrument. Subsection (b), which provides an alternative method of payment, deals with the situation in which a person entitled to enforce the instrument transfers the instrument without giving notice to parties obligated to pay the instrument. If that happens and one of those parties subsequently makes a payment to the transferor, the payment is eective even though it is not made to the person entitled to enforce the instrument. Unlike the earlier version of Section 3-602, this rule is consistent with Section 9-406(a), Restatement of Mortgages 5.5, and Restatement of Contracts 338(1). 3. In determining the party to whom a payment is made for purposes of this section, courts should look to traditional rules of agency. Thus, if the original payee of a note transfers ownership of the note to a third party but continues to service the obligation, the law of agency might treat payments made to the original payee as payments made to the third party. 4. Subsection (d) assures that the discharge provided by subsection (c) is eective against the transferee and those whose rights derive from the transferee. By deeming those persons to have notice of any payment made under subsection (b), subsection (d) gives those persons notice of the discharge within the meaning of Section 3-302(b). Accordingly, the discharge is eective against those persons, even if any of them has the rights of a holder in due course. Compare Section 3-601(b). The deemed notice provided by subsection (d) does not, 421

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however, prevent a person from becoming or acquiring the rights of, a holder in due course. See Section 3-302(b). Thus, such a person does not become subject to other defenses described in Section 3-305(a)(2), claims in recoupment described in Section 3-305(a)(3), or claims to the instrument under Section 3-306. A transferee can prevent payment to the transferor from discharging the obligation on the note by assuring that each person who is obligated on the note receives adequate notication pursuant to subsection (b) prior to making a payment. Amendment approved by the Permanent Editorial Board for Uniform Commercial Code October 31, 2003.

As amended in 2002 and 2003.

See Appendix Q for material relating to changes in Ocial Comment in 2002.

3-603. Tender of Payment. (a) If tender of payment of an obligation to pay an instrument is made to a person entitled to enforce the instrument, the eect of tender is governed by principles of law applicable to tender of payment under a simple contract. (b) If tender of payment of an obligation to pay an instrument is made to a person entitled to enforce the instrument and the tender is refused, there is discharge, to the extent of the amount of the tender, of the obligation of an indorser or accommodation party having a right of recourse with respect to the obligation to which the tender relates. (c) If tender of payment of an amount due on an instrument is made to a person entitled to enforce the instrument, the obligation of the obligor to pay interest after the due date on the amount tendered is discharged. If presentment is required with respect to an instrument and the obligor is able and ready to pay on the due date at every place of payment stated in the instrument, the obligor is deemed to have made tender of payment on the due date to the person entitled to enforce the instrument. Ocial Comment
Section 3-603 replaces former Section 3-604. Subsection (a) generally incorporates the law of tender of payment applicable to simple contracts. Subsections (b) and (c) state particular rules. Subsection (b) replaces former Section 3-604(2). Under subsection (b) refusal of a tender of payment discharges any indorser or accommodation party having a right of recourse against the party making the tender. Subsection (c) replaces former Section 3-604(1) and (3).

3-604. Discharge by Cancellation or Renunciation. (a) A person entitled to enforce an instrument, with or without consideration, may discharge the obligation of a party to pay the instrument (i) by an intentional voluntary act, such as surrender of the instrument to the party, destruction, mutilation, or cancellation of the instrument, cancellation or striking out of the party's signature, or the addition of words to the instrument indicating discharge, or (ii) by agreeing not to sue or otherwise renouncing rights against the party by a signed record. (b) Cancellation or striking out of an indorsement pursuant to subsection (a) does not aect the status and rights of a party derived from the indorsement. (c) In this section, signed, with respect to a record that is not a writing, includes the attachment to or logical association with the record of an electronic symbol, sound, or process with the present intent to adopt or accept the record.
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As amended in 2002.
See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
Section 3-604 replaces former Section 3-605.

3-605. Discharge of Secondary Obligors. (a) If a person entitled to enforce an instrument releases the obligation of a principal obligor in whole or in part, and another party to the instrument is a secondary obligor with respect to the obligation of that principal obligor, the following rules apply: (1) Any obligations of the principal obligor to the secondary obligor with respect to any previous payment by the secondary obligor are not aected. Unless the terms of the release preserve the secondary obligor's recourse, the principal obligor is discharged, to the extent of the release, from any other duties to the secondary obligor under this article. (2) Unless the terms of the release provide that the person entitled to enforce the instrument retains the right to enforce the instrument against the secondary obligor, the secondary obligor is discharged to the same extent as the principal obligor from any unperformed portion of its obligation on the instrument. If the instrument is a check and the obligation of the secondary obligor is based on an indorsement of the check, the secondary obligor is discharged without regard to the language or circumstances of the discharge or other release. (3) If the secondary obligor is not discharged under paragraph (2), the secondary obligor is discharged to the extent of the value of the consideration for the release, and to the extent that the release would otherwise cause the secondary obligor a loss. (b) If a person entitled to enforce an instrument grants a principal obligor an extension of the time at which one or more payments are due on the instrument and another party to the instrument is a secondary obligor with respect to the obligation of that principal obligor, the following rules apply: (1) Any obligations of the principal obligor to the secondary obligor with respect to any previous payment by the secondary obligor are not aected. Unless the terms of the extension preserve the secondary obligor's recourse, the extension correspondingly extends the time for performance of any other duties owed to the secondary obligor by the principal obligor under this article. (2) The secondary obligor is discharged to the extent that the extension would otherwise cause the secondary obligor a loss. (3) To the extent that the secondary obligor is not discharged under paragraph (2), the secondary obligor may perform its obligations to a person entitled to enforce the instrument as if the time for payment had not been extended or, unless the terms of the extension provide that the person entitled to enforce the instrument retains the right to enforce the instrument against the secondary obligor as if the time for payment had not been extended, treat the time for performance of its obligations as having been extended correspondingly. (c) If a person entitled to enforce an instrument agrees, with or without
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consideration, to a modication of the obligation of a principal obligor other than a complete or partial release or an extension of the due date and another party to the instrument is a secondary obligor with respect to the obligation of that principal obligor, the following rules apply: (1) Any obligations of the principal obligor to the secondary obligor with respect to any previous payment by the secondary obligor are not aected. The modication correspondingly modies any other duties owed to the secondary obligor by the principal obligor under this article. (2) The secondary obligor is discharged from any unperformed portion of its obligation to the extent that the modication would otherwise cause the secondary obligor a loss. (3) To the extent that the secondary obligor is not discharged under paragraph (2), the secondary obligor may satisfy its obligation on the instrument as if the modication had not occurred, or treat its obligation on the instrument as having been modied correspondingly. (d) If the obligation of a principal obligor is secured by an interest in collateral, another party to the instrument is a secondary obligor with respect to that obligation, and a person entitled to enforce the instrument impairs the value of the interest in collateral, the obligation of the secondary obligor is discharged to the extent of the impairment. The value of an interest in collateral is impaired to the extent the value of the interest is reduced to an amount less than the amount of the recourse of the secondary obligor, or the reduction in value of the interest causes an increase in the amount by which the amount of the recourse exceeds the value of the interest. For purposes of this subsection, impairing the value of an interest in collateral includes failure to obtain or maintain perfection or recordation of the interest in collateral, release of collateral without substitution of collateral of equal value or equivalent reduction of the underlying obligation, failure to perform a duty to preserve the value of collateral owed, under Article 9 or other law, to a debtor or other person secondarily liable, and failure to comply with applicable law in disposing of or otherwise enforcing the interest in collateral. (e) A secondary obligor is not discharged under subsections (a)(3), (b), (c), or (d) unless the person entitled to enforce the instrument knows that the person is a secondary obligor or has notice under Section 3-419(c) that the instrument was signed for accommodation. (f) A secondary obligor is not discharged under this section if the secondary obligor consents to the event or conduct that is the basis of the discharge, or the instrument or a separate agreement of the party provides for waiver of discharge under this section specically or by general language indicating that parties waive defenses based on suretyship or impairment of collateral. Unless the circumstances indicate otherwise, consent by the principal obligor to an act that would lead to a discharge under this section constitutes consent to that act by the secondary obligor if the secondary obligor controls the principal obligor or deals with the person entitled to enforce the instrument on behalf of the principal obligor. (g) A release or extension preserves a secondary obligor's recourse if the terms of the release or extension provide that: (1) the person entitled to enforce the instrument retains the right to enforce the instrument against the secondary obligor; and
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(2) the recourse of the secondary obligor continues as if the release or extension had not been granted. (h) Except as otherwise provided in subsection (i), a secondary obligor asserting discharge under this section has the burden of persuasion both with respect to the occurrence of the acts alleged to harm the secondary obligor and loss or prejudice caused by those acts. (i) If the secondary obligor demonstrates prejudice caused by an impairment of its recourse, and the circumstances of the case indicate that the amount of loss is not reasonably susceptible of calculation or requires proof of facts that are not ascertainable, it is presumed that the act impairing recourse caused a loss or impairment equal to the liability of the secondary obligor on the instrument. In that event, the burden of persuasion as to any lesser amount of the loss is on the person entitled to enforce the instrument. As amended in 2002.
See Appendix Q for material relating to changes in text in 2002.

Ocial Comment
1. This section contains rules that are applicable when a secondary obligor (as dened in Section 3-103(a)(17)) is a party to an instrument. These rules essentially parallel modern interpretations of the law of suretyship and guaranty that apply when a secondary obligor is not a party to an instrument. See generally Restatement of the Law, Third, Suretyship and Guaranty (1996). Of course, the rules in this section do not resolve all possible issues concerning the rights and duties of the parties. In the event that a situation is presented that is not resolved by this section (or the other related sections of this Article), the resolution may be provided by the general law of suretyship because, pursuant to Section 1-103, that law is applicable unless displaced by provisions of this Act. 2. Like the law of suretyship and guaranty, Section 3-605 provides secondary obligors with defenses that are not available to other parties to instruments. The general operation of Section 3-605, and its relationship to the law of suretyship and guaranty, can be illustrated by an example. Bank agrees to lend $10,000 to Borrower, but only if Backer also is liable for repayment of the loan. The parties could consummate that transaction in three dierent ways. First, if Borrower and Backer incurred those obligations with contracts not governed by this Article (such as a note that is not an instrument for purposes of this Article), the general law of suretyship and guaranty would be applicable. Under modern nomenclature, Bank is the obligee, Borrower is the principal obligor, and Backer is the secondary obligor. See Restatement of Suretyship and Guaranty 1. Then assume that Bank and Borrower agree to a modication of their rights and obligations after the note is signed. For example, they might agree that Borrower may repay the loan at some date after the due date, or that Borrower may discharge its repayment obligation by paying Bank $3,000 rather than $10,000. Alternatively, suppose that Bank releases collateral that Borrower has given to secure the loan. Under the law of suretyship and guaranty, the secondary obligor may be discharged under certain circumstances if these modications of the obligations between Bank (the obligee) and Borrower (the principal obligor) are made without the consent of Backer (the secondary obligor). The rights that the secondary obligor has to a discharge of its liability in such cases commonly are referred to as suretyship defenses. The extent of the discharge depends upon the particular circumstances. See Restatement of Suretyship and Guaranty 37, 3944. A second possibility is that the parties might decide to evidence the loan by a negotiable instrument. In that scenario, Borrower signs a note under which Borrower is obliged to pay $10,000 to the order of Bank on a due date stated in the note. Backer becomes liable for the repayment obligation by signing the note as a co-maker or indorser. In either case the note is signed for accommodation, Backer is an accommodation party, and Borrower is the accommodated party. See Section 3-419 (describing the obligations of accommodation parties). For purposes of Section 3-605, Backer is also a secondary obligor and Borrower is a principal obligor, as those terms are dened in Section 3-103. Because Backer is a party 425

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to the instrument, its rights to a discharge based on any modication of obligations between Bank and Borrower are governed by Section 3-605 rather than by the general law of suretyship and guaranty. Within Section 3-605, subsection (a) describes the consequences of a release of Borrower, subsection (b) describes the consequences of an extension of time, and subsection (c) describes the consequences of other modications. The third possibility is that Borrower would use an instrument governed by this Article to evidence its repayment obligation, but Backer's obligation would be created in some way other than by becoming party to that instrument. In that case, Backer's rights are determined by suretyship and guaranty law rather than by this Article. See Comment 3 to Section 3-419. A person also can acquire secondary liability without having been a secondary obligor at the time that the principal obligation was created. For example, a transferee of real or personal property that assumes the obligation of the transferor as maker of a note secured by the property becomes by operation of law a principal obligor, with the transferor becoming a secondary obligor. Restatement of Suretyship and Guaranty 2(e); Restatement of Mortgages 5.1. Article 3 does not determine the eect of the release of the transferee in that case because the assuming transferee is not a party to the instrument as dened in Section 3-103(a)(10). Section 3-605(a) does not apply then because the holder has not discharged the obligation of a principal obligor, a term dened in Section 3-103(a)(11). Thus, the resolution of that question is governed by the law of suretyship. See Restatement of Suretyship and Guaranty 39. 3. Section 3-605 is not, however, limited to the conventional situation of the accommodation party discussed in Comment 2. It also applies in four other situations. First, it applies to indorsers of notes who are not accommodation parties. Unless an indorser signs without recourse, the indorser's liability under Section 3-415(a) is functionally similar to that of a guarantor of payment. For example, if Bank in the second hypothetical discussed in Comment 2 indorsed the note and transferred it to Second Bank, Bank is liable to Second Bank in the event of dishonor of the note by Borrower. Section 3-415(a). Because of that secondary liability as indorser, Bank qualies as a secondary obligor under Section 3-103(a)(17) and has the same rights under Section 3-605 as an accommodation party. Second, a similar analysis applies to the drawer of a draft that is accepted by a party that is not a bank. Under Section 3-414(d), that drawer has liability on the same terms as an indorser under Section 3-415(a). Thus, the drawer in that case is a secondary obligor under Section 3-103(a)(17) and has rights under Section 3-605 to that extent. Third, a similar principle justies application of Section 3-605 to persons who indorse a check. Assume that Drawer draws a check to the order of Payee. Payee then indorses the check and transfers it to Transferee. If Transferee presents the check and it is dishonored, Transferee may recover from Drawer under Section 3-414 or Payee under Section 3-415. Because of that secondary liability as an indorser, Payee is a secondary obligor under Section 3-103(a)(17). Drawer is a principal obligor under Section 3-103(a)(11). As noted in Comment 4, below, however, Section 3-605(a)(3) will discharge indorsers of checks in some cases in which other secondary obligors will not be discharged by this section. Fourth, this section also deals with the rights of co-makers of instruments, even when those co-makers do not qualify as accommodation parties. The co-makers' rights of contribution under Section 3-116 make each co-maker a secondary obligor to the extent of that right of contribution. 4. Subsection (a) is based on Restatement of Suretyship and Guaranty 39. It addresses the eects of a release of the principal obligor by the person entitled to enforce the instrument. Paragraph (a)(1) governs the eect of that release on the principal obligor's duties to the secondary obligor; paragraphs (a)(2) and (a)(3) govern the eect of that release on the secondary obligor's duties to the person entitled to enforce the instrument. With respect to the duties of the principal obligor, the release of course cannot aect obligations of the principal obligor with respect to payments that the secondary obligor already has made. But with respect to future payments by the secondary obligor, paragraph (a)(1) (based on Restatement of Suretyship and Guaranty 39(a)) provides that the principal obligor is discharged, to the extent of the release, from any other duties to the secondary obligor. That rule is appropriate because otherwise the discharge granted to the principal obligor would be illusory: it would have obtained a release from a person entitled to enforce that instrument, but it would be directly liable for the same sum to the secondary obligor if 426

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the secondary obligor later complied with its secondary obligation to pay the instrument. This discharge does not occur, though, if the terms of the release eect a preservation of recourse as described in subsection (g). See Comment 10, below. The discharge under paragraph (a)(1) of the principal obligor's duties to the secondary obligor is broad, applying to all duties under this article. This includes not only the principal obligor's liability as a party to an instrument (as a maker, drawer or indorser under Sections 3-412 through 3-415) but also obligations under Sections 3-116 and 3-419. Paragraph (a)(2) is based closely on Restatement of Suretyship and Guaranty 39(b). It articulates a default rule that the release of a principal obligor also discharges the secondary obligor, to the extent of the release granted to the principal obligor, from any unperformed portion of its obligation on the instrument. The discharge of the secondary obligor under paragraph (a)(2) is phrased more narrowly than the discharge of the principal obligor is phrased under paragraph (a)(1) because, unlike principal obligors, the only obligations of secondary obligors in Article 3 are on the instrument as makers or indorsers. The parties can opt out of that rule by including a contrary statement in the terms of the release. The provision does not contemplate that any magic words are necessary. Thus, discharge of the secondary obligor under paragraph (a)(2) is avoided not only if the terms of the release track the statutory language (e.g., the person entitled to enforce the instrument retains the right to enforce the instrument against the secondary obligor), or if the terms of the release eect a preservation of recourse under subsection (g), but also if the terms of the release include a simple statement that the parties intend to release the principal obligor but not the secondary obligor or that the person entitled to enforce the instrument reserves its rights against the secondary obligor. At the same time, because paragraph (a)(2) refers to the terms of the release, extrinsic circumstances cannot be used to establish that the parties intended the secondary obligor to remain obligated. If a release of the principal obligor includes such a provision, the secondary obligor is, nonetheless, discharged to the extent of the consideration that is paid for the release; that consideration is treated as a payment in partial satisfaction of the instrument. Notwithstanding language in the release that prevents discharge of the secondary obligor under paragraph (a)(2), paragraph (a)(3) discharges the secondary obligor from its obligation to a person entitled to enforce the instrument to the extent that the release otherwise would cause the secondary obligor a loss. The rationale for that provision is that a release of the principal obligor changes the economic risk for which the secondary obligor contracted. This risk may be increased in two ways. First, by releasing the principal obligor, the person entitled to enforce the instrument has eliminated the likelihood of future payments by the principal obligor that would lessen the obligation of the secondary obligor. Second, unless the release eects a preservation of the secondary obligor's recourse, the release eliminates the secondary obligor's claims against the principal obligor with respect to any future payment by the secondary obligor. The discharge provided by this paragraph prevents that increased risk from causing the secondary obligor a loss. Moreover, permitting releases to be negotiated between the principal obligor and the person entitled to enforce the instrument without regard to the consequences to the secondary obligor would create an undue risk of opportunistic behavior by the obligee and principal obligor. That concern is lessened, and the discharge is not provided by paragraph (a)(3), if the secondary obligor has consented to the release or is deemed to have consented to it under subsection (f) (which presumes consent by a secondary obligor to actions taken by a principal obligor if the secondary obligor controls the principal obligor or deals with the person entitled to enforce the instrument on behalf of the principal obligor). See Comment 9, below. Subsection (a) (and Restatement Section 39(b), the concepts of which it follows quite closely) is designed to facilitate negotiated workouts between a creditor and a principal obligor, so long as they are not at the expense of a secondary obligor who has not consented to the arrangement (either specically or by waiving its rights to discharge under this section). Thus, for example, the provision facilitates an arrangement in which the principal obligor pays some portion of a guaranteed obligation, the person entitled to enforce the instrument grants a release to the principal obligor in exchange for that payment, and the person entitled to enforce the instrument pursues the secondary obligor for the remainder of the obligation. Under paragraph (a)(2), the person entitled to enforce the instrument may pursue the secondary obligor despite the release of the principal obligor so long as the terms of the release provide for this result. Under paragraph (a)(3), though, the secondary 427

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obligor will be protected against any loss it might suer by reason of that release (if the secondary obligor has not waived discharge under subsection (f)). It should be noted that the obligee may be able to minimize the risk of such loss (and, thus, of the secondary obligor's discharge) by giving the secondary obligor prompt notice of the release even though such notice is not required. The foregoing principles are illustrated by the following cases: Case 1. D borrows $1000 from C. The repayment obligation is evidenced by a note issued by D, payable to the order of C. S is an accommodation indorser of the note. As the due date of the note approaches, it becomes obvious that D cannot pay the full amount of the note and may soon be facing bankruptcy. C, in order to collect as much as possible from D and lessen the need to seek recovery from S, agrees to release D from its obligation under the note in exchange for $100 in cash. The agreement to release D is silent as to the eect of the release on S. Pursuant to Section 3-605(a)(2), the release of D discharges S from its obligations to C on the note. Case 2. Same facts as Case 1, except that the terms of the release provide that C retains its rights to enforce the instrument against S. D is discharged from its obligations to S pursuant to Section 3-605(a)(1), but S is not discharged from its obligations to C pursuant to Section 3-605(a)(2). However, if S could have recovered from D any sum it paid to C (had D not been discharged from its obligation to S), S has been harmed by the release and is discharged pursuant to Section 3-605(a)(3) to the extent of that harm. Case 3. Same facts as Case 1, except that the terms of the release provide that C retains its rights to enforce the instrument against S and that S retains its recourse against D. Under subsection (g), the release eects a preservation of recourse. Thus, S is not discharged from its obligations to C pursuant to Section 3-605(a)(2) and D is not discharged from its obligations to S pursuant to Section 3-605(a)(1). Because S's claims against D are preserved, S will not suer the kind of loss described in Case 2. If no other loss is suered by S as a result of the release, S is not discharged pursuant to this section. Case 4. Same facts as Case 3, except that D had made arrangements to work at a second job in order to earn the money to fulll its obligations on the note. When C released D, however, D canceled the plans for the second job. While S still retains its recourse against D, S may be discharged from its obligation under the instrument to the extent that D's decision to forgo the second job causes S a loss because forgoing the job renders D unable to fulll its obligations to S under Section 3-419. Subsection (a) reects a change from former Section 3-605(b), which provided categorically that the release of a principal obligor by the person entitled to enforce the instrument did not discharge a secondary obligor's obligation on the instrument and assumed that the release also did not discharge the principal obligor's obligations to the secondary obligor under Section 3-419. The rule under subsection (a) is much closer to the policy of the Restatement of Suretyship and Guaranty than was former Section 3-605(b). The change, however, is likely to aect only a narrow category of cases. First, as discussed above, Section 3-605 applies only to transactions in which the payment obligation is represented by a negotiable instrument, and, within that set of transactions, only to those transactions in which the secondary obligation is incurred by indorsement or cosigning, not to transactions that involve a separate document of guaranty. See Comment 2, above. Second, as provided in subsection (f), secondary obligors cannot obtain a discharge under subsection (a) in any transaction in which they have consented to the challenged conduct. Thus, subsection (a) will not apply to any transaction that includes a provision waiving suretyship defenses (a provision that is almost universally included in commercial loan documentation) or to any transaction in which the creditor obtains the consent of the secondary obligor at the time of the release. The principal way in which subsection (a) goes beyond the policy of Restatement 39 is with respect to the liability of indorsers of checks. Specically, the last sentence of paragraph (a)(2) provides that a release of a principal obligor grants a complete discharge to the indorser of a check, without requiring the indorser to prove harm. In that particular context, it seems likely that continuing responsibility for the indorser often would be so inconsistent with the expectations of the parties as to create a windfall for the creditor and an unfair surprise for the indorser. Thus, the statute implements a simple rule that grants a complete discharge. The creditor, of course, can avoid that rule by contracting with the secondary obligor for a dierent result at the time that the creditor grants the release to 428

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the principal obligor. 5. Subsection (b) is based on Restatement of Suretyship and Guaranty 40 and relates to extensions of the due date of the instrument. An extension of time to pay a note is often benecial to the secondary obligor because the additional time may enable the principal obligor to obtain the funds to pay the instrument. In some cases, however, the extension may cause loss to the secondary obligor, particularly if deterioration of the nancial condition of the principal obligor reduces the amount that the secondary obligor is able to recover on its right of recourse when default occurs. For example, suppose that the instrument is an installment note and the principal debtor is temporarily short of funds to pay a monthly installment. The payee agrees to extend the due date of the installment for a month or two to allow the debtor to pay when funds are available. Paragraph (b)(2) provides that an extension of time results in a discharge of the secondary obligor, but only to the extent that the secondary obligor proves that the extension caused loss. See subsection (h) (discussing the burden of proof under Section 3-605). Thus, if the extension is for a long period, the secondary obligor might be able to prove that during the period of extension the principal obligor became insolvent, reducing the value of the right of recourse of the secondary obligor. In such a case, paragraph (b)(2) discharges the secondary obligor to the extent of that harm. Although not required to notify the secondary obligor of the extension, the payee can minimize the risk of loss by the secondary obligor by giving the secondary obligor prompt notice of the extension; prompt notice can enhance the likelihood that the secondary obligor's right of recourse can remain valuable, and thus can limit the likelihood that the secondary obligor will suer a loss because of the extension. See Restatement of Suretyship and Guaranty Section 38 comment b. If the secondary obligor is not discharged under paragraph (b)(2) (either because it would not suer a loss by reason of the extension or because it has waived its right to discharge pursuant to subsection (f)), it is important to understand the eect of the extension on the rights and obligations of the secondary obligor. Consider the following cases: Case 5. A borrows money from Lender and issues a note payable to the order of Lender that is due on April 1, 2002. B signs the note for accommodation at the request of Lender. B signed the note either as co-maker or as an anomalous indorser. In either case Lender subsequently makes an agreement with A extending the due date of A's obligation to pay the note to July 1, 2002. In either case B did not agree to the extension, and the extension did not address Lender's rights against B. Under paragraph (b)(1), A's obligations to B under this article are also extended to July 1, 2002. Under paragraph (b)(3), if B is not discharged, B may treat its obligations to Lender as also extended, or may pay the instrument on the original due date. Case 6. Same facts as Case 5, except that the extension agreement includes a statement that the Lender retains its right to enforce the note against B on its original terms. Under paragraph (b)(3), B is liable on the original due date, but under paragraph (b)(1), A's obligations to B under Section 3-419 are not due until July 1, 2002. Case 7. Same facts as Case 5, except that the extension agreement includes a statement that the Lender retains its right to enforce the note against B on its original terms and B retains its recourse against A as though no extension had been granted. Under paragraph (b)(3), B is liable on the original due date. Under paragraph (b)(1), A's obligations to B under Section 3-419 are not extended. Under section 3-605(b), the results in Case 5 and Case 7 are identical to the results that follow from the law of suretyship and guaranty. See Restatement of Suretyship and Guaranty 40. The situation in Case 6 is not specically addressed in the Restatement, but the resolution in this Section is consistent with the concepts of suretyship and guaranty law as reected in the Restatement. If the secondary obligor is called upon to pay on the due date, it may be dicult to quantify the extent to which the extension has impaired the right of recourse of the secondary obligor at that time. Still, the secondary obligor does have a right to make a claim against the obligee at that time. As a practical matter a suit making such a claim should establish the facts relevant to the extent of the impairment. See Restatement of Suretyship and Guaranty 37(4). As a practical matter, an extension of the due date will normally occur only when the principal obligor is unable to pay on the due date. The interest of the secondary obligor normally is to acquiesce in the willingness of the person entitled to enforce the instrument to wait for payment from the principal obligor rather than to pay right away and rely on an action against the principal obligor that may have little or no value. But in unusual cases 429

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the secondary obligor may prefer to pay the holder on the original due date so as to avoid continuing accrual of interest. In such cases, the secondary obligor may do so. See paragraph (b)(3). If the terms of the extension provide that the person entitled to enforce the instrument retains its right to enforce the instrument against the secondary obligor on the original due date, though, those terms are eective and the secondary obligor may not delay payment until the extended due date. Unless the extension agreement eects a preservation of recourse, however, the secondary obligor may not proceed against the principal obligor under Section 3-419 until the extended due date. See paragraph (b)(1). To the extent that delay causes loss to the secondary obligor it is discharged under paragraph (b)(2). Even in those cases in which a secondary obligor does not have a duty to pay the instrument on the original due date, it always has the right to pay the instrument on that date, and perhaps minimize its loss by doing so. The secondary obligor is not precluded, however, from asserting its rights to discharge under Section 3-605(b)(2) if it does not exercise that option. The critical issue is whether the extension caused the secondary obligor a loss by increasing the dierence between its cost of performing its obligation on the instrument and the amount recoverable from the principal obligor under this Article. The decision by the secondary obligor not to exercise its option to pay on the original due date may, under the circumstances, be a factor to be considered in the determination of that issue, especially if the secondary obligor has been given prompt notice of the extension (as discussed above). 6. Subsection (c) is based on Restatement of Suretyship and Guaranty 41. It is a residual provision, which applies to modications of the obligation of the principal obligor that are not covered by subsections (a) and (b). Under subsection (c)(1), a modication of the obligation of the principal obligor on the instrument (other than a release covered by subsection (a) or an extension of the due date covered by subsection (b)), will correspondingly modify the duties of the principal obligor to the secondary obligor. Under subsection (c)(2), such a modication also will result in discharge of the secondary obligor to the extent the modication causes loss to the secondary obligor. To the extent that the secondary obligor is not discharged and the obligation changes the amount of money payable on the instrument, or the timing of such payment, subsection (c)(3) provides the secondary obligor with a choice: it may satisfy its obligation on the instrument as if the modication had not occurred, or it may treat its obligation to pay the instrument as having been modied in a manner corresponding to the modication of the principal obligor's obligation. The following cases illustrate the application of subsection (c): Case 8. Corporation borrows money from Lender and issues a note payable to Lender. X signs the note as an accommodation party for Corporation. The note refers to a loan agreement under which the note was issued, which states various events of default that allow Lender to accelerate the due date of the note. Among the events of default are breach of covenants not to incur debt beyond specied limits and not to engage in any line of business substantially dierent from that currently carried on by Corporation. Without consent of X, Lender agrees to modify the covenants to allow Corporation to enter into a new line of business that X considers to be risky, and to incur debt beyond the limits specied in the loan agreement to nance the new venture. This modication discharges X to the extent that the modication otherwise would cause X a loss. Case 9. Corporation borrows money from Lender and issues a note payable to Lender in the amount of $100,000. X signs the note as an accommodation party for Corporation. The note calls for 60 equal monthly payments of interest and principal. Before the rst payment is made, Corporation and Lender agree to modify the note by changing the repayment schedule to require four annual payments of interest only, followed by a fth payment of interest and the entire $100,000 principal balance. To the extent that the modication does not discharge X, X has the option of fullling its obligation on the note in accordance with the original terms or the modied terms. 7. Subsection (d) is based on Restatement of Suretyship and Guaranty 42 and deals with the discharge of secondary obligors by impairment of collateral. The last sentence of subsection (d) states four common examples of what is meant by impairment. Because it uses the term includes, the provision allows a court to nd impairment in other cases as well. There is extensive case law on impairment of collateral. The secondary obligor is discharged to the extent that the secondary obligor proves that impairment was caused by a person entitled to enforce the instrument. For example, assume that the payee of a secured note 430

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fails to perfect the security interest. The collateral is owned by the principal obligor who subsequently les in bankruptcy. As a result of the failure to perfect, the security interest is not enforceable in bankruptcy. If the payee were to obtain payment from the secondary obligor, the secondary obligor would be subrogated to the payee's security interest in the collateral under Section 3-419 and general principles of suretyship law. See Restatement of Suretyship and Guaranty 28(1)(c). In this situation, though, the value of the security interest is impaired completely because the security interest is unenforceable. Thus, the secondary obligor is discharged from its obligation on the note to the extent of that impairment. If the value of the collateral impaired is as much or more than the amount of the note, and if there will be no recovery on the note as an unsecured claim, there is a complete discharge. Subsection (d) applies whether the collateral is personalty or realty, whenever the obligation in question is in the form of a negotiable instrument. 8. Subsection (e) is based on the former Section 3-605(h). The requirement of knowledge in the rst clause is consistent with Section 9-628. The requirement of notice in the second clause is consistent with Section 3-419(c). 9. The importance of the suretyship defenses provided in Section 3-605 is greatly diminished by the fact that the right to discharge can be waived as provided in subsection (f). The waiver can be eectuated by a provision in the instrument or in a separate agreement. It is standard practice to include such a waiver of suretyship defenses in notes prepared by nancial institutions or other commercial creditors. Thus, Section 3-605 will result in the discharge of an accommodation party on a note only in the occasional case in which the note does not include such a waiver clause and the person entitled to enforce the note nevertheless takes actions that would give rise to a discharge under this section without obtaining the consent of the secondary obligor. Because subsection (f) by its terms applies only to a discharge under this section, subsection (f) does not operate to waive a defense created by other law (such as the law governing enforcement of security interests under Article 9) that cannot be waived under that law. See, e.g., Section 9-602. The last sentence of subsection (f) creates an inference of consent on the part of the secondary obligor whenever the secondary obligor controls the principal obligor or deals with the creditor on behalf of the principal obligor. That sentence is based on Restatement of Suretyship and Guaranty 48(2). 10. Subsection (g) explains the criteria for determining whether the terms of a release or extension preserve the secondary obligor's recourse, a concept of importance in the application of subsections (a) and (b). First, the terms of the release or extension must provide that the person entitled to enforce the instrument retains the right to enforce the instrument against the secondary obligor. Second, the terms of the release or extension must provide that the recourse of the secondary obligor against the principal obligor continues as though the release or extension had not been granted. Those requirements are drawn from Restatement of Suretyship and Guaranty 38. 11. Subsections (h) and (i) articulate rules for the burden of persuasion under Section 3-605. Those rules are based on Restatement of Suretyship and Guaranty 49.

As amended in 2002.
See Appendix Q for material relating to changes in Ocial Comment in 2002.
ADDENDUM TO REVISED ARTICLE 3 Notes to Legislative Counsel 1. If revised Article 3 is adopted in your state, the reference in Section 2-511 to Section 3-802 should be changed to Section 3-310. 2. If revised Article 3 is adopted in your state and the Uniform Fiduciaries Act is also in eect in your state, you may want to consider amending Uniform Fiduciaries Act 9 to conform to Section 3-307(b)(2)(iii) and (4)(iii). See Ocial Comment 3 to Section 3-307. CONFORMING AMENDMENTS TO ARTICLES 1 AND 4 See Appendices H and I.

431

ARTICLE 4. BANK DEPOSITS AND COLLECTIONS*

PART 1. GENERAL PROVISIONS AND DEFINITIONS
4-101. Short Title. 4-102. Applicability. 4-103. Variation by Agreement; Measure of Damages; Action Constituting Ordinary Care. 4-104. Denitions and Index of Denitions. 4-105. Denitions of Types of Banks. 4-106. Payable Through or Payable at Bank: Collecting Bank. 4-107. Separate Oce of Bank. 4-108. Time of Receipt of Items. 4-109. Delays. 4-110. Electronic Presentment. 4-111. Statute of Limitations.

PART 2. COLLECTION OF ITEMS: DEPOSITARY AND COLLECTING BANKS

4-201. Status of Collecting Bank as Agent and Provisional Status of Credits; Applicability of Article; Item Indorsed Pay Any Bank. 4-202. Responsibility for Collection or Return; When Action Timely. 4-203. Eect of Instructions. 4-204. Methods of Sending and Presenting; Sending Directly to Payor Bank. 4-205. Depositary Bank Holder of Unindorsed Item. 4-206. Transfer Between Banks. 4-207. Transfer Warranties. 4-208. Presentment Warranties. 4-209. Encoding and Retention Warranties. 4-210. Security Interest of Collecting Bank in Items, Accompanying Documents and Proceeds. 4-211. When Bank Gives Value for Purposes of Holder in Due Course. 4-212. Presentment by Notice of Item Not Payable by, Through, or at Bank; Liability of Drawer or Indorser. 4-213. Medium and Time of Settlement by Bank. 4-214. Right of Charge-Back or Refund; Liability of Collecting Bank: Return of Item. 4-215. Final Payment of Item by Payor Bank; When Provisional Debits and Credits Become Final; When Certain Credits Become Available for Withdrawal.
*Article 4 was amended in 1990 and 2002. For the 1990 amendments, see Appendix I. For the 2002 Amendments, along 432 with Prefatory Note and list of drafting committee members, see Appendix Q.

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4-216. Insolvency and Preference.

PART 3. COLLECTION OF ITEMS: PAYOR BANKS

4-301. Deferred Posting; Recovery of Payment by Return of Items; Time of Dishonor; Return of Items by Payor Bank. 4-302. Payor Bank's Responsibility for Late Return of Item. 4-303. When Items Subject to Notice, Stop-Payment Order, Legal Process, or Seto; Order in Which Items May Be Charged or Certied.

PART 4. RELATIONSHIP BETWEEN PAYOR BANK AND ITS CUSTOMER

4-401. When Bank May Charge Customer's Account. 4-402. Bank's Liability to Customer for Wrongful Dishonor; Time of Determining Insuciency of Account. 4-403. Customer's Right to Stop Payment; Burden of Proof of Loss. 4-404. Bank Not Obliged to Pay Check More Than Six Months Old. 4-405. Death or Incompetence of Customer. 4-406. Customer's Duty to Discover and Report Unauthorized Signature or Alteration. 4-407. Payor Bank's Right to Subrogation on Improper Payment.

PART 5. COLLECTION OF DOCUMENTARY DRAFTS

4-501. Handling of Documentary Drafts; Duty to Send for Presentment and to Notify Customer of Dishonor. 4-502. Presentment of On Arrival Drafts. 4-503. Responsibility of Presenting Bank for Documents and Goods; Report of Reasons for Dishonor; Referee in Case of Need. 4-504. Privilege of Presenting Bank to Deal With Goods; Security Interest for Expenses.

PART 1. GENERAL PROVISIONS AND DEFINITIONS

4-101. Short Title. This Article may be cited as Uniform Commercial CodeBank Deposits and Collections. As amended in 1990.
See Appendix I for material relating to changes in text in 1990.

Ocial Comment
1. The great number of checks handled by banks and the country-wide nature of the bank collection process require uniformity in the law of bank collections. There is needed a uniform statement of the principal rules of the bank collection process with ample provision for exibility to meet the needs of the large volume handled and the changing needs and conditions that are bound to come with the years. This Article meets that need. 2. In 1950 at the time Article 4 was drafted, 6.7 billion checks were written annually. By the time of the 1990 revision of Article 4 annual volume was estimated by the American Bankers Association to be about 50 billion checks. The banking system could not have 433

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coped with this increase in check volume had it not developed in the late 1950s and early 1960s an automated system for check collection based on encoding checks with machinereadable information by Magnetic Ink Character Recognition (MICR). An important goal of the 1990 revision of Article 4 is to promote the eciency of the check collection process by making the provisions of Article 4 more compatible with the needs of an automated system and, by doing so, increase the speed and lower the cost of check collection for those who write and receive checks. An additional goal of the 1990 revision of Article 4 is to remove any statutory barriers in the Article to the ultimate adoption of programs allowing the presentment of checks to payor banks by electronic transmission of information captured from the MICR line on the checks. The potential of these programs for saving the time and expense of transporting the huge volume of checks from depositary to payor banks is evident. 3. Article 4 denes rights between parties with respect to bank deposits and collections. It is not a regulatory statute. It does not regulate the terms of the bank-customer agreement, nor does it prescribe what constraints dierent jurisdictions may wish to impose on that relationship in the interest of consumer protection. The revisions in Article 4 are intended to create a legal framework that accommodates automation and truncation for the benet of all bank customers. This may raise consumer problems which enacting jurisdictions may wish to address in individual legislation. For example, with respect to Section 4-401(c), jurisdictions may wish to examine their unfair and deceptive practices laws to determine whether they are adequate to protect drawers who postdate checks from unscrupulous practices that may arise on the part of persons who induce drawers to issue postdated checks in the erroneous belief that the checks will not be immediately payable. Another example arises from the fact that under various truncation plans customers will no longer receive their cancelled checks and will no longer have the cancelled check to prove payment. Individual legislation might provide that a copy of a bank statement along with a copy of the check is prima facie evidence of payment.

4-102. Applicability. (a) To the extent that items within this Article are also within Articles 3 and 8, they are subject to those Articles. If there is conict, this Article governs Article 3, but Article 8 governs this Article. (b) The liability of a bank for action or non-action with respect to an item handled by it for purposes of presentment, payment, or collection is governed by the law of the place where the bank is located. In the case of action or non-action by or at a branch or separate oce of a bank, its liability is governed by the law of the place where the branch or separate ofce is located. As amended in 1990.
See Appendix I for material relating to changes in text in 1990.

Ocial Comment
1. The rules of Article 3 governing negotiable instruments, their transfer, and the contracts of the parties thereto apply to the items collected through banking channels wherever no specic provision is found in this Article. In the case of conict, this Article governs. See Section 3-102(b). Bonds and like instruments constituting investment securities under Article 8 may also be handled by banks for collection purposes. Various sections of Article 8 prescribe rules of transfer some of which (see Sections 8-304 and 8-306 Sections 8-108 and 8-304) may conict with provisions of this Article (Sections 4-205, 4-207, and 4-208). In the case of conict, Article 8 governs. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 4, 1995. Section 4-210 deals specically with overlapping problems and possible conicts between this Article and Article 9. However, similar reconciling provisions are not necessary in the case of Articles 5 and 7. Sections 4-301 and 4-302 are consistent with Section 5-112. In the case of Article 7 documents of title frequently accompany items but they are not themselves items. See Section 4-104(a)(9). 434

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In Cleareld Trust Co. v. United States, 318 U.S. 363 (1943), the Court held that if the United States is a party to an instrument, its rights and duties are governed by federal common law in the absence of a specic federal statute or regulation. In United States v. Kimbell Foods, Inc., 440 U.S. 715 (1979), the Court stated a three-pronged test to ascertain whether the federal common-law rule should follow the state rule. In most instances courts under the Kimbell test have shown a willingness to adopt UCC rules in formulating federal common law on the subject. In Kimbell the Court adopted the priorities rules of Article 9. In addition, applicable federal law may supersede provisions of this Article. One federal law that does so is the Expedited Funds Availability Act, 12 U.S.C. 4001 et seq., and its implementing Regulation CC, 12 CFR Pt. 229. In some instances this law is alluded to in the statute, e.g., Section 4-215(e) and (f). In other instances, although not referred to in this Article, the provisions of the EFAA and Regulation CC control with respect to checks. For example, except between the depositary bank and its customer, all settlements are nal and not provisional (Regulation CC, Section 229.36(d)), and the midnight deadline may be extended (Regulation CC, Section 229.30(c)). The comments to this Article suggest in most instances the relevant Regulation CC provisions. 2. Subsection (b) is designed to state a workable rule for the solution of otherwise vexatious problems of the conicts of laws: a. The routine and mechanical nature of bank collections makes it imperative that one law govern the activities of one oce of a bank. The requirement found in some cases that to hold an indorser notice must be given in accordance with the law of the place of indorsement, since that method of notice became an implied term of the indorser's contract, is more theoretical than practical. b. Adoption of what is in essence a tort theory of the conict of laws is consistent with the general theory of this Article that the basic duty of a collecting bank is one of good faith and the exercise of ordinary care. Justication lies in the fact that, in using an ambulatory instrument, the drawer, payee, and indorsers must know that action will be taken with respect to it in other jurisdictions. This is especially pertinent with respect to the law of the place of payment. c. The phrase action or non-action with respect to any item handled by it for purposes of presentment, payment, or collection is intended to make the conicts rule of subsection (b) apply from the inception of the collection process of an item through all phases of deposit, forwarding, presentment, payment and remittance or credit of proceeds. Specically the subsection applies to the initial act of a depositary bank in receiving an item and to the incidents of such receipt. The conicts rule of Weissman v. Banque De Bruxelles, 254 N.Y. 488, 173 N.E. 835 (1930), is rejected. The subsection applies to questions of possible vicarious liability of a bank for action or non-action of sub-agents (see Section 4-202(c)), and tests these questions by the law of the state of the location of the bank which uses the sub-agent. The conicts rule of St. Nicholas Bank of New York v. State Nat. Bank, 128 N.Y. 26, 27 N.E. 849, 13 L.R.A. 241 (1891), is rejected. The subsection applies to action or non-action of a payor bank in connection with handling an item (see Sections 4-215(a), 4-301, 4-302, 4-303) as well as action or non-action of a collecting bank (Sections 4-201 through 4-216); to action or non-action of a bank which suspends payment or is aected by another bank suspending payment (Section 4-216); to action or non-action of a bank with respect to an item under the rule of Part 4 of Article 4. d. In a case in which subsection (b) makes this Article applicable, Section 4-103(a) leaves open the possibility of an agreement with respect to applicable law. This freedom of agreement follows the general policy of Section 1-105.

4-103. Variation by Agreement; Measure of Damages; Action Constituting Ordinary Care. (a) The eect of the provisions of this Article may be varied by agreement, but the parties to the agreement cannot disclaim a bank's responsibility for its lack of good faith or failure to exercise ordinary care or limit the measure of damages for the lack or failure. However, the parties may determine by agreement the standards by which the bank's responsibility is to be measured if those standards are not manifestly unreasonable.
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(b) Federal Reserve regulations and operating circulars, clearing-house rules, and the like have the eect of agreements under subsection (a), whether or not specically assented to by all parties interested in items handled. (c) Action or non-action approved by this Article or pursuant to Federal Reserve regulations or operating circulars is the exercise of ordinary care and, in the absence of special instructions, action or non-action consistent with clearing-house rules and the like or with a general banking usage not disapproved by this Article, is prima facie the exercise of ordinary care. (d) The specication or approval of certain procedures by this Article is not disapproval of other procedures that may be reasonable under the circumstances. (e) The measure of damages for failure to exercise ordinary care in handling an item is the amount of the item reduced by an amount that could not have been realized by the exercise of ordinary care. If there is also bad faith it includes any other damages the party suered as a proximate consequence. As amended in 1990.
See Appendix I for material relating to changes in text in 1990.

Ocial Comment
1. Section 1-102 states the general principles and rules for variation of the eect of this Act by agreement and the limitations to this power. Section 4-103 states the specic rules for variation of Article 4 by agreement and also certain standards of ordinary care. In view of the technical complexity of the eld of bank collections, the enormous number of items handled by banks, the certainty that there will be variations from the normal in each day's work in each bank, the certainty of changing conditions and the possibility of developing improved methods of collection to speed the process, it would be unwise to freeze present methods of operation by mandatory statutory rules. This section, therefore, permits within wide limits variation of the eect of provisions of the Article by agreement. 2. Subsection (a) confers blanket power to vary all provisions of the Article by agreements of the ordinary kind. The agreements may not disclaim a bank's responsibility for its own lack of good faith or failure to exercise ordinary care and may not limit the measure of damages for the lack or failure, but this subsection like Section 1-102(3) approves the practice of parties determining by agreement the standards by which the responsibility is to be measured. In the absence of a showing that the standards manifestly are unreasonable, the agreement controls. Owners of items and other interested parties are not aected by agreements under this subsection unless they are parties to the agreement or are bound by adoption, ratication, estoppel or the like. As here used agreement has the meaning given to it by Section 1-201(3). The agreement may be direct, as between the owner and the depositary bank; or indirect, as in the case in which the owner authorizes a particular type of procedure and any bank in the collection chain acts pursuant to such authorization. It may be with respect to a single item; or to all items handled for a particular customer, e.g., a general agreement between the depositary bank and the customer at the time a deposit account is opened. Legends on deposit tickets, collection letters and acknowledgments of items, coupled with action by the aected party constituting acceptance, adoption, ratication, estoppel or the like, are agreements if they meet the tests of the denition of agreement. See Section 1-201(3). First Nat. Bank of Denver v. Federal Reserve Bank, 6 F.2d 339 (8th Cir.1925) (deposit slip); Jeerson County Bldg. Ass'n v. Southern Bank & Trust Co., 225 Ala. 25, 142 So. 66 (1932) (signature card and deposit slip); Semingson v. Stock Yards Nat. Bank, 162 Minn. 424, 203 N.W. 412 (1925) (passbook); Farmers State Bank v. Union Nat. Bank, 42 N.D. 449, 454, 173 N.W. 789, 790 (1919) (acknowledgment of receipt of item). 3. Subsection (a) (subject to its limitations with respect to good faith and ordinary care) goes far to meet the requirements of exibility. However, it does not by itself confer fully ef436

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fective exibility. Since it is recognized that banks handle a great number of items every business day and that the parties interested in each item include the owner of the item, the drawer (if it is a check), all nonbank indorsers, the payor bank and from one to ve or more collecting banks, it is obvious that it is impossible, practically, to obtain direct agreements from all of these parties on all items. In total, the interested parties constitute virtually every adult person and business organization in the United States. On the other hand they may become bound to agreements on the principle that collecting banks acting as agents have authority to make binding agreements with respect to items being handled. This conclusion was assumed but was not atly decided in Federal Reserve Bank of Richmond v. Malloy, 264 U.S. 160, at 167, 44 S.Ct. 296, at 298, 68 L.Ed. 617, 31 A.L.R. 1261 (1924). To meet this problem subsection (b) provides that ocial or quasi-ocial rules of collection, that is Federal Reserve regulations and operating circulars, clearing-house rules, and the like, have the eect of agreements under subsection (a), whether or not specically assented to by all parties interested in items handled. Consequently, such ocial or quasiocial rules may, standing by themselves but subject to the good faith and ordinary care limitations, vary the eect of the provisions of Article 4. Federal Reserve regulations. Various sections of the Federal Reserve Act (12 U.S.C. 221 et seq.) authorize the Board of Governors of the Federal Reserve System to direct the Federal Reserve banks to exercise bank collection functions. For example, Section 16 (12 U.S.C. 248(o)) authorizes the Board to require each Federal Reserve bank to exercise the functions of a clearing house for its members and Section 13 (12 U.S.C. 342) authorizes each Federal Reserve bank to receive deposits from nonmember banks solely for the purposes of exchange or of collection. Under this statutory authorization the Board has issued Regulation J (Subpart ACollection of Checks and Other Items). Under the supremacy clause of the Constitution, federal regulations prevail over state statutes. Moreover, the Expedited Funds Availability Act, 12 U.S.C. Section 4007(b) provides that the Act and Regulation CC, 12 CFR 229, supersede any provision of the law of any State, including the Uniform Commercial Code as in eect in such State, which is inconsistent with this chapter or such regulations. See Comment 1 to Section 4-102. Federal Reserve operating circulars. The regulations of the Federal Reserve Board authorize the Federal Reserve banks to promulgate operating circulars covering operating details. Regulation J, for example, provides that Each Reserve Bank shall receive and handle items in accordance with this subpart, and shall issue operating circulars governing the details of its handling of items and other matters deemed appropriate by the Reserve Bank. This Article recognizes that operating circulars issued pursuant to the regulations and concerned with operating details as appropriate may, within their proper sphere, vary the eect of the Article. Clearing-House Rules. Local clearing houses have long issued rules governing the details of clearing; hours of clearing, media of remittance, time for return of mis-sent items and the like. The case law has recognized these rules, within their proper sphere, as binding on aected parties and as appropriate sources for the courts to look to in lling out details of bank collection law. Subsection (b) in recognizing clearing-house rules as a means of preserving exibility continues the sensible approach indicated in the cases. Included in the term clearing houses are county and regional clearing houses as well as those within a single city or town. There is, of course, no intention of authorizing a local clearing house or a group of clearing houses to rewrite the basic law generally. The term clearing-house rules should be understood in the light of functions the clearing houses have exercised in the past. And the like. This phrase is to be construed in the light of the foregoing. Federal Reserve regulations and operating circulars cover rules and regulations issued by public or quasipublic agencies under statutory authority. Clearing-house rules cover rules issued by a group of banks which have associated themselves to perform through a clearing house some of their collection, payment and clearing functions. Other agencies or associations of this kind may be established in the future whose rules and regulations could be appropriately looked on as constituting means of avoiding absolute statutory rigidity. The phrase and the like leaves open possibilities for future development. An agreement between a number of banks or even all the banks in an area simply because they are banks, would not of itself, by virtue of the phrase and the like, meet the purposes and objectives of subsection (b). 4. Under this Article banks come under the general obligations of the use of good faith 437

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and the exercise of ordinary care. Good faith is dened in Section 1-201(b)(20). The term ordinary care is dened in Section 3-103(a)(9). These denitions are made to apply to Article 4 by Section 4-104(c). Section 4-202 states respects in which collecting banks must use ordinary care. Subsection (c) of Section 4-103 provides that action or non-action approved by the Article or pursuant to Federal Reserve regulations or operating circulars constitutes the exercise of ordinary care. Federal Reserve regulations and operating circulars constitute an armative standard of ordinary care equally with the provisions of Article 4 itself. Subsection (c) further provides that, absent special instructions, action or non-action consistent with clearing-house rules and the like or with a general banking usage not disapproved by the Article, prima facie constitutes the exercise of ordinary care. Clearing-house rules and the phrase and the like have the signicance set forth above in these Comments. The term general banking usage is not dened but should be taken to mean a general usage common to banks in the area concerned. See Section 1-205(2). In a case in which the adjective general is used, the intention is to require a usage broader than a mere practice between two or three banks but it is not intended to require a usage broader than a mere practice between two or three banks but it is not intended to require anything as broad as a country-wide usage. A usage followed generally throughout a state, a substantial portion of a state, a metropolitan area or the like would certainly be sucient. Consistently with the principle of Section 1-205(3), action or non-action consistent with clearing-house rules or the like or with banking usages prima facie constitutes the exercise of ordinary care. However, the phrase in the absence of special instructions aords owners of items an opportunity to prescribe other standards and although there may be no direct supervision or control of clearing houses or banking usages by ocial supervisory authorities, the conrmation of ordinary care by compliance with these standards is prima facie only, thus conferring on the courts the ultimate power to determine ordinary care in any case in which it should appear desirable to do so. The prima facie rule does, however, impose on the party contesting the standards to establish that they are unreasonable, arbitrary or unfair as used by the particular bank. 5. Subsection (d), in line with the exible approach required for the bank collection process is designed to make clear that a novel procedure adopted by a bank is not to be considered unreasonable merely because that procedure is not specically contemplated by this Article or by agreement, or because it has not yet been generally accepted as a bank usage. Changing conditions constantly call for new procedures and someone has to use the new procedure rst. If this procedure is found to be reasonable under the circumstances, provided, of course, that it is not inconsistent with any provision of the Article or other law or agreement, the bank which has followed the new procedure should not be found to have failed in the exercise of ordinary care. 6. Subsection (e) sets forth a rule for determining the measure of damages for failure to exercise ordinary care which, under subsection (a), cannot be limited by agreement. In the absence of bad faith the maximum recovery is the amount of the item concerned. The term bad faith is not dened; the connotation is the absence of good faith (Section 3-103). When it is established that some part or all of the item could not have been collected even by the use of ordinary care the recovery is reduced by the amount that would have been in any event uncollectible. This limitation on recovery follows the case law. Finally, if bad faith is established the rule opens to allow the recovery of other damages, whose proximateness is to be tested by the ordinary rules applied in comparable cases. Of course, it continues to be as necessary under subsection (e) as it has been under ordinary common law principles that, before the damage rule of the subsection becomes operative, liability of the bank and some loss to the customer or owner must be established.

As amended in 2002.
See Appendix Q for material relating to changes in Ocial Comment in 2002.

4-104. Denitions and Index of Denitions. (a) In this Article, unless the context otherwise requires: (1) Account means any deposit or credit account with a bank, including a demand, time, savings, passbook, share draft, or like account, other than an account evidenced by a certicate of deposit;
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(2) Afternoon means the period of a day between noon and midnight; (3) Banking day means the part of a day on which a bank is open to the public for carrying on substantially all of its banking functions; (4) Clearing house means an association of banks or other payors regularly clearing items; (5) Customer means a person having an account with a bank or for whom a bank has agreed to collect items, including a bank that maintains an account at another bank; (6) Documentary draft means a draft to be presented for acceptance or payment if specied documents, certicated securities (Section 8-102) or instructions for uncerticated securities (Section 8-102), or other certicates, statements, or the like are to be received by the drawee or other payor before acceptance or payment of the draft; (7) Draft means a draft as dened in Section 3-104 or an item, other than an instrument, that is an order; (8) Drawee means a person ordered in a draft to make payment; (9) Item means an instrument or a promise or order to pay money handled by a bank for collection or payment. The term does not include a payment order governed by Article 4A or a credit or debit card slip; (10) Midnight deadline with respect to a bank is midnight on its next banking day following the banking day on which it receives the relevant item or notice or from which the time for taking action commences to run, whichever is later; (11) Settle means to pay in cash, by clearing-house settlement, in a charge or credit or by remittance, or otherwise as agreed. A settlement may be either provisional or nal; (12) Suspends payments with respect to a bank means that it has been closed by order of the supervisory authorities, that a public ocer has been appointed to take it over, or that it ceases or refuses to make payments in the ordinary course of business. (b) Other denitions applying to this Article and the sections in which they appear are: Agreement for electronic presentment Collecting bank Depositary bank Intermediary bank Payor bank Presenting bank Presentment notice Section Section Section Section Section Section Section 4-110. 4-105. 4-105. 4-105. 4-105. 4-105. 4-110.

(c) Control as provided in Section 7-106 and the following denitions in other Articles apply to this Article: Acceptance Section 3-409.
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Alteration Cashier's check Certicate of deposit Certied check Check Holder in due course Instrument Notice of dishonor Order Ordinary care Person entitled to enforce Presentment Promise Prove Record Remotely-Created consumer item Teller's check Unauthorized signature

Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section

3-407. 3-104. 3-104. 3-409. 3-104. 3-302. 3-104. 3-503. 3-103. 3-103. 3-301. 3-501. 3-103. 3-103. 3-103. 3-103. 3-104. 3-403.

(d) In addition, Article 1 contains general denitions and principles of construction and interpretation applicable throughout this Article. As amended in 1990, 1994, 2001, 2002 and 2003.
See Appendix I for material relating to changes in text in 1990. See Appendix K for material relating to changes in text in 1994. See Appendix I contained within revised Article 1 for material relating to changes made in text in 2001. See Appendix Q for material relating to changes in text in 2002. See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Paragraph (a)(1): Account is dened to include both asset accounts in which a customer has deposited money and accounts from which a customer may draw on a line of credit. The limiting factor is that the account must be in a bank. 2. Paragraph (a)(3): Banking day. Under this denition that part of a business day when a bank is open only for limited functions, e.g., to receive deposits and cash checks, but with loan, bookkeeping and other departments closed, is not part of a banking day. 3. Paragraph (a)(4): Clearing house. Occasionally express companies, governmental agencies and other nonbanks deal directly with a clearing house; hence the denition does not limit the term to an association of banks. 4. Paragraph (a)(5): Customer. It is to be noted that this term includes a bank carrying an account with another bank as well as the more typical nonbank customer or depositor. 5. Paragraph (a)(6): Documentary draft applies even though the documents do not accompany the draft but are to be received by the drawee or other payor before acceptance or payment of the draft. Documents may be either in electronic or tangible form. See Article 5, Section 5-102, Comment 2 and Article 1, Section 1-201 (denition of document of title). 6. Paragraph (a)(7): Draft is dened in Section 3-104 as a form of instrument. Since Article 4 applies to items that may not fall within the denition of instrument, the term is dened here to include an item that is a written order to pay money, even though the item may not qualify as an instrument. The term order is dened in Section 3-103. 440

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7. Paragraph (a)(8): Drawee is dened in Section 3-103 in terms of an Article 3 draft which is a form of instrument. Here drawee is dened in terms of an Article 4 draft which includes items that may not be instruments. 8. Paragraph (a)(9): Item is dened broadly to include an instrument, as dened in Section 3-104, as well as promises or orders that may not be within the denition of instrument. The terms promise and order are dened in Section 3-103. A promise is a written undertaking to pay money. An order is a written instruction to pay money. But see Section 4-110(c). Since bonds and other investment securities under Article 8 may be within the term instrument or promise, they are items and when handled by banks for collection are subject to this Article. See Comment 1 to Section 4-102. The functional limitation on the meaning of this term is the willingness of the banking system to handle the instrument, undertaking or instruction for collection or payment. 9. Paragraph (a)(10): Midnight deadline. The use of this phrase is an example of the more mechanical approach used in this Article. Midnight is selected as a termination point or time limit to obtain greater uniformity and deniteness than would be possible from other possible terminating points, such as the close of the banking day or business day. 10. Paragraph (a)(11): The term settle has substantial importance throughout Article 4. In the American Bankers Association Bank Collection Code, in deferred posting statutes, in Federal Reserve regulations and operating circulars, in clearing-house rules, in agreements between banks and customers and in legends on deposit tickets and collection letters, there is repeated reference to conditional or provisional credits or payments. Tied in with this concept of creditors or payments being in some way tentative, has been a related but somewhat dierent problem as to when an item is paid or nally paid either to determine the relative priority of the item as against attachments, stop-payment orders and the like or in insolvency situations. There has been extensive litigation in the various states on these problems. To a substantial extent the confusion, the litigation and even the resulting court decisions fail to take into account that in the collection process some debits or credits are provisional or tentative and others are nal and that very many debits or credits are provisional or tentative for awhile but later become nal. Similarly, some cases fail to recognize that within a single bank, particularly a payor bank, each item goes through a series of processes and that in a payor bank most of these processes are preliminary to the basic act of payment or nal payment. The term settle is used as a convenient term to characterize a broad variety of conditional, provisional, tentative and also nal payments of items. Such a comprehensive term is needed because it is frequently dicult or unnecessary to determine whether a particular action is tentative or nal or when a particular credit shifts from the tentative class to the nal class. Therefore, its use throughout the Article indicates that in that particular context it is unnecessary or unwise to determine whether the debit or the credit or the payment is tentative or nal. However, if qualied by the adjective provisional its tentative nature is intended, and if qualied by the adjective nal its permanent nature is intended. Examples of the various types of settlement contemplated by the term include payments in cash; the ecient but somewhat complicated process of payment through the adjustment and osetting of balances through clearing houses; debit or credit entries in accounts between banks; the forwarding of various types of remittance instruments, sometimes to cover a particular item but more frequently to cover an entire group of items received on a particular day. 11. Paragraph (a)(12): Suspends payments. This term is designed to aord an objective test to determine when a bank is no longer operating as a part of the banking system.

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

4-105. Denitions of Types of Banks. In this Article: (1) [Bank means a person engaged in the business of banking, including a savings bank, savings and loan association, credit union, or trust company;]
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(2) Depositary bank means the rst bank to take an item even though it is also the payor bank, unless the item is presented for immediate payment over the counter; (3) Payor bank means a bank that is the drawee of a draft; (4) Intermediary bank means a bank to which an item is transferred in course of collection except the depositary or payor bank; (5) Collecting bank means a bank handling an item for collection except the payor bank; (6) Presenting bank means a bank presenting an item except a payor bank.
Legislative Note: A jurisdiction that enacts this statute that has not yet enacted the revised version of UCC Article 1 should leave the denition of Bank in Section 4-105(1). Section 4-105(1) is reserved for that purpose. A jurisdiction that has adopted or simultaneously adopts the revised Article 1 should delete the denition of Bank from Section 4-105(1), but should leave those numbers reserved. If jurisdictions follow the numbering suggested here, the subsections will have the same numbering in all jurisdictions that have adopted these amendments (whether they have or have not adopted the revised version of UCC Article 1). In either case, they should change the title of the section, as indicated in these revisions, so that all jurisdictions will have the same title for the section.

As amended in 1990 and 2002.

See Appendix I for material relating to changes in text in 1990. See Appendix R for material relating to changes in text in 2002.

Ocial Comment
1. The denitions in general exclude a bank to which an item is issued, as this bank does not take by transfer except in the particular case covered in which the item is issued to a payee for collection, as in the case in which a corporation is transferring balances from one account to another. Thus, the denition of depositary bank does not include the bank to which a check is made payable if a check is given in payment of a mortgage. This bank has the status of a payee under Article 3 on Negotiable Instruments and not that of a collecting bank. 2. Paragraph (1): Bank is dened in Section 1-201(4) as meaning any person engaged in the business of banking. The denition in paragraph (1) makes clear that bank includes savings banks, savings and loan associations, credit unions and trust companies, in addition to the commercial banks commonly denoted by use of the term bank. 3. Paragraph (2): A bank that takes an on us item for collection, for application to a customer's loan, or rst handles the item for other reasons is a depositary bank even though it is also the payor bank. However, if the holder presents the item for immediate payment over the counter, the payor bank is not a depositary bank. 4. Paragraph (3): The denition of payor bank is claried by use of the term drawee. That term is dened in Section 4-104 as meaning a person ordered in a draft to make payment. An order is dened in Section 3-103 as meaning a written instruction to pay money . . .. An authorization to pay is not an order unless the person authorized to pay is also instructed to pay. The denition of order is incorporated into Article 4 by Section 4-104(c). Thus a payor bank is one instructed to pay in the item. A bank does not become a payor bank by being merely authorized to pay or by being given an instruction to pay not contained in the item. 5. Paragraph (4): The term intermediary bank includes the last bank in the collection process if the drawee is not a bank. Usually the last bank is also a presenting bank.

4-106. Payable Through or Payable at Bank: Collecting Bank. (a) If an item states that it is payable through a bank identied in the item, (i) the item designates the bank as a collecting bank and does not by itself authorize the bank to pay the item, and (ii) the item may be presented for payment only by or through the bank.
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(b) If an item states that it is payable at a bank identied in the item, the item is equivalent to a draft drawn on the bank.
ALTERNATIVE B

(b) If an item states that it is payable at a bank identied in the item, (i) the item designates the bank as a collecting bank and does not by itself authorize the bank to pay the item, and (ii) the item may be presented for payment only by or through the bank. (c) If a draft names a nonbank drawee and it is unclear whether a bank named in the draft is a co-drawee or a collecting bank, the bank is a collecting bank. As added in 1990.
See Appendix I for material relating to adoption of section in 1990.

Ocial Comment
1. This section replaces former Sections 3-120 and 3-121. Some items are made payable through a particular bank. Subsection (a) states that such language makes the bank a collecting bank and not a payor bank. An item identifying a payable through bank can be presented for payment to the drawee only by the payable through bank. The item cannot be presented to the drawee over the counter for immediate payment or by a collecting bank other than the payable through bank. 2. Subsection (b) retains the alternative approach of the present law. Under Alternative A a note payable at a bank is the equivalent of a draft drawn on the bank and the midnight deadline provisions of Sections 4-301 and 4-302 apply. Under Alternative B a payable at bank is in the same position as a payable through bank under subsection (a). 3. Subsection (c) rejects the view of some cases that a bank named below the name of a drawee is itself a drawee. The commercial understanding is that this bank is a collecting bank and is not accountable under Section 4-302 for holding an item beyond its deadline. The liability of the bank is governed by Sections 4-202(a) and 4-103(e).

4-107. Separate Oce of Bank. A branch or separate oce of a bank is a separate bank for the purpose of computing the time within which and determining the place at or to which action may be taken or notices or orders shall be given under this Article and under Article 3. As amended in 1962 and 1990.
See Appendix I for material relating to changes in text in 1990.

Ocial Comment
1. A rule with respect to the status of a branch or separate oce of a bank as a part of any statute on bank collections is highly desirable if not absolutely necessary. However, practices in the operations of branches and separate oces vary substantially in the dierent states and it has not been possible to nd any single rule that is logically correct, fair in all situations and workable under all dierent types of practices. The decision not to draft the section with greater specicity leaves to the courts the resolution of the issues arising under this section on the basis of the facts of each case. 2. In many states and for many purposes a branch or separate oce of the bank should be treated as a separate bank. Many branches function as separate banks in the handling and payment of items and require time for doing so similar to that of a separate bank. This is particularly true if branch banking is permitted throughout a state or in dierent towns and cities. Similarly, if there is this separate functioning a particular branch or separate ofce is the only proper place for various types of action to be taken or orders or notices to be given. Examples include the drawing of a check on a particular branch by a customer whose account is carried at that branch; the presentment of that same check at that 443

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branch; the issuance of an order to the branch to stop payment on the check. 3. Section 1 of the American Bankers Association Bank Collection Code provided simply: A branch or oce of any such bank shall be deemed a bank. Although this rule appears to be brief and simple, as applied to particular sections of the ABA Code it produces illogical and, in some cases, unreasonable results. For example, under Section 11 of the ABA Code it seems anomalous for one branch of a bank to have charged an item to the account of the drawer and another branch to have the power to elect to treat the item as dishonored. Similar logical problems would ow from applying the same rule to Article 4. Warranties by one branch to another branch under Sections 4-207 and 4-208 (each considered a separate bank) do not make sense. 4. Assuming that it is not desirable to make each branch a separate bank for all purposes, this section provides that a branch or separate oce is a separate bank for certain purposes. In so doing the single legal entity of the bank as a whole is preserved, thereby carrying with it the liability of the institution as a whole on such obligations as it may be under. On the other hand, in cases in which the Article provides a number of time limits for dierent types of action by banks, if a branch functions as a separate bank, it should have the time limits available to a separate bank. Similarly if in its relations to customers a branch functions as a separate bank, notices and orders with respect to accounts of customers of the branch should be given at the branch. For example, whether a branch has notice sucient to aect its status as a holder in due course of an item taken by it should depend upon what notice that branch has received with respect to the item. Similarly the receipt of a stop-payment order at one branch should not be notice to another branch so as to impair the right of the second branch to be a holder in due course of the item, although in circumstances in which ordinary care requires the communication of a notice or order to the proper branch of a bank, the notice or order would be eective at the proper branch from the time it was or should have been received. See Section 1-201(27). 5. The bracketed language (maintaining its own deposit ledger) in former Section 4-106 is deleted. Today banks keep records on customer accounts by electronic data storage. This has led most banks with branches to centralize to some degree their record keeping. The place where records are kept has little meaning if the information is electronically stored and is instantly retrievable at all branches of the bank. Hence, the inference to be drawn from the deletion of the bracketed language is that where record keeping is done is no longer an important factor in determining whether a branch is a separate bank.

4-108. Time of Receipt of Items. (a) For the purpose of allowing time to process items, prove balances, and make the necessary entries on its books to determine its position for the day, a bank may x an afternoon hour of 2 P.M. or later as a cuto hour for the handling of money and items and the making of entries on its books. (b) An item or deposit of money received on any day after a cuto hour so xed or after the close of the banking day may be treated as being received at the opening of the next banking day. As amended in 1990.
See Appendix I for material relating to changes in text in 1990.

Ocial Comment
1. Each of the huge volume of checks processed each day must go through a series of accounting procedures that consume time. Many banks have found it necessary to establish a cuto hour to allow time for these procedures to be completed within the time limits imposed by Article 4. Subsection (a) approves a cuto hour of this type provided it is not earlier than 2 P.M. Subsection (b) provides that if such a cuto hour is xed, items received after the cuto hour may be treated as being received at the opening of the next banking day. If the number of items received either through the mail or over the counter tends to taper o radically as the afternoon hours progress, a 2 P.M. cuto hour does not involve a large portion of the items received but at the same time permits a bank using such a cuto hour to leave its doors open later in the afternoon without forcing into the evening the 444

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completion of its settling and proving process. 2. The provision in subsection (b) that items or deposits received after the close of the banking day may be treated as received at the opening of the next banking day is important in cases in which a bank closes at twelve or one o'clock, e.g., on a Saturday, but continues to receive some items by mail or over the counter if, for example, it opens Saturday evening for the limited purpose of receiving deposits and cashing checks.

4-109. Delays. (a) Unless otherwise instructed, a collecting bank in a good faith eort to secure payment of a specic item drawn on a payor other than a bank, and with or without the approval of any person involved, may waive, modify, or extend time limits imposed or permitted by this [Act] for a period not exceeding two additional banking days without discharge of drawers or indorsers or liability to its transferor or a prior party. (b) Delay by a collecting bank or payor bank beyond time limits prescribed or permitted by this [Act] or by instructions is excused if (i) the delay is caused by interruption of communication or computer facilities, suspension of payments by another bank, war, emergency conditions, failure of equipment, or other circumstances beyond the control of the bank, and (ii) the bank exercises such diligence as the circumstances require. As amended in 1990.
See Appendix I for material relating to changes in text in 1990.

Ocial Comment
1. Sections 4-202(b), 4-214, 4-301, and 4-302 prescribe various time limits for the handling of items. These are the limits of time within which a bank, in fulllment of its obligation to exercise ordinary care, must handle items entrusted to it for collection or payment. Under Section 4-103 they may be varied by agreement or by Federal Reserve regulations or operating circular, clearing-house rules, or the like. Subsection (a) permits a very limited extension of these time limits. It authorizes a collecting bank to take additional time in attempting to collect drafts drawn on nonbank payors with or without the approval of any interested party. The right of a collecting bank to waive time limits under subsection (a) does not apply to checks. The two-day extension can only be granted in a good faith eort to secure payment and only with respect to specic items. It cannot be exercised if the customer instructs otherwise. Thus limited the escape provision should aord a limited degree of exibility in special cases but should not interfere with the overall requirement and objective of speedy collections. 2. An extension granted under subsection (a) is without discharge of drawers or indorsers. It therefore extends the times for presentment or payment as specied in Article 3. 3. Subsection (b) is another escape clause from time limits. This clause operates not only with respect to time limits imposed by the Article itself but also time limits imposed by special instructions, by agreement or by Federal regulations or operating circulars, clearinghouse rules or the like. The latter time limits are permitted by the Code. For example, a payor bank that fails to make timely return of a dishonored item may be accountable for the amount of the item. Subsection (b) excuses a bank from this liability when its failure to meet its midnight deadline resulted from, for example, a computer breakdown that was beyond the control of the bank, so long as the bank exercised the degree of diligence that the circumstances required. In Port City State Bank v. American National Bank, 486 F.2d 196 (10th Cir.1973), the court held that a bank exercised sucient diligence to be excused under this subsection. If delay is sought to be excused under this subsection, the bank has the burden of proof on the issue of whether it exercised such diligence as the circumstances require. The subsection is consistent with Regulation CC, Section 229.38(e).

4-110. Electronic Presentment. (a) Agreement for electronic presentment means an agreement, clearing-house rule, or Federal Reserve regulation or operating circular,
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providing that presentment of an item may be made by transmission of an image of an item or information describing the item (presentment notice) rather than delivery of the item itself. The agreement may provide for procedures governing retention, presentment, payment, dishonor, and other matters concerning items subject to the agreement. (b) Presentment of an item pursuant to an agreement for presentment is made when the presentment notice is received. (c) If presentment is made by presentment notice, a reference to item or check in this Article means the presentment notice unless the context otherwise indicates. As added in 1990.
See Appendix I for material relating to adoption of section in 1990.

Ocial Comment
1. An agreement for electronic presentment refers to an agreement under which presentment may be made to a payor bank by a presentment notice rather than by presentment of the item. Under imaging technology now under development, the presentment notice might be an image of the item. The electronic presentment agreement may provide that the item may be retained by a depositary bank, other collecting bank, or even a customer of the depositary bank, or it may provide that the item will follow the presentment notice. The identifying characteristic of an electronic presentment agreement is that presentment occurs when the presentment notice is received. An agreement for electronic presentment does not refer to the common case of retention of items by payor banks because the item itself is presented to the payor bank in these cases. Payor bank check retention is a matter of agreement between payor banks and their customers. Provisions on payor bank check retention are found in Section 4-406(b). 2. The assumptions under which the electronic presentment amendments are based are as follows: No bank will participate in an electronic presentment program without an agreement. These agreements may be either bilateral (Section 4-103(a)), under which two banks that frequently do business with each other may agree to depositary bank check retention, or multilateral (Section 4-103(b)), in which large segments of the banking industry may participate in such a program. In the latter case, federal or other uniform regulatory standards would likely supply the substance of the electronic presentment agreement, the application of which could be triggered by the use of some form of identier on the item. Regulation CC, Section 229.36(c) authorizes truncation agreements but forbids them from extending return times or otherwise varying requirements of the part of Regulation CC governing check collection without the agreement of all parties interested in the check. For instance, an extension of return time could damage a depositary bank which must make funds available to its customers under mandatory availability schedules. The Expedited Funds Availability Act, 12 U.S.C. Section 4008(b)(2), directs the Federal Reserve Board to consider requiring that banks provide for check truncation. 3. The parties aected by an agreement for electronic presentment, with the exception of the customer, can be expected to protect themselves. For example, the payor bank can probably be expected to limit its risk of loss from drawer forgery by limiting the dollar amount of eligible items (Federal Reserve program), by reconcilement agreements (ABA Safekeeping program), by insurance (credit union share draft program), or by other means. Because agreements will exist, only minimal amendments are needed to make clear that the UCC does not prohibit electronic presentment.

4-111. Statute of Limitations. An action to enforce an obligation, duty, or right arising under this Article must be commenced within three years after the [cause of action] accrues. As added in 1990.
See Appendix I for material relating to adoption of section in 1990.
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Ocial Comment
This section conforms to the period of limitations set by Section 3-118(g) for actions for breach of warranty and to enforce other obligations, duties or rights arising under Article 3. Bracketing cause of action recognizes that some states use a dierent term, such as claim for relief.

PART 2. COLLECTION OF ITEMS: DEPOSITARY AND COLLECTING BANKS

4-201. Status of Collecting Bank as Agent and Provisional Status of Credits; Applicability of Article; Item Indorsed Pay Any Bank. (a) Unless a contrary intent clearly appears and before the time that a settlement given by a collecting bank for an item is or becomes nal, the bank, with respect to an item, is an agent or sub-agent of the owner of the item and any settlement given for the item is provisional. This provision applies regardless of the form of indorsement or lack of indorsement and even though credit given for the item is subject to immediate withdrawal as of right or is in fact withdrawn; but the continuance of ownership of an item by its owner and any rights of the owner to proceeds of the item are subject to rights of a collecting bank, such as those resulting from outstanding advances on the item and rights of recoupment or seto. If an item is handled by banks for purposes of presentment, payment, collection, or return, the relevant provisions of this Article apply even though action of the parties clearly establishes that a particular bank has purchased the item and is the owner of it. (b) After an item has been indorsed with the words pay any bank or the like, only a bank may acquire the rights of a holder until the item has been: (1) returned to the customer initiating collection; or (2) specially indorsed by a bank to a person who is not a bank. As amended in 1990.
See Appendix I for material relating to changes in text in 1990.

Ocial Comment
1. This section states certain basic rules of the bank collection process. One basic rule, appearing in the last sentence of subsection (a), is that, to the extent applicable, the provisions of the Article govern without regard to whether a bank handling an item owns the item or is an agent for collection. Historically, much time has been spent and eort expended in determining or attempting to determine whether a bank was a purchaser of an item or merely an agent for collection. See discussion of this subject and cases cited in 11 A.L.R. 1043, 16 A.L.R. 1084, 42 A.L.R. 492, 68 A.L.R. 725, 99 A.L.R. 486. See also Section 4 of the American Bankers Association Bank Collection Code. The general approach of Article 4, similar to that of other articles, is to provide, within reasonable limits, rules or answers to major problems known to exist in the bank collection process without regard to questions of status and ownership but to keep general principles such as status and ownership available to cover residual areas not covered by specic rules. In line with this approach, the last sentence of subsection (a) says in eect that Article 4 applies to practically every item moving through banks for the purpose of presentment, payment or collection. 2. Within this general rule of broad coverage, the rst two sentences of subsection (a) state a rule of agency status. Unless a contrary intent clearly appears the status of a collecting bank is that of an agent or sub-agent for the owner of the item. Although as indicated in Comment 1 it is much less important under Article 4 to determine status than 447

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has been the case heretofore, status may have importance in some residual areas not covered by specic rules. Further, since status has been considered so important in the past, to omit all reference to it might cause confusion. The status of agency applies regardless of the form of indorsement or lack of indorsement and even though credit given for the item is subject to immediate withdrawal as of right or is in fact withdrawn. Thus questions heretofore litigated as to whether ordinary indorsements for deposit, for collection or in blank have the eect of creating an agency status or a purchase, no longer have signicance in varying the prima facie rule of agency. Similarly, the nature of the credit given for an item or whether it is subject to immediate withdrawal as of right or is in fact withdrawn, does not alter the agency status. See A.L.R. references supra in Comment 1. A contrary intent can change agency status but this must be clear. An example of a clear contrary intent would be if collateral papers established or the item bore a legend stating that the item was sold absolutely to the depositary bank. 3. The prima facie agency status of collecting banks is consistent with prevailing law and practice today. Section 2 of the American Bankers Association Bank Collection Code so provided. Legends on deposit tickets, collection letters and acknowledgments of items and Federal Reserve operating circulars consistently so provide. The status is consistent with rights of charge-back (Section 4-214 and Section 11 of the ABA Code) and risk of loss in the event of insolvency (Section 4-216 and Section 13 of the ABA Code). The right of chargeback with respect to checks is limited by Regulation CC, Section 226.36(d). 4. Armative statement of a prima facie agency status for collecting banks requires certain limitations and qualications. Under current practices substantially all bank collections sooner or later merge into bank credits, at least if collection is eected. Usually, this takes place within a few days of the initiation of collection. An intermediary bank receives nal collection and evidences the result of its collection by a credit on its books to the depositary bank. The depositary bank evidences the results of its collection by a credit in the account of its customer. As used in these instances the term credit clearly indicates a debtor-creditor relationship. At some stage in the bank collection process the agency status of a collecting bank changes to that of debtor, a debtor of its customer. Usually at about the same time it also becomes a creditor for the amount of the item, a creditor of some intermediary, payor or other bank. Thus the collection is completed, all agency aspects are terminated and the identity of the item has become completely merged in bank accounts, that of the customer with the depositary bank and that of one bank with another. Although Section 4-215(a) provides that an item is nally paid when the payor bank takes or fails to take certain action with respect to the item, the nal payment of the item may or may not result in the simultaneous nal settlement for the item in the case of all prior parties. If a series of provisional debits and credits for the item have been entered in accounts between banks, the nal payment of the item by the payor bank may result in the automatic rming up of all these provisional debits and credits under Section 4-215(c), and the consequent receipt of nal settlement for the item by each collecting bank and the customer of the depositary bank simultaneously with such action of the payor bank. However, if the payor bank or some intermediary bank accounts for the item with a remittance draft, the next prior bank usually does not receive nal settlement for the item until the remittance draft nally clears. See Section 4-213(c). The rst sentence of subsection (a) provides that the agency status of a collecting bank (whether intermediary or depositary) continues until the settlement given by it for the item is or becomes nal. In the case of the series of provisional credits covered by Section 4-215(c), this could be simultaneously with the nal payment of the item by the payor bank. In cases in which remittance drafts are used or in straight noncash collections, this would not be until the times specied in Sections 4-213(c) and 4-215(d). With respect to checks Regulation CC Sections 229.31(c), 229.32(b) and 229.36(d) provide that all settlements between banks are nal in both the forward collection and return of checks. Under Section 4-213(a) settlements for items may be made by any means agreed to by the parties. Since it is impossible to contemplate all the kinds of settlements that will be utilized, no attempt is made in Article 4 to provide when settlement is nal in all cases. The guiding principle is that settlements should be nal when the presenting person has received usable funds. Section 4-213(c) and (d) and Section 4-215(c) provide when nal settlement occurs with respect to certain kinds of settlement, but these provisions are not intended to be exclusive. A number of practical results ow from the rule continuing the agency status of a collect448

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ing bank until its settlement for the item is or becomes nal, some of which are specically set forth in this Article. One is that risk of loss continues in the owner of the item rather than the agent bank. See Section 4-214. Osetting rights favorable to the owner are that pending such nal settlement, the owner has the preference rights of Section 4-216 and the direct rights of Section 4-302 against the payor bank. It also follows from this rule that the dollar limitations of Federal Deposit Insurance are measured by the claim of the owner of the item rather than that of the collecting bank. With respect to checks, rights of the parties in insolvency are determined by Regulation CC Section 229.39 and the liability of a bank handling a check to a subsequent bank that does not receive payment because of suspension of payments by another bank is stated in Regulation CC Section 229.35(b). 5. In those cases in which some period of time elapses between the nal payment of the item by the payor bank and the time that the settlement of the collecting bank is or becomes nal, e.g., if the payor bank or an intermediary bank accounts for the item with a remittance draft or in straight noncash collections, the continuance of the agency status of the collecting bank necessarily carries with it the continuance of the owner's status as principal. The second sentence of subsection (a) provides that whatever rights the owner has to proceeds of the item are subject to the rights of collecting banks for outstanding advances on the item and other valid rights, if any. The rule provides a sound rule to govern cases of attempted attachment of proceeds of a non-cash item in the hands of the payor bank as property of the absent owner. If a collecting bank has made an advance on an item which is still outstanding, its right to obtain reimbursement for this advance should be superior to the rights of the owner to the proceeds or to the rights of a creditor of the owner. An intentional crediting of proceeds of an item to the account of a prior bank known to be insolvent, for the purpose of acquiring a right of seto, would not produce a valid seto. See 8 Zollman, Banks and Banking (1936) Sec. 5443. 6. This section and Article 4 as a whole represent an intentional abandonment of the approach to bank collection problems appearing in Section 4 of the American Bankers Association Bank Collection Code. Because the tremendous volume of items handled makes impossible the examination by all banks of all indorsements on all items and thus in fact this examination is not made, except perhaps by depositary banks, it is unrealistic to base the rights and duties of all banks in the collection chain on variations in the form of indorsements. It is anomalous to provide throughout the ABA Code that the prima facie status of collecting banks is that of agent or sub-agent but in Section 4 to provide that subsequent holders (sub-agents) shall have the right to rely on the presumption that the bank of deposit (the primary agent) is the owner of the item. It is unrealistic, particularly in this background, to base rights and duties on status of agent or owner. Thus Section 4-201 makes the pertinent provisions of Article 4 applicable to substantially all items handled by banks for presentment, payment or collection, recognizes the prima facie status of most banks as agents, and then seeks to state appropriate limits and some attributes to the general rules so expressed. 7. Subsection (b) protects the ownership rights with respect to an item indorsed pay any bank or banker or in similar terms of a customer initiating collection or of any bank acquiring a security interest under Section 4-210, in the event the item is subsequently acquired under improper circumstances by a person who is not a bank and transferred by that person to another person, whether or not a bank. Upon return to the customer initiating collection of an item so indorsed, the indorsement may be cancelled (Section 3-207). A bank holding an item so indorsed may transfer the item out of banking channels by special indorsement; however, under Section 4-103(e), the bank would be liable to the owner of the item for any loss resulting therefrom if the transfer had been made in bad faith or with lack of ordinary care. If briefer and more simple forms of bank indorsements are developed under Section 4-206 (e.g., the use of bank transit numbers in lieu of present lengthy forms of bank indorsements), a depositary bank having the transit number X100 could make subsection (b) operative by indorsements such as Pay any bankX100. Regulation CC Section 229.35(c) states the eect of an indorsement on a check by a bank.

4-202. Responsibility for Collection or Return; When Action Timely. (a) A collecting bank must exercise ordinary care in: (1) presenting an item or sending it for presentment;
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(2) sending notice of dishonor or nonpayment or returning an item other than a documentary draft to the bank's transferor after learning that the item has not been paid or accepted, as the case may be; (3) settling for an item when the bank receives nal settlement; and (4) notifying its transferor of any loss or delay in transit within a reasonable time after discovery thereof. (b) A collecting bank exercises ordinary care under subsection (a) by taking proper action before its midnight deadline following receipt of an item, notice, or settlement. Taking proper action within a reasonably longer time may constitute the exercise of ordinary care, but the bank has the burden of establishing timeliness. (c) Subject to subsection (a)(1), a bank is not liable for the insolvency, neglect, misconduct, mistake, or default of another bank or person or for loss or destruction of an item in the possession of others or in transit. As amended in 1990.
See Appendix I for material relating to changes in text in 1990.

Ocial Comment
1. Subsection (a) states the basic responsibilities of a collecting bank. Of course, under Section 1-203 a collecting bank is subject to the standard requirement of good faith. By subsection (a) it must also use ordinary care in the exercise of its basic collection tasks. By Section 4-103(a) neither requirement may be disclaimed. 2. If the bank makes presentment itself, subsection (a)(1) requires ordinary care with respect both to the time and manner of presentment. (Sections 3-501 and 4-212.) If it forwards the item to be presented the subsection requires ordinary care with respect to routing (Section 4-204), and also in the selection of intermediary banks or other agents. 3. Subsection (a) describes types of basic action with respect to which a collecting bank must use ordinary care. Subsection (b) deals with the time for taking action. It rst prescribes the general standard for timely action, namely, for items received on Monday, proper action (such as forwarding or presenting) on Monday or Tuesday is timely. Although under current production line operations banks customarily move items along on regular schedules substantially briefer than two days, the subsection states an outside time within which a bank may know it has taken timely action. To provide exibility from this standard norm, the subsection further states that action within a reasonably longer time may be timely but the bank has the burden of proof. In the case of time items, action after the midnight deadline, but suciently in advance of maturity for proper presentation, is a clear example of a reasonably longer time that is timely. The standard of requiring action not later than Tuesday in the case of Monday items is also subject to possibilities of variation under the general provisions of Section 4-103, or under the special provisions regarding time of receipt of items (Section 4-108), and regarding delays (Section 4-109). This subsection (b) deals only with collecting banks. The time limits applicable to payor banks appear in Sections 4-301 and 4-302. 4. At common law the so-called New York collection rule subjected the initial collecting bank to liability for the actions of subsequent banks in the collection chain; the so-called Massachusetts rule was that each bank, subject to the duty of selecting proper intermediaries, was liable only for its own negligence. Subsection (c) adopts the Massachusetts rule. But since this is stated to be subject to subsection (a)(1) a collecting bank remains responsible for using ordinary care in selecting properly qualied intermediary banks and agents and in giving proper instructions to them. Regulation CC Section 229.36(d) states the liability of a bank during the forward collection of checks.

4-203. Eect of Instructions. Subject to Article 3 concerning conversion of instruments (Section 3-420) and restrictive indorsements (Section 3-206), only a collecting bank's transferor can give instructions that aect the bank or constitute notice to it,
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and a collecting bank is not liable to prior parties for any action taken pursuant to the instructions or in accordance with any agreement with its transferor. As amended in 1990.
See Appendix I for material relating to changes in text in 1990.

Ocial Comment
This section adopts a chain of command theory which renders it unnecessary for an intermediary or collecting bank to determine whether its transferor is authorized to give the instructions. Equally the bank is not put on notice of any revocation of authority or lack of authority by notice received from any other person. The desirability of speed in the collection process and the fact that, by reason of advances made, the transferor may have the paramount interest in the item requires the rule. The section is made subject to the provisions of Article 3 concerning conversion of instruments (Section 3-420) and restrictive indorsements (Section 3-206). Of course instructions from or an agreement with its transferor does not relieve a collecting bank of its general obligation to exercise good faith and ordinary care. See Section 4-103(a). If in any particular case a bank has exercised good faith and ordinary care and is relieved of responsibility by reason of instructions of or an agreement with its transferor, the owner of the item may still have a remedy for loss against the transferor (another bank) if such transferor has given wrongful instructions. The rules of the section are applied only to collecting banks. Payor banks always have the problem of making proper payment of an item; whether such payment is proper should be based upon all of the rules of Articles 3 and 4 and all of the facts of any particular case, and should not be dependent exclusively upon instructions from or an agreement with a person presenting the item.

4-204. Methods of Sending and Presenting; Sending Directly to Payor Bank. (a) A collecting bank shall send items by a reasonably prompt method, taking into consideration relevant instructions, the nature of the item, the number of those items on hand, the cost of collection involved, and the method generally used by it or others to present those items. (b) A collecting bank may send: (1) an item directly to the payor bank; (2) an item to a nonbank payor if authorized by its transferor; and (3) an item other than documentary drafts to a nonbank payor, if authorized by Federal Reserve regulation or operating circular, clearinghouse rule, or the like. (c) Presentment may be made by a presenting bank at a place where the payor bank or other payor has requested that presentment be made. As amended in 1962 and 1990.
See Appendix I for material relating to changes in text in 1990.

Ocial Comment
1. Subsection (a) prescribes the general standards applicable to proper sending or forwarding of items. Because of the many types of methods available and the desirability of preserving exibility any attempt to prescribe limited or precise methods is avoided. 2. Subsection (b)(1) codies the practice of direct mail, express, messenger or like presentment to payor banks. The practice is now country-wide and is justied by the need for speed, the general responsibility of banks, Federal Deposit Insurance protection and other reasons. 3. Full approval of the practice of direct sending is limited to cases in which a bank is a payor. Since nonbank drawees or payors may be of unknown responsibility, substantial 451

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risks may be attached to placing in their hands the instruments calling for payments from them. This is obviously so in the case of documentary drafts. However, in some cities practices have long existed under clearing-house procedures to forward certain types of items to certain nonbank payors. Examples include insurance loss drafts drawn by eld agents on home oces. For the purpose of leaving the door open to legitimate practices of this kind, subsection (b)(3) armatively approves direct sending of any item other than documentary drafts to any nonbank payor, if authorized by Federal Reserve regulation or operating circular, clearing-house rule or the like. On the other hand subsection (b)(2) approves sending any item directly to a nonbank payor if authorized by a collecting bank's transferor. This permits special instructions or agreements out of the norm and is consistent with the chain of command theory of Section 4-203. However, if a transferor other than the owner of the item, e.g., a prior collecting bank, authorizes a direct sending to a nonbank payor, such transferor assumes responsibility for the propriety or impropriety of such authorization. 4. Section 3-501(b) provides where presentment may be made. This provision is expressly subject to Article 4. Section 4-204(c) specically approves presentment by a presenting bank at any place requested by the payor bank or other payor. The time when a check is received by a payor bank for presentment is governed by Regulation CC Section 229.36(b).

4-205. Depositary Bank Holder of Unindorsed Item. If a customer delivers an item to a depositary bank for collection: (1) the depositary bank becomes a holder of the item at the time it receives the item for collection if the customer at the time of delivery was a holder of the item, whether or not the customer indorses the item, and, if the bank satises the other requirements of Section 3-302, it is a holder in due course; and (2) the depositary bank warrants to collecting banks, the payor bank or other payor, and the drawer that the amount of the item was paid to the customer or deposited to the customer's account. As amended in 1990.
See Appendix I for material relating to changes in text in 1990.

Ocial Comment
Section 3-201(b) provides that negotiation of an instrument payable to order requires indorsement by the holder. The rule of former Section 4-205(1) was that the depositary bank may supply a missing indorsement of its customer unless the item contains the words payee's indorsement required or the like. The cases have diered on the status of the depositary bank as a holder if it fails to supply its customer's indorsement. Marine Midland Bank, N.A. v. Price, Miller, Evans & Flowers, 446 N.Y.S.2d 797 (N.Y.App.Div. 4th Dept.1981), rev'd, 455 N.Y.S.2d 565 (N.Y.1982). It is common practice for depositary banks to receive unindorsed checks under so-called lock-box agreements from customers who receive a high volume of checks. No function would be served by requiring a depositary bank to run these items through a machine that would supply the customer's indorsement except to aord the drawer and the subsequent banks evidence that the proceeds of the item reached the customer's account. Paragraph (1) provides that the depositary bank becomes a holder when it takes the item for deposit if the depositor is a holder. Whether it supplies the customer's indorsement is immaterial. Paragraph (2) satises the need for a receipt of funds by the depositary bank by imposing on that bank a warranty that it paid the customer or deposited the item to the customer's account. This warranty runs not only to collecting banks and to the payor bank or nonbank drawee but also to the drawer, aording protection to these parties that the depositary bank received the item and applied it to the benet of the holder.

4-206. Transfer Between Banks. Any agreed method that identies the transferor bank is sucient for the item's further transfer to another bank.
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As amended in 1990.
See Appendix I for material relating to changes in text in 1990.

Ocial Comment
This section is designed to permit the simplest possible form of transfer from one bank to another, once an item gets in the bank collection chain, provided only identity of the transferor bank is preserved. This is important for tracing purposes and if recourse is necessary. However, since the responsibilities of the various banks appear in the Article it becomes unnecessary to have liability or responsibility depend on more formal indorsements. Simplicity in the form of transfer is conducive to speed. If the transfer is between banks, this section takes the place of the more formal requirements of Section 3-201.

4-207. Transfer Warranties. (a) A customer or collecting bank that transfers an item and receives a settlement or other consideration warrants to the transferee and to any subsequent collecting bank that: (1) the warrantor is a person entitled to enforce the item; (2) all signatures on the item are authentic and authorized; (3) the item has not been altered; (4) the item is not subject to a defense or claim in recoupment (Section 3-305(a)) of any party that can be asserted against the warrantor; (5) the warrantor has no knowledge of any insolvency proceeding commenced with respect to the maker or acceptor or, in the case of an unaccepted draft, the drawer; and (6) with respect to any remotely-created consumer item, that the person on whose account the item is drawn authorized the issuance of the item in the amount for which the item is drawn. (b) If an item is dishonored, a customer or collecting bank transferring the item and receiving settlement or other consideration is obliged to pay the amount due on the item (i) according to the terms of the item at the time it was transferred, or (ii) if the transfer was of an incomplete item, according to its terms when completed as stated in Sections 3-115 and 3-407. The obligation of a transferor is owed to the transferee and to any subsequent collecting bank that takes the item in good faith. A transferor cannot disclaim its obligation under this subsection by an indorsement stating that it is made without recourse or otherwise disclaiming liability. (c) A person to whom the warranties under subsection (a) are made and who took the item in good faith may recover from the warrantor as damages for breach of warranty an amount equal to the loss suered as a result of the breach, but not more than the amount of the item plus expenses and loss of interest incurred as a result of the breach. (d) The warranties stated in subsection (a) cannot be disclaimed with respect to checks. Unless notice of a claim for breach of warranty is given to the warrantor within 30 days after the claimant has reason to know of the breach and the identity of the warrantor, the warrantor is discharged to the extent of any loss caused by the delay in giving notice of the claim. (e) A cause of action for breach of warranty under this section accrues when the claimant has reason to know of the breach. As added in 1990 and amended in 2002.
See Appendix I for material relating to adoption of section in 1990. See Appendix R for material relating to changes in text in 2002.
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Ocial Comment
1. Except for subsection (b), this section conforms to Section 3-416 and extends its coverage to items. The substance of this section is discussed in the Comment to Section 3-416. Subsection (b) provides that customers or collecting banks that transfer items, whether by indorsement or not, undertake to pay the item if the item is dishonored. This obligation cannot be disclaimed by a without recourse indorsement or otherwise. With respect to checks, Regulation CC Section 229.34 states the warranties made by paying and returning banks. 2. For an explanation of subsection (a)(6), see comment 8 to Section 3-416.

As amended in 2002.
See Appendix Q for material relating to changes in Ocial Comment in 2002.

4-208. Presentment Warranties. (a) If an unaccepted draft is presented to the drawee for payment or acceptance and the drawee pays or accepts the draft, (i) the person obtaining payment or acceptance, at the time of presentment, and (ii) a previous transferor of the draft, at the time of transfer, warrant to the drawee that pays or accepts the draft in good faith that: (1) the warrantor is, or was, at the time the warrantor transferred the draft, a person entitled to enforce the draft or authorized to obtain payment or acceptance of the draft on behalf of a person entitled to enforce the draft; (2) the draft has not been altered; and (3) the warrantor has no knowledge that the signature of the purported drawer of the draft is unauthorized; and (4) with respect to any remotely-created consumer item, that the person on whose account the item is drawn authorized the issuance of the item in the amount for which the item is drawn. (b) A drawee making payment may recover from a warrantor damages for breach of warranty equal to the amount paid by the drawee less the amount the drawee received or is entitled to receive from the drawer because of the payment. In addition, the drawee is entitled to compensation for expenses and loss of interest resulting from the breach. The right of the drawee to recover damages under this subsection is not aected by any failure of the drawee to exercise ordinary care in making payment. If the drawee accepts the draft (i) breach of warranty is a defense to the obligation of the acceptor, and (ii) if the acceptor makes payment with respect to the draft, the acceptor is entitled to recover from a warrantor for breach of warranty the amounts stated in this subsection. (c) If a drawee asserts a claim for breach of warranty under subsection (a) based on an unauthorized indorsement of the draft or an alteration of the draft, the warrantor may defend by proving that the indorsement is effective under Section 3-404 or 3-405 or the drawer is precluded under Section 3-406 or 4-406 from asserting against the drawee the unauthorized indorsement or alteration. (d) If (i) a dishonored draft is presented for payment to the drawer or an indorser or (ii) any other item is presented for payment to a party obliged to pay the item, and the item is paid, the person obtaining payment and a prior transferor of the item warrant to the person making payment in good
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faith that the warrantor is, or was, at the time the warrantor transferred the item, a person entitled to enforce the item or authorized to obtain payment on behalf of a person entitled to enforce the item. The person making payment may recover from any warrantor for breach of warranty an amount equal to the amount paid plus expenses and loss of interest resulting from the breach. (e) The warranties stated in subsections (a) and (d) cannot be disclaimed with respect to checks. Unless notice of a claim for breach of warranty is given to the warrantor within 30 days after the claimant has reason to know of the breach and the identity of the warrantor, the warrantor is discharged to the extent of any loss caused by the delay in giving notice of the claim. (f) A cause of action for breach of warranty under this section accrues when the claimant has reason to know of the breach. As added in 1990 and amended in 2002.
See Appendix I for material relating to adoption of section in 1990. See Appendix R for material relating to changes in text in 2002.

Ocial Comment
1. This section conforms to Section 3-417 and extends its coverage to items. The substance of this section is discussed in the Comment to Section 3-417. Draft is dened in Section 4-104 as including an item that is an order to pay so as to make clear that the term draft in Article 4 may include items that are not instruments within Section 3-104. 2. For an explanation of subsection (a)(4), see comment 8 to Section 3-416.

As amended in 2002.
See Appendix Q for material relating to changes in Ocial Comment in 2002.

4-209. Encoding and Retention Warranties. (a) A person who encodes information on or with respect to an item after issue warrants to any subsequent collecting bank and to the payor bank or other payor that the information is correctly encoded. If the customer of a depositary bank encodes, that bank also makes the warranty. (b) A person who undertakes to retain an item pursuant to an agreement for electronic presentment warrants to any subsequent collecting bank and to the payor bank or other payor that retention and presentment of the item comply with the agreement. If a customer of a depositary bank undertakes to retain an item, that bank also makes this warranty. (c) A person to whom warranties are made under this section and who took the item in good faith may recover from the warrantor as damages for breach of warranty an amount equal to the loss suered as a result of the breach, plus expenses and loss of interest incurred as a result of the breach. As added in 1990.
See Appendix I for material relating to adoption of section in 1990.

Ocial Comment
1. Encoding and retention warranties are included in Article 4 because they are unique to the bank collection process. These warranties are breached only by the person doing the encoding or retaining the item and not by subsequent banks handling the item. Encoding and check retention may be done by customers who are payees of a large volume of checks; hence, this section imposes warranties on customers as well as banks. If a customer encodes 455

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or retains, the depositary bank is also liable for any breach of this warranty. 2. A misencoding of the amount on the MICR line is not an alteration under Section 3-407(a) which denes alteration as changing the contract of the parties. If a drawer wrote a check for $2,500 and the depositary bank encoded $25,000 on the MICR line, the payor bank could debit the drawer's account for only $2,500. This subsection would allow the payor bank to hold the depositary bank liable for the amount paid out over $2,500 without rst pursuing the person who received payment. Intervening collecting banks would not be liable to the payor bank for the depositary bank's error. If a drawer wrote a check for $25,000 and the depositary bank encoded $2,500, the payor bank becomes liable for the full amount of the check. The payor bank's rights against the depositary bank depend on whether the payor bank has suered a loss. Since the payor bank can debit the drawer's account for $25,000, the payor bank has a loss only to the extent that the drawer's account is less than the full amount of the check. There is no requirement that the payor bank pursue collection against the drawer beyond the amount in the drawer's account as a condition to the payor bank's action against the depositary bank for breach of warranty. See Georgia Railroad Bank & Trust Co. v. First National Bank & Trust, 229 S.E.2d 482 (Ga.App.1976), a'd, 235 S.E.2d 1 (Ga.1977), and First National Bank of Boston v. Fidelity Bank, National Association, 724 F.Supp. 1168 (E.D.Pa.1989). 3. A person retaining items under an electronic presentment agreement (Section 4-110) warrants that it has complied with the terms of the agreement regarding its possession of the item and its sending a proper presentment notice. If the keeper is a customer, its depositary bank also makes this warranty.

4-210. Security Interest of Collecting Bank in Items, Accompanying Documents and Proceeds. (a) A collecting bank has a security interest in an item and any accompanying documents or the proceeds of either: (1) in case of an item deposited in an account, to the extent to which credit given for the item has been withdrawn or applied; (2) in case of an item for which it has given credit available for withdrawal as of right, to the extent of the credit given, whether or not the credit is drawn upon or there is a right of charge-back; or (3) if it makes an advance on or against the item. (b) If credit given for several items received at one time or pursuant to a single agreement is withdrawn or applied in part, the security interest remains upon all the items, any accompanying documents or the proceeds of either. For the purpose of this section, credits rst given are rst withdrawn. (c) Receipt by a collecting bank of a nal settlement for an item is a realization on its security interest in the item, accompanying documents, and proceeds. So long as the bank does not receive nal settlement for the item or give up possession of the item or possession or control of the accompanying documents for purposes other than collection, the security interest continues to that extent and is subject to Article 9, but: (1) no security agreement is necessary to make the security interest enforceable (Section 9-203(b)(3)(A)); (2) no ling is required to perfect the security interest; and (3) the security interest has priority over conicting perfected security interests in the item, accompanying documents, or proceeds. As amended in 1999, 1999 and 2003.
See Appendix I for material relating to changes made to text to 1990. See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999.
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See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Subsection (a) states a rational rule for the interest of a bank in an item. The customer of the depositary bank is normally the owner of the item and the several collecting banks are agents of the customer (Section 4-201). A collecting agent may properly make advances on the security of paper held for collection, and acquires at common law a possessory lien for these advances. Subsection (a) applies an analogous principle to a bank in the collection chain which extends credit on items in the course of collection. The bank has a security interest to the extent stated in this section. To the extent of its security interest it is a holder for value (Sections 3-303, 4-211) and a holder in due course if it satises the other requirements for that status (Section 3-302). Subsection (a) does not derogate from the banker's general common law lien or right of seto against indebtedness owing in deposit accounts. See Section 1-103. Rather subsection (a) specically implements and extends the principle as a part of the bank collection process. 2. Subsection (b) spreads the security interest of the bank over all items in a single deposit or received under a single agreement and a single giving of credit. It also adopts the rst-in, rst-out rule. 3. Collection statistics establish that the vast majority of items handled for collection are in fact collected. The rst sentence of subsection (c) reects the fact that in the normal case the bank's security interest is self-liquidating. The remainder of the subsection correlates the security interest with the provisions of Article 9, particularly for use in the cases of noncollection in which the security interest may be important.

4-211. When Bank Gives Value for Purposes of Holder in Due Course. For purposes of determining its status as a holder in due course, a bank has given value to the extent it has a security interest in an item, if the bank otherwise complies with the requirements of Section 3-302 on what constitutes a holder in due course. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
The section completes the thought of the previous section and makes clear that a security interest in an item is value for the purpose of determining the holder's status as a holder in due course. The provision is in accord with the prior law (N.I.L. Section 27) and with Article 3 (Section 3-303). The section does not prescribe a security interest under Section 4-210 as a test of value generally because the meaning of value under other Articles is adequately dened in Section 1-201.

4-212. Presentment by Notice of Item Not Payable by, Through, or at Bank; Liability of Drawer or Indorser. (a) Unless otherwise instructed, a collecting bank may present an item not payable by, through, or at a bank by sending to the party to accept or pay a record providing notice that the bank holds the item for acceptance or payment. The notice must be sent in time to be received on or before the day when presentment is due and the bank must meet any requirement of the party to accept or pay under Section 3-501 by the close of the bank's next banking day after it knows of the requirement. (b) If presentment is made by notice and payment, acceptance, or request for compliance with a requirement under Section 3-501 is not received by the close of business on the day after maturity or, in the case of demand items, by the close of business on the third banking day after notice was
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sent, the presenting bank may treat the item as dishonored and charge any drawer or indorser by sending it notice of the facts. As amended in 1990 and 2002.
See Appendix I for material relating to changes made in text in 1990. See Appendix R for material relating to changes made in text in 2002.

Ocial Comment
1. This section codies a practice extensively followed in presentation of trade acceptances and documentary and other drafts drawn on nonbank payors. It imposes a duty on the payor to respond to the notice of the item if the item is not to be considered dishonored. Notice of such a dishonor charges drawers and indorsers. Presentment under this section is good presentment under Article 3. See Section 3-501. 2. A drawee not receiving notice is not, of course, liable to the drawer for wrongful dishonor. 3. A bank so presenting an instrument must be suciently close to the drawee to be able to exhibit the instrument on the day it is requested to do so or the next business day at the latest.

4-213. Medium and Time of Settlement by Bank. (a) With respect to settlement by a bank, the medium and time of settlement may be prescribed by Federal Reserve regulations or circulars, clearing-house rules, and the like, or agreement. In the absence of such prescription: (1) the medium of settlement is cash or credit to an account in a Federal Reserve bank of or specied by the person to receive settlement; and (2) the time of settlement, is: (i) with respect to tender of settlement by cash, a cashier's check, or teller's check, when the cash or check is sent or delivered; (ii) with respect to tender of settlement by credit in an account in a Federal Reserve Bank, when the credit is made; (iii) with respect to tender of settlement by a credit or debit to an account in a bank, when the credit or debit is made or, in the case of tender of settlement by authority to charge an account, when the authority is sent or delivered; or (iv) with respect to tender of settlement by a funds transfer, when payment is made pursuant to Section 4A-406(a) to the person receiving settlement. (b) If the tender of settlement is not by a medium authorized by subsection (a) or the time of settlement is not xed by subsection (a), no settlement occurs until the tender of settlement is accepted by the person receiving settlement. (c) If settlement for an item is made by cashier's check or teller's check and the person receiving settlement, before its midnight deadline: (1) presents or forwards the check for collection, settlement is nal when the check is nally paid; or (2) fails to present or forward the check for collection, settlement is nal at the midnight deadline of the person receiving settlement. (d) If settlement for an item is made by giving authority to charge the account of the bank giving settlement in the bank receiving settlement,
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settlement is nal when the charge is made by the bank receiving settlement if there are funds available in the account for the amount of the item. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
1. Subsection (a) sets forth the medium of settlement that the person receiving settlement must accept. In nearly all cases the medium of settlement will be determined by agreement or by Federal Reserve regulations and circulars, clearing-house rules, and the like. In the absence of regulations, rules or agreement, the person receiving settlement may demand cash or credit in a Federal Reserve bank. If the person receiving settlement does not have an account in a Federal Reserve bank, it may specify the account of another bank in a Federal Reserve bank. In the unusual case in which there is no agreement on the medium of settlement and the bank making settlement tenders settlement other than cash or Federal Reserve bank credit, no settlement has occurred under subsection (b) unless the person receiving settlement accepts the settlement tendered. For example, if a payor bank, without agreement, tenders a teller's check, the bank receiving the settlement may reject the check and return it to the payor bank or it may accept the check as settlement. 2. In several provisions of Article 4 the time that a settlement occurs is relevant. Subsection (a) sets out a general rule that the time of settlement, like the means of settlement, may be prescribed by agreement. In the absence of agreement, the time of settlement for tender of the common agreed media of settlement is that set out in subsection (a)(2). The time of settlement by cash, cashier's or teller's check or authority to charge an account is the time the cash, check or authority is sent, unless presentment is over the counter in which case settlement occurs upon delivery to the presenter. If there is no agreement on the time of settlement and the tender of settlement is not made by one of the media set out in subsection (a), under subsection (b) the time of settlement is the time the settlement is accepted by the person receiving settlement. 3. Subsections (c) and (d) are special provisions for settlement by remittance drafts and authority to charge an account in the bank receiving settlement. The relationship between nal settlement and nal payment under Section 4-215 is addressed in subsection (b) of Section 4-215. With respect to settlement by cashier's checks or teller's checks, other than in response to over-the-counter presentment, the bank receiving settlement can keep the risk that the check will not be paid on the bank tendering the check in settlement by acting to initiate collection of the check within the midnight deadline of the bank receiving settlement. If the bank fails to initiate settlement before its midnight deadline, nal settlement occurs at the midnight deadline, and the bank receiving settlement assumes the risk that the check will not be paid. If there is no agreement that permits the bank tendering settlement to tender a cashier's or teller's check, subsection (b) allows the bank receiving the check to reject it, and, if it does, no settlement occurs. However, if the bank accepts the check, settlement occurs and the time of nal settlement is governed by subsection (c). With respect to settlement by tender of authority to charge the account of the bank making settlement in the bank receiving settlement, subsection (d) provides that nal settlement does not take place until the account charged has available funds to cover the amount of the item. If there is no agreement that permits the bank tendering settlement to tender an authority to charge an account as settlement, subsection (b) allows the bank receiving the tender to reject it. However, if the bank accepts the authority, settlement occurs and the time of nal settlement is governed by subsection (d).

4-214. Right of Charge-Back or Refund; Liability of Collecting Bank: Return of Item. (a) If a collecting bank has made provisional settlement with its customer for an item and fails by reason of dishonor, suspension of payments by a bank, or otherwise to receive settlement for the item which is or becomes nal, the bank may revoke the settlement given by it, charge back the amount of any credit given for the item to its customer's account, or obtain
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refund from its customer, whether or not it is able to return the item, if by its midnight deadline or within a longer reasonable time after it learns the facts it returns the item or sends notication of the facts. If the return or notice is delayed beyond the bank's midnight deadline or a longer reasonable time after it learns the facts, the bank may revoke the settlement, charge back the credit, or obtain refund from its customer, but it is liable for any loss resulting from the delay. These rights to revoke, charge back, and obtain refund terminate if and when a settlement for the item received by the bank is or becomes nal. (b) A collecting bank returns an item when it is sent or delivered to the bank's customer or transferor or pursuant to its instructions. (c) A depositary bank that is also the payor may charge back the amount of an item to its customer's account or obtain refund in accordance with the section governing return of an item received by a payor bank for credit on its books (Section 4-301). (d) The right to charge back is not aected by: (1) previous use of a credit given for the item; or (2) failure by any bank to exercise ordinary care with respect to the item, but a bank so failing remains liable. (e) A failure to charge back or claim refund does not aect other rights of the bank against the customer or any other party. (f) If credit is given in dollars as the equivalent of the value of an item payable in foreign money, the dollar amount of any charge-back or refund must be calculated on the basis of the bank-oered spot rate for the foreign money prevailing on the day when the person entitled to the charge-back or refund learns that it will not receive payment in ordinary course. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
1. Under current bank practice, in a major portion of cases banks make provisional settlement for items when they are rst received and then await subsequent determination of whether the item will be nally paid. This is the principal characteristic of what are referred to in banking parlance as cash items. Statistically, this practice of settling provisionally rst and then awaiting nal payment is justied because the vast majority of such cash items are nally paid, with the result that in this great preponderance of cases it becomes unnecessary for the banks making the provisional settlements to make any further entries. In due course the provisional settlements become nal simply with the lapse of time. However, in those cases in which the item being collected is not nally paid or if for various reasons the bank making the provisional settlement does not itself receive nal payment, provision is made in subsection (a) for the reversal of the provisional settlements, charge-back of provisional credits and the right to obtain refund. 2. Various causes of a bank's not receiving nal payment, with the resulting right of charge-back or refund, are stated or suggested in subsection (a). These include dishonor of the original item; dishonor of a remittance instrument given for it; reversal of a provisional credit for the item; suspension of payments by another bank. The causes stated are illustrative; the right of charge-back or refund is stated to exist whether the failure to receive nal payment in ordinary course arises through one of them or otherwise. 3. The right of charge-back or refund exists if a collecting bank has made a provisional settlement for an item with its customer but terminates if and when a settlement received by the bank for the item is or becomes nal. If the bank fails to receive such a nal settlement the right of charge-back or refund must be exercised promptly after the bank learns the facts. The right exists (if so promptly exercised) whether or not the bank is able to 460

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return the item. The second sentence of subsection (a) adopts the view of Appliance Buyers Credit Corp. v. Prospect National Bank, 708 F.2d 290 (7th Cir.1983), that if the midnight deadline for returning an item or giving notice is not met, a collecting bank loses its rights only to the extent of damages for any loss resulting from the delay. 4. Subsection (b) states when an item is returned by a collecting bank. Regulation CC, Section 229.31 preempts this subsection with respect to checks by allowing direct return to the depositary bank. Because a returned check may follow a dierent path than in forward collection, settlement given for the check is nal and not provisional except as between the depositary bank and its customer. Regulation CC Section 229.36(d). See also Regulations CC Sections 229.31(c) and 229.32(b). Thus owing to the federal preemption, this subsection applies only to noncheck items. 5. The rule of subsection (d) relating to charge-back (as distinguished from claim for refund) applies irrespective of the cause of the nonpayment, and of the person ultimately liable for nonpayment. Thus charge-back is permitted even if nonpayment results from the depositary bank's own negligence. Any other rule would result in litigation based upon a claim for wrongful dishonor of other checks of the customer, with potential damages far in excess of the amount of the item. Any other rule would require a bank to determine dicult questions of fact. The customer's protection is found in the general obligation of good faith (Sections 1-203 and 4-103). If bad faith is established the customer's recovery includes other damages, if any, suered by the party as a proximate consequence (Section 4-103(e); see also Section 4-402). 6. It is clear that the charge-back does not relieve the bank from any liability for failure to exercise ordinary care in handling the item. The measure of damages for such failure is stated in Section 4-103(e). 7. Subsection (f) states a rule xing the time for determining the rate of exchange if there is a charge-back or refund of a credit given in dollars for an item payable in a foreign currency. Compare Section 3-107. Fixing such a rule is desirable to avoid disputes. If in any case the parties wish to x a dierent time for determining the rate of exchange, they may do so by agreement.

4-215. Final Payment of Item by Payor Bank; When Provisional Debits and Credits Become Final; When Certain Credits Become Available for Withdrawal. (a) An item is nally paid by a payor bank when the bank has rst done any of the following: (1) paid the item in cash; (2) settled for the item without having a right to revoke the settlement under statute, clearing-house rule, or agreement; or (3) made a provisional settlement for the item and failed to revoke the settlement in the time and manner permitted by statute, clearing-house rule, or agreement. (b) If provisional settlement for an item does not become nal, the item is not nally paid. (c) If provisional settlement for an item between the presenting and payor banks is made through a clearing house or by debits or credits in an account between them, then to the extent that provisional debits or credits for the item are entered in accounts between the presenting and payor banks or between the presenting and successive prior collecting banks seriatim, they become nal upon nal payment of the item by the payor bank. (d) If a collecting bank receives a settlement for an item which is or becomes nal, the bank is accountable to its customer for the amount of the item and any provisional credit given for the item in an account with its customer becomes nal.
461

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(e) Subject to (i) applicable law stating a time for availability of funds and (ii) any right of the bank to apply the credit to an obligation of the customer, credit given by a bank for an item in a customer's account becomes available for withdrawal as of right: (1) if the bank has received a provisional settlement for the item, when the settlement becomes nal and the bank has had a reasonable time to receive return of the item and the item has not been received within that time; (2) if the bank is both the depositary bank and the payor bank, and the item is nally paid, at the opening of the bank's second banking day following receipt of the item. (f) Subject to applicable law stating a time for availability of funds and any right of a bank to apply a deposit to an obligation of the depositor, a deposit of money becomes available for withdrawal as of right at the opening of the bank's next banking day after receipt of the deposit. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
1. By the denition and use of the term settle (Section 4-104(a)(11)) this Article recognizes that various debits or credits, remittances, settlements or payments given for an item may be either provisional or nal, that settlements sometimes are provisional and sometimes are nal and sometimes are provisional for awhile but later become nal. Subsection (a) denes when settlement for an item constitutes nal payment. Final payment of an item is important for a number of reasons. It is one of several factors determining the relative priorities between items and notices, stop-payment orders, legal process and setos (Section 4-303). It is the end of the line in the collection process and the turn around point commencing the return ow of proceeds. It is the point at which many provisional settlements become nal. See Section 4-215(c). Final payment of an item by the payor bank xes preferential rights under Section 4-216. 2. If an item being collected moves through several states, e.g., is deposited for collection in California, moves through two or three California banks to the Federal Reserve Bank of San Francisco, to the Federal Reserve Bank of Boston, to a payor bank in Maine, the collection process involves the eastward journey of the item from California to Maine and the westward journey of the proceeds from Maine to California. Subsection (a) recognizes that nal payment does not take place, in this hypothetical case, on the journey of the item eastward. It also adopts the view that neither does nal payment occur on the journey westward because what in fact is journeying westward are proceeds of the item. 3. Traditionally and under various decisions payment in cash of an item by a payor bank has been considered nal payment. Subsection (a)(1) recognizes and provides that payment of an item in cash by a payor bank is nal payment. 4. Section 4-104(a)(11) denes settle as meaning to pay in cash, by clearing-house settlement, in a charge or credit or by remittance, or otherwise as agreed. A settlement may be either provisional or nal. Subsection (a)(2) of Section 4-215 provides that an item is nally paid by a payor bank when the bank has settled for the item without having a right to revoke the settlement under statute, clearing-house rule or agreement. Former subsection (1)(b) is modied by subsection (a)(2) to make clear that a payor bank cannot make settlement provisional by unilaterally reserving a right to revoke the settlement. The right must come from a statute (e.g., Section 4-301), clearing-house rule or other agreement. Subsection (a)(2) provides in eect that if the payor bank nally settles for an item this constitutes nal payment of the item. The subsection operates if nothing has occurred and no situation exists making the settlement provisional. If under statute, clearing-house rule or agreement, a right of revocation of the settlement exists, the settlement is provisional. Conversely, if there is an absence of a right to revoke under statute, clearing-house rule or agreement, the settlement is nal and such nal settlement constitutes nal payment of the item. 462

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A primary example of a statutory right on the part of the payor bank to revoke a settlement is the right to revoke conferred by Section 4-301. The underlying theory and reason for deferred posting statutes (Section 4-301) is to require a settlement on the date of receipt of an item but to keep that settlement provisional with the right to revoke prior to the midnight deadline. In any case in which Section 4-301 is applicable, any settlement by the payor bank is provisional solely by virtue of the statute, subsection (a)(2) of Section 4-215 does not operate, and such provisional settlement does not constitute nal payment of the item. With respect to checks, Regulation CC Section 229.36(d) provides that settlement between banks for the forward collection of checks is nal. The relationship of this provision to Article 4 is discussed in the Commentary to that section. A second important example of a right to revoke a settlement is that arising under clearing-house rules. It is very common for clearing-house rules to provide that items exchanged and settled for in a clearing (e.g., before 10:00 a.m. on Monday) may be returned and the settlements revoked up to but not later than 2:00 p.m. on the same day (Monday) or under deferred posting at some hour on the next business day (e.g., 2:00 p.m. Tuesday). Under this type of rule the Monday morning settlement is provisional and being provisional does not constitute a nal payment of the item. An example of an agreement allowing the payor bank to revoke a settlement is a case in which the payor bank is also the depositary bank and has signed a receipt or duplicate deposit ticket or has made an entry in a passbook acknowledging receipt, for credit to the account of A, of a check drawn on it by B. If the receipt, deposit ticket, passbook or other agreement with A is to the eect that any credit so entered is provisional and may be revoked pending the time required by the payor bank to process the item to determine if it is in good form and there are funds to cover it, the agreement keeps the receipt or credit provisional and avoids its being either nal settlement or nal payment. The most important application of subsection (a)(2) is that in which presentment of an item has been made over the counter for immediate payment. In this case Section 4-301(a) does not apply to make the settlement provisional, and nal payment has occurred unless a rule or agreement provides otherwise. 5. Former Section 4-213(1)(c) provided that nal payment occurred when the payor bank completed the process of posting. The term was dened in former Section 4-109. In the present Article, Section 4-109 has been deleted and the process-of-posting test has been abandoned in Section 4-215(a) for determining when nal payment is made. Diculties in determining when the events described in former Section 4-109 take place make the process-of-posting test unsuitable for a system of automated check collection or electronic presentment. 6. The last sentence of former Section 4-213(1) is deleted as an unnecessary source of confusion. Initially the view that payor bank may be accountable for, that is, liable for the amount of, an item that it has already paid seems incongruous. This is particularly true in the light of the language formerly found in Section 4-302 stating that the payor bank can defend against liability for accountability by showing that it has already settled for the item. But, at least with respect to former Section 4-213(1)(c), such a provision was needed because under the process-of-posting test a payor bank may have paid an item without settling for it. Now that Article 4 has abandoned the process-of-posting test, the sentence is no longer needed. If the payor bank has neither paid the item nor returned it within its midnight deadline, the payor bank is accountable under Section 4-302. 7. Subsection (a)(3) covers the situation in which the payor bank makes a provisional settlement for an item, and this settlement becomes nal at a later time by reason of the failure of the payor bank to revoke it in the time and manner permitted by statute, clearinghouse rule or agreement. An example of this type of situation is the clearing-house settlement referred to in Comment 4. In the illustration there given if the time limit for the return of items received in the Monday morning clearing is 2:00 p.m. on Tuesday and the provisional settlement has not been revoked at that time in a manner permitted by the clearing-house rules, the provisional settlement made on Monday morning becomes nal at 2:00 p.m. on Tuesday. Subsection (a)(3) provides specically that in this situation the item is nally paid at 2:00 p.m. Tuesday. If on the other hand a payor bank receives an item in the mail on Monday and makes some provisional settlement for the item on Monday, it has until midnight on Tuesday to return the item or give notice and revoke any settlement under Section 4-301. In this situation subsection (a)(3) of Section 4-215 provides that if the provisional settlement made on Monday is not revoked before midnight on Tuesday as 463

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permitted by Section 4-301, the item is nally paid at midnight on Tuesday. With respect to checks, Regulation CC Section 229.30(c) allows an extension of the midnight deadline under certain circumstances. If a bank does not expeditiously return a check liability may accrue under Regulation CC Section 229.38. For the relationship of that liability to responsibility under this Article, see Regulation CC Sections 229.30 and 229.38. 8. Subsection (b) relates nal settlement to nal payment under Section 4-215. For example, if a payor bank makes provisional settlement for an item by sending a cashier's or teller's check and that settlement fails to become nal under Section 4-213(c), subsection (b) provides that nal payment has not occurred. If the item is not paid, the drawer remains liable, and under Section 4-302(a) the payor bank is accountable unless it has returned the item before its midnight deadline. In this regard, subsection (b) is an exception to subsection (a)(3). Even if the payor bank has not returned an item by its midnight deadline there is still no nal payment if provisional settlement had been made and settlement failed to become nal. However, if presentment of the item was over the counter for immediate payment, nal payment has occurred under Section 4-215(a)(2). Subsection (b) does not apply because the settlement was not provisional. Section 4-301(a). In this case the presenting person, often the payee of the item, has the right to demand cash or the cash equivalent of federal reserve credit. If the presenting person accepts another medium of settlement such as a cashier's or teller's check, the presenting person takes the risk that the payor bank may fail to pay a cashier's check because of insolvency or that the drawee of a teller's check may dishonor it. 9. Subsection (c) states the country-wide usage that when the item is nally paid by the payor bank under subsection (a) this nal payment automatically without further action rms up other provisional settlements made for it. However, the subsection makes clear that this rming up occurs only if the settlement between the presenting and payor banks was made either through a clearing house or by debits and credits in accounts between them. It does not take place if the payor bank remits for the item by sending some form of remittance instrument. Further, the rming up continues only to the extent that provisional debits and credits are entered seriatim in accounts between banks which are successive to the presenting bank. The automatic rming up is broken at any time that any collecting bank remits for the item by sending a remittance draft, because nal payment to the remittee then usually depends upon nal payment of the remittance draft. 10. Subsection (d) states the general rule that if a collecting bank receives settlement for an item which is or becomes nal, the bank is accountable to its customer for the amount of the item. One means of accounting is to remit to its customer the amount it has received on the item. If previously it gave to its customer a provisional credit for the item in an account its receipt of nal settlement for the item rms up this provisional credit and makes it nal. When this credit given by it so becomes nal, in the usual case its agency status terminates and it becomes a debtor to its customer for the amount of the item. See Section 4-201(a). If the accounting is by a remittance instrument or authorization to charge further time will usually be required to complete its accounting (Section 4-213). 11. Subsection (e) states when certain credits given by a bank to its customer become available for withdrawal as of right. Subsection (e)(1) deals with the situation in which a bank has given a credit (usually provisional) for an item to its customer and in turn has received a provisional settlement for the item from an intermediary or payor bank to which it has forwarded the item. In this situation before the provisional credit entered by the collecting bank in the account of its customer becomes available for withdrawal as of right, it is not only necessary that the provisional settlement received by the bank for the item becomes nal but also that the collecting bank has a reasonable time to receive return of the item and the item has not been received within that time. How much time is reasonable for these purposes will of course depend on the distance the item has to travel and the number of banks through which it must pass (having in mind not only travel time by regular lines of transmission but also the successive midnight deadlines of the several banks) and other pertinent facts. Also, if the provisional settlement received is some form of a remittance instrument or authorization to charge, the reasonable time depends on the identity and location of the payor of the remittance instrument, the means for clearing such instrument, and other pertinent facts. With respect to checks Regulation CC Sections 229.10229.13 or similar applicable state law (Section 229.20) control. This is also time for the situation described in Comment 12. 12. Subsection (e)(2) deals with the situation of a bank that is both a depositary bank 464

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and a payor bank. The subsection recognizes that if A and B are both customers of a depositary-payor bank and A deposits B's check on the depositary-payor in A's account on Monday, time must be allowed to permit the check under the deferred posting rules of Section 4-301 to reach the bookkeeper for B's account at some time on Tuesday, and, if there are insucient funds in B's account, to reverse or charge back the provisional credit in A's account. Consequently this provisional credit in A's account does not become available for withdrawal as of right until the opening of business on Wednesday. If it is determined on Tuesday that there are insucient funds in B's account to pay the check, the credit to A's account can be reversed on Tuesday. On the other hand if the item is in fact paid on Tuesday, the rule of subsection (e)(2) is desirable to avoid uncertainty and possible disputes between the bank and its customer as to exactly what hour within the day the credit is available.

4-216. Insolvency and Preference. (a) If an item is in or comes into the possession of a payor or collecting bank that suspends payment and the item has not been nally paid, the item must be returned by the receiver, trustee, or agent in charge of the closed bank to the presenting bank or the closed bank's customer. (b) If a payor bank nally pays an item and suspends payments without making a settlement for the item with its customer or the presenting bank which settlement is or becomes nal, the owner of the item has a preferred claim against the payor bank. (c) If a payor bank gives or a collecting bank gives or receives a provisional settlement for an item and thereafter suspends payments, the suspension does not prevent or interfere with the settlement's becoming nal if the nality occurs automatically upon the lapse of certain time or the happening of certain events. (d) If a collecting bank receives from subsequent parties settlement for an item, which settlement is or becomes nal and the bank suspends payments without making a settlement for the item with its customer which settlement is or becomes nal, the owner of the item has a preferred claim against the collecting bank. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
1. The underlying purpose of the provisions of this section is not to confer upon banks, holders of items or anyone else preferential positions in the event of bank failures over general depositors or any other creditors of the failed banks. The purpose is to x as denitely as possible the cut-o point of time for the completion or cessation of the collection process in the case of items that happen to be in the process at the time a particular bank suspends payments. It must be remembered that in bank collections as a whole and in the handling of items by an individual bank, items go through a whole series of processes. It must also be remembered that at any particular point of time a particular bank (at least one of any size) is functioning as a depositary bank for some items, as an intermediary bank for others, as a presenting bank for still others and as a payor bank for still others, and that when it suspends payments it will have close to its normal load of items working through its various processes. For the convenience of receivers, owners of items, banks, and in fact substantially everyone concerned, it is recognized that at the particular moment of time that a bank suspends payment, a certain portion of the items being handled by it have progressed far enough in the bank collection process that it is preferable to permit them to continue the remaining distance, rather than to send them back and reverse the many entries that have been made or the steps that have been taken with respect to them. Therefore, having this background and these purposes in mind, the section states what items must be turned backward at the moment suspension intervenes and what items have 465

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progressed far enough that the collection process with respect to them continues, with the resulting necessary statement of rights of various parties owing from this prescription of the cut-o time. 2. The rules stated are similar to those stated in the American Bankers Association Bank Collection Code, but with the abandonment of any theory of trust. On the other hand, some law previous to this Act may be relevant. See Note, Uniform Commercial Code: Stopping Payment of an Item Deposited with an Insolvent Depositary Bank, 40 Okla.L.Rev. 689 (1987). Although for practical purposes Federal Deposit Insurance aects materially the result of bank failures on holders of items and banks, no attempt is made to vary the rules of the section by reason of such insurance. 3. It is recognized that in view of Jennings v. United States Fidelity & Guaranty Co., 294 U.S. 216, 55 S.Ct. 394, 79 L.Ed. 869, 99 A.L.R. 1248 (1935), amendment of the National Bank Act would be necessary to have this section apply to national banks. But there is no reason why it should not apply to others. See Section 1-108.

PART 3. COLLECTION OF ITEMS: PAYOR BANKS

4-301. Deferred Posting; Recovery of Payment by Return of Items; Time of Dishonor; Return of Items by Payor Bank. (a) If a payor bank settles for a demand item other than a documentary draft presented otherwise than for immediate payment over the counter before midnight of the banking day of receipt, the payor bank may revoke the settlement and recover the settlement if, before it has made nal payment and before its midnight deadline, it (1) returns the item; (2) returns an image of the item, if the party to which the return is made has entered into an agreement to accept an image as a return of the item and the image is returned in accordance with that agreement; or (3) sends a record providing notice of dishonor or nonpayment if the item is unavailable for return. (b) If a demand item is received by a payor bank for credit on its books, it may return the item or send notice of dishonor and may revoke any credit given or recover the amount thereof withdrawn by its customer, if it acts within the time limit and in the manner specied in subsection (a). (c) Unless previous notice of dishonor has been sent, an item is dishonored at the time when for purposes of dishonor it is returned or notice sent in accordance with this section. (d) An item is returned: (1) as to an item presented through a clearing house, when it is delivered to the presenting or last collecting bank or to the clearing house or is sent or delivered in accordance with clearing-house rules; or (2) in all other cases, when it is sent or delivered to the bank's customer or transferor or pursuant to instructions. As amended in 1990 and 2002.
See Appendix I for material relating to changes made in text in 1990. See Appendix R for material relating to changes made in text in 2002.

Ocial Comment
1. The term deferred posting appears in the caption of Section 4-301. This refers to the practice permitted by statute in most of the states before the UCC under which a payor 466

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bank receives items on one day but does not post the items to the customer's account until the next day. Items dishonored were then returned after the posting on the day after receipt. Under Section 4-301 the concept of deferred posting merely allows a payor bank that has settled for an item on the day of receipt to return a dishonored item on the next day before its midnight deadline, without regard to when the item was actually posted. With respect to checks Regulation CC Section 229.30(c) extends the midnight deadline under the UCC under certain circumstances. See the Commentary to Regulation CC Section 229.38(d) on the relationship between the UCC and Regulation CC on settlement. 2. The function of this section is to provide the circumstances under which a payor bank that has made timely settlement for an item may return the item and revoke the settlement so that it may recover any settlement made. These circumstances are: (1) the item must be a demand item other than a documentary draft; (2) the item must be presented otherwise than for immediate payment over the counter; and (3) the payor bank must return the item (or give notice if the item is unavailable for return) before its midnight deadline and before it has paid the item. With respect to checks, see Regulation CC Section 229.31(f) on notice in lieu of return and Regulation CC Section 229.33 as to the dierent requirement of notice of nonpayment. An instance of when an item may be unavailable for return arises under a collecting bank check retention plan under which presentment is made by a presentment notice and the item is retained by the collecting bank. Section 4-215(a)(2) provides that nal payment occurs if the payor bank has settled for an item without a right to revoke the settlement under statute, clearing-house rule or agreement. In any case in which Section 4-301(a) is applicable, the payor bank has a right to revoke the settlement by statute; therefore, Section 4-215(a)(2) is inoperable, and the settlement is provisional. Hence, if the settlement is not over the counter and the payor bank settles in a manner that does not constitute nal payment, the payor bank can revoke the settlement by returning the item before its midnight deadline. 3. The relationship of Section 4-301(a) to nal settlement and nal payment under Section 4-215 is illustrated by the following case. Depositary Bank sends by mail an item to Payor Bank with instructions to settle by remitting a teller's check drawn on a bank in the city where Depositary Bank is located. Payor Bank sends the teller's check on the day the item was presented. Having made timely settlement, under the deferred posting provisions of Section 4-301(a), Payor Bank may revoke that settlement by returning the item before its midnight deadline. If it fails to return the item before its midnight deadline, it has nally paid the item if the bank on which the teller's check was drawn honors the check. But if the teller's check is dishonored there has been no nal settlement under Section 4-213(c) and no nal payment under Section 4-215(b). Since the Payor Bank has neither paid the item nor made timely return, it is accountable for the item under Section 4-302(a). 4. The time limits for action imposed by subsection (a) are adopted by subsection (b) for cases in which the payor bank is also the depositary bank, but in this case the requirement of a settlement on the day of receipt is omitted. 5. Subsection (c) xes a base point from which to measure the time within which notice of dishonor must be given. See Section 3-503. 6. Subsection (d) leaves banks free to agree upon the manner of returning items but establishes a precise time when an item is returned. For denition of sent as used in paragraphs (1) and (2) see Section 1-201(38). Obviously the subsection assumes that the item has not been nally paid under Section 4-215(a). If it has been, this provision has no operation. 7. The fact that an item has been paid under proposed Section 4-215 does not preclude the payor bank from asserting rights of restitution or revocation under Section 3-418. National Savings and Trust Co. v. Park Corp., 722 F.2d 1303 (6th Cir.1983), cert. denied, 466 U.S. 939 (1984), is the correct interpretation of the present law on this issue. 8. Paragraph (a)(2) is designed to facilitate electronic check-processing by authorizing the payor bank to return an image of the item instead of the actual item. It applies only when the payor bank and the party to which the return has been made have agreed that the payor bank can make such a return and when the return complies with the agreement. The purpose of the paragraph is to prevent third parties (such as the depositor of the check) from contending that the payor bank missed its midnight deadline because it failed to return the actual item in a timely manner. If the payor bank missed its midnight deadline, payment would have become nal under Section 4-215 and the depositary bank would have 467

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lost its right of chargeback under Section 4-214. Of course, the depositary bank might enter into an agreement with its depositor to resolve that problem, but it is not clear that agreements by banks with their customers can resolve all such issues. In any event, paragraph (a)(2) should eliminate the need for such agreements. The provision rests on the premise that it is inappropriate to penalize a payor bank simply because it returns the actual item a few business days after the midnight deadline of the payor bank sent notice before that deadline to a collecting bank that had agreed to accept such notices. Nothing in paragraph (a)(2) authorizes the payor bank to destroy the check.

As amended in 2002.
See Appendix Q for material relating to changes in Ocial Comment in 2002.

4-302. Payor Bank's Responsibility for Late Return of Item. (a) If an item is presented to and received by a payor bank, the bank is accountable for the amount of: (1) a demand item, other than a documentary draft, whether properly payable or not, if the bank, in any case in which it is not also the depositary bank, retains the item beyond midnight of the banking day of receipt without settling for it or, whether or not it is also the depositary bank, does not pay or return the item or send notice of dishonor until after its midnight deadline; or (2) any other properly payable item unless, within the time allowed for acceptance or payment of that item, the bank either accepts or pays the item or returns it and accompanying documents. (b) The liability of a payor bank to pay an item pursuant to subsection (a) is subject to defenses based on breach of a presentment warranty (Section 4-208) or proof that the person seeking enforcement of the liability presented or transferred the item for the purpose of defrauding the payor bank. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
1. Subsection (a)(1) continues the former law distinguishing between cases in which the payor bank is not also the depositary bank and those in which the payor bank is also the depositary bank (on us items). For on us items the payor bank is accountable if it retains the item beyond its midnight deadline without settling for it. If the payor bank is not the depositary bank it is accountable if it retains the item beyond midnight of the banking day of receipt without settling for it. It may avoid accountability either by settling for the item on the day of receipt and returning the item before its midnight deadline under Section 4-301 or by returning the item on the day of receipt. This rule is consistent with the deferred posting practice authorized by Section 4-301 which allows the payor bank to make provisional settlement for an item on the day of receipt and to revoke that settlement by returning the item on the next day. With respect to checks, Regulation CC Section 229.36(d) provides that settlements between banks for forward collection of checks are nal when made. See the Commentary on that provision for its eect on the UCC. 2. If the settlement given by the payor bank does not become nal, there has been no payment under Section 4-215(b), and the payor bank giving the failed settlement is accountable under subsection (a)(1) of Section 4-302. For instance, the payor bank makes provisional settlement by sending a teller's check that is dishonored. In such a case settlement is not nal under Section 4-213(c) and no payment occurs under Section 4-215(b). Payor bank is accountable on the item. The general principle is that unless settlement provides the presenting bank with usable funds, settlement has failed and the payor bank is accountable for the amount of the item. On the other hand, if the payor bank makes a settle468

Art. 4

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ment for the item that becomes nal under Section 4-215, the item has been paid and thus the payor bank is not accountable for the item under this Section. Amendments approved by the Permanent Editorial Board for Uniform Commercial Code November 2, 2002. 3. Subsection (b) is an elaboration of the deleted introductory language of former Section 4-302: In the absence of a valid defense such as breach of a presentment warranty (subsection (1) of Section 4-207), settlement eected or the like . . .. A payor bank can defend an action against it based on accountability by showing that the item contained a forged indorsement or a fraudulent alteration. Subsection (b) drops the ambiguous or the like language and provides that the payor bank may also raise the defense of fraud. Decisions that hold an accountable bank's liability to be absolute are rejected. A payor bank that makes a late return of an item should not be liable to a defrauder operating a check kiting scheme. In Bank of Leumi Trust Co. v. Bally's Park Place Inc., 528 F.Supp. 349 (S.D.N.Y. 1981), and American National Bank v. Foodbasket, 497 P.2d 546 (Wyo.1972), banks that were accountable under Section 4-302 for missing their midnight deadline were successful in defending against parties who initiated collection knowing that the check would not be paid. The settlement eected language is deleted as unnecessary. If a payor bank is accountable for an item it is liable to pay it. If it has made nal payment for an item, it is no longer accountable for the item.

4-303. When Items Subject to Notice, Stop-Payment Order, Legal Process, or Seto; Order in Which Items May Be Charged or Certied. (a) Any knowledge, notice, or stop-payment order received by, legal process served upon, or seto exercised by a payor bank comes too late to terminate, suspend, or modify the bank's right or duty to pay an item or to charge its customer's account for the item if the knowledge, notice, stoppayment order, or legal process is received or served and a reasonable time for the bank to act thereon expires or the seto is exercised after the earliest of the following: (1) the bank accepts or certies the item; (2) the bank pays the item in cash; (3) the bank settles for the item without having a right to revoke the settlement under statute, clearing-house rule, or agreement; (4) the bank becomes accountable for the amount of the item under Section 4-302 dealing with the payor bank's responsibility for late return of items; or (5) with respect to checks, a cuto hour no earlier than one hour after the opening of the next banking day after the banking day on which the bank received the check and no later than the close of that next banking day or, if no cuto hour is xed, the close of the next banking day after the banking day on which the bank received the check. (b) Subject to subsection (a), items may be accepted, paid, certied, or charged to the indicated account of its customer in any order. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
1. While a payor bank is processing an item presented for payment, it may receive knowledge or a legal notice aecting the item, such as knowledge or a notice that the drawer has led a petition in bankruptcy or made an assignment for the benet of creditors; may receive an order of the drawer stopping payment on the item; may have served on it an attachment of the account of the drawer; or the bank itself may exercise a right of seto against the drawer's account. Each of these events aects the account of the drawer and 469

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may eliminate or freeze all or part of whatever balance is available to pay the item. Subsection (a) states the rule for determining the relative priorities between these various legal events and the item. 2. The rule is that if any one of several things has been done to the item or if it has reached any one of several stages in its processing at the time the knowledge, notice, stoppayment order or legal process is received or served and a reasonable time for the bank to act thereon expires or the seto is exercised, the knowledge, notice, stop-payment order, legal process or seto comes too late, the item has priority and a charge to the customer's account may be made and is eective. With respect to the eect of the customer's bankruptcy, the bank's rights are governed by Bankruptcy Code Section 542(c) which codies the result of Bank of Marin v. England, 385 U.S. 99 (1966). Section 4-405 applies to the death or incompetence of the customer. 3. Once a payor bank has accepted or certied an item or has paid the item in cash, the event has occurred that determines priorities between the item and the various legal events usually described as the four legals. Paragraphs (1) and (2) of subsection (a) so provide. If a payor bank settles for an item presented over the counter for immediate payment by a cashier's check or teller's check which the presenting person agrees to accept, paragraph (3) of subsection (a) would control and the event determining priority has occurred. Because presentment was over the counter, Section 4-301(a) does not apply to give the payor bank the statutory right to revoke the settlement. Thus the requirements of paragraph (3) have been met unless a clearing-house rule or agreement of the parties provides otherwise. 4. In the usual case settlement for checks is by entries in bank accounts. Since the process-of-posting test has been abandoned as inappropriate for automated check collection, the determining event for priorities is a given hour on the day after the item is received. (Paragraph (5) of subsection (a).) The hour may be xed by the bank no earlier than one hour after the opening on the next banking day after the bank received the check and no later than the close of that banking day. If an item is received after the payor bank's regular Section 4-108 cuto hour, it is treated as received the next banking day. If a bank receives an item after its regular cuto hour on Monday and an attachment is levied at noon on Tuesday, the attachment is prior to the item if the bank had not before that hour taken the action described in paragraphs (1), (2), and (3) of subsection (a). The Commentary to Regulation CC Section 229.36(d) explains that even though settlement by a paying bank for a check is nal for Regulation CC purposes, the paying bank's right to return the check before its midnight deadline under the UCC is not aected. 5. Another event conferring priority for an item and a charge to the customer's account based upon the item is stated by the language become accountable for the amount of the item under Section 4-302 dealing with the payor bank's responsibility for late return of items. Expiration of the deadline under Section 4-302 with resulting accountability by the payor bank for the amount of the item, establishes priority of the item over notices, stoppayment orders, legal process or seto. 6. In the case of knowledge, notice, stop-payment orders and legal process the eective time for determining whether they were received too late to aect the payment of an item and a charge to the customer's account by reason of such payment, is receipt plus a reasonable time for the bank to act on any of these communications. Usually a relatively short time is required to communicate to the accounting department advice of one of these events but certainly some time is necessary. Compare Sections 1-201(27) and 4-403. In the case of seto the eective time is when the seto is actually made. 7. As between one item and another no priority rule is stated. This is justied because of the impossibility of stating a rule that would be fair in all cases, having in mind the almost innite number of combinations of large and small checks in relation to the available balance on hand in the drawer's account; the possible methods of receipt; and other variables. Further, the drawer has drawn all the checks, the drawer should have funds available to meet all of them and has no basis for urging one should be paid before another; and the holders have no direct right against the payor bank in any event, unless of course, the bank has accepted, certied or nally paid a particular item, or has become liable for it under Section 4-302. Under subsection (b) the bank has the right to pay items for which it is itself liable ahead of those for which it is not. 470

Art. 4

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PART 4. RELATIONSHIP BETWEEN PAYOR BANK AND ITS CUSTOMER

4-401. When Bank May Charge Customer's Account. (a) A bank may charge against the account of a customer an item that is properly payable from the account even though the charge creates an overdraft. An item is properly payable if it is authorized by the customer and is in accordance with any agreement between the customer and bank. (b) A customer is not liable for the amount of an overdraft if the customer neither signed the item nor beneted from the proceeds of the item. (c) A bank may charge against the account of a customer a check that is otherwise properly payable from the account, even though payment was made before the date of the check, unless the customer has given notice to the bank of the postdating describing the check with reasonable certainty. The notice is eective for the period stated in Section 4-403(b) for stoppayment orders, and must be received at such time and in such manner as to aord the bank a reasonable opportunity to act on it before the bank takes any action with respect to the check described in Section 4-303. If a bank charges against the account of a customer a check before the date stated in the notice of postdating, the bank is liable for damages for the loss resulting from its act. The loss may include damages for dishonor of subsequent items under Section 4-402. (d) A bank that in good faith makes payment to a holder may charge the indicated account of its customer according to: (1) the original terms of the altered item; or (2) the terms of the completed item, even though the bank knows the item has been completed unless the bank has notice that the completion was improper. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
1. An item is properly payable from a customer's account if the customer has authorized the payment and the payment does not violate any agreement that may exist between the bank and its customer. For an example of a payment held to violate an agreement with a customer, see Torrance National Bank v. Enesco Federal Credit Union, 285 P.2d 737 (Cal. App.1955). An item drawn for more than the amount of a customer's account may be properly payable. Thus under subsection (a) a bank may charge the customer's account for an item even though payment results in an overdraft. An item containing a forged drawer's signature or forged indorsement is not properly payable. Concern has arisen whether a bank may require a customer to execute a stop-payment order when the customer noties the bank of the loss of an unindorsed or specially indorsed check. Since such a check cannot be properly payable from the customer's account, it is inappropriate for a bank to require stop-payment order in such a case. 2. Subsection (b) adopts the view of case authority holding that if there is more than one customer who can draw on an account, the nonsigning customer is not liable for an overdraft unless that person benets from the proceeds of the item. 3. Subsection (c) is added because the automated check collection system cannot accommodate postdated checks. A check is usually paid upon presentment without respect to the date of the check. Under the former law, if a payor bank paid a postdated check before its stated date, it could not charge the customer's account because the check was not properly payable. Hence, the bank might have been liable for wrongfully dishonoring subsequent 471

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checks of the drawer that would have been paid had the postdated check not been prematurely paid. Under subsection (c) a customer wishing to postdate a check must notify the payor bank of its postdating in time to allow the bank to act on the customer's notice before the bank has to commit itself to pay the check. If the bank fails to act on the customer's timely notice, it may be liable for damages for the resulting loss which may include damages for dishonor of subsequent items. This Act does not regulate fees that banks charge their customers for a notice of postdating or other services covered by the Act, but under principles of law such as unconscionability or good faith and fair dealing, courts have reviewed fees and the bank's exercise of a discretion to set fees. Perdue v. Crocker National Bank, 38 Cal.3d 913 (1985) (unconscionability); Best v. United Bank of Oregon, 739 P.2d 554, 562566 (1987) (good faith and fair dealing). In addition, Section 1-203 provides that every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement. 4. Section 3-407(c) states that a payor bank or drawee which pays a fraudulently altered instrument in good faith and without notice of the alteration may enforce rights with respect to the instrument according to its original terms or, in the case of an incomplete instrument altered by unauthorized completion, according to its terms as completed. Section 4-401(d) follows the rule stated in Section 3-407(c) by applying it to an altered item and allows the bank to enforce rights with respect to the altered item by charging the customer's account.

4-402. Bank's Liability to Customer for Wrongful Dishonor; Time of Determining Insuciency of Account. (a) Except as otherwise provided in this Article, a payor bank wrongfully dishonors an item if it dishonors an item that is properly payable, but a bank may dishonor an item that would create an overdraft unless it has agreed to pay the overdraft. (b) A payor bank is liable to its customer for damages proximately caused by the wrongful dishonor of an item. Liability is limited to actual damages proved and may include damages for an arrest or prosecution of the customer or other consequential damages. Whether any consequential damages are proximately caused by the wrongful dishonor is a question of fact to be determined in each case. (c) A payor bank's determination of the customer's account balance on which a decision to dishonor for insuciency of available funds is based may be made at any time between the time the item is received by the payor bank and the time that the payor bank returns the item or gives notice in lieu of return, and no more than one determination need be made. If, at the election of the payor bank, a subsequent balance determination is made for the purpose of reevaluating the bank's decision to dishonor the item, the account balance at that time is determinative of whether a dishonor for insuciency of available funds is wrongful. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
1. Subsection (a) states positively what has been assumed under the original Article: that if a bank fails to honor a properly payable item it may be liable to its customer for wrongful dishonor. Under subsection (b) the payor bank's wrongful dishonor of an item gives rise to a statutory cause of action. Damages may include consequential damages. Confusion has resulted from the attempts of courts to reconcile the rst and second sentences of former Section 4-402. The second sentence implied that the bank was liable for some form of damages other than those proximately caused by the dishonor if the dishonor was other than by mistake. But nothing in the section described what these noncompensatory damages might be. Some courts have held that in distinguishing between mistaken dishonors and 472

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nonmistaken dishonors, the so-called trader rule has been retained that allowed a merchant or trader to recover substantial damages for wrongful dishonor without proof of damages actually suered. Comment 3 to former Section 4-402 indicated that this was not the intent of the drafters. White & Summers, Uniform Commercial Code, Section 18-4 (1988), states: The negative implication is that when wrongful dishonors occur not through mistake but willfully, the court may impose damages greater than actual damages . . .. Certainly the reference to mistake in the second sentence of 4-402 invites a court to adopt the relevant pre-Code distinction. Subsection (b) by deleting the reference to mistake in the second sentence precludes any inference that Section 4-402 retains the trader rule. Whether a bank is liable for noncompensatory damages, such as punitive damages, must be decided by Section 1-103 and Section 1-106 (by other rule of law). 2. Wrongful dishonor is dierent from failure to exercise ordinary care in handling an item, and the measure of damages is that stated in this section, not that stated in Section 4-103(e). By the same token, if a dishonor comes within this section, the measure of damages of this section applies and not another measure of damages. If the wrongful refusal of the beneciary's bank to make funds available from a funds transfer causes the beneciary's check to be dishonored, no specic guidance is given as to whether recovery is under this section or Article 4A. In each case this issue must be viewed in its factual context, and it was thought unwise to seek to establish certainty at the cost of fairness. 3. The second and third sentences of subsection (b) reject decisions holding that as a matter of law the dishonor of a check is not the proximate cause of the arrest and prosecution of the customer and leave to determination in each case as a question of fact whether the dishonor is or may be the proximate cause. 4. Banks commonly determine whether there are sucient funds in an account to pay an item after the close of banking hours on the day of presentment when they post debit and credit items to the account. The determination is made on the basis of credits available for withdrawal as of right or made available for withdrawal by the bank as an accommodation to its customer. When it is determined that payment of the item would overdraw the account, the item may be returned at any time before the bank's midnight deadline the following day. Before the item is returned new credits that are withdrawable as of right may have been added to the account. Subsection (c) eliminates uncertainty under Article 4 as to whether the failure to make a second determination before the item is returned on the day following presentment is a wrongful dishonor if new credits were added to the account on that day that would have covered the amount of the check. 5. Section 4-402 has been construed to preclude an action for wrongful dishonor by a plainti other than the bank's customer. Loucks v. Albuquerque National Bank, 418 P.2d 191 (N.Mex.1966). Some courts have allowed a plainti other than the customer to sue when the customer is a business entity that is one and the same with the individual or individuals operating it. Murdaugh Volkswagen, Inc. v. First National Bank, 801 F.2d 719 (4th Cir.1986) and Karsh v. American City Bank, 113 Cal.App.3d 419, 169 Cal.Rptr. 851 (1980). However, where the wrongful dishonor impugns the reputation of an operator of the business, the issue is not merely, as the court in Koger v. East First National Bank, 443 So.2d 141 (Fla.App.1983), put it, one of a literal versus a liberal interpretation of Section 4-402. Rather the issue is whether the statutory cause of action in Section 4-402 displaces, in accordance with Section 1-103, any cause of action that existed at common law in a person who is not the customer whose reputation was damaged. See Marcum v. Security Trust and Savings Co., 221 Ala. 419, 129 So. 74 (1930). While Section 4-402 should not be interpreted to displace the latter cause of action, the section itself gives no cause of action to other than a customer, however that denition is construed, and thus confers no cause of action on the holder of a dishonored item. First American National Bank v. Commerce Union Bank, 692 S.W.2d 642 (Tenn.App.1985).

4-403. Customer's Right to Stop Payment; Burden of Proof of Loss. (a) A customer or any person authorized to draw on the account if there is more than one person may stop payment of any item drawn on the customer's account or close the account by an order to the bank describing the item or account with reasonable certainty received at a time and in a
473

 4-403

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Art. 4

manner that aords the bank a reasonable opportunity to act on it before any action by the bank with respect to the item described in Section 4-303. If the signature of more than one person is required to draw on an account, any of these persons may stop payment or close the account. (b) A stop-payment order is eective for six months, but it lapses after 14 calendar days if the original order was oral and was not conrmed in a record within that period. A stop-payment order may be renewed for additional six-month periods by a record given to the bank within a period during which the stop-payment order is eective. (c) The burden of establishing the fact and amount of loss resulting from the payment of an item contrary to a stop-payment order or order to close an account is on the customer. The loss from payment of an item contrary to a stop-payment order may include damages for dishonor of subsequent items under Section 4-402. As amended in 1990 and 2002.
See Appendix I for material relating to changes made in text in 1990. See Appendix R for material relating to changes made in text in 2002.

Ocial Comment
1. The position taken by this section is that stopping payment or closing an account is a service which depositors expect and are entitled to receive from banks notwithstanding its diculty, inconvenience and expense. The inevitable occasional losses through failure to stop or close should be borne by the banks as a cost of the business of banking. 2. Subsection (a) follows the decisions holding that a payee or indorsee has no right to stop payment. This is consistent with the provision governing payment or satisfaction. See Section 3-602. The sole exception to this rule is found in Section 4-405 on payment after notice of death, by which any person claiming an interest in the account can stop payment. 3. Payment is commonly stopped only on checks; but the right to stop payment is not limited to checks, and extends to any item payable by any bank. If the maker of a note payable at a bank is in a position analogous to that of a drawer (Section 4-106) the maker may stop payment of the note. By analogy the rule extends to drawees other than banks. 4. A cashier's check or teller's check purchased by a customer whose account is debited in payment for the check is not a check drawn on the customer's account within the meaning of subsection (a); hence, a customer purchasing a cashier's check or teller's check has no right to stop payment of such a check under subsection (a). If a bank issuing a cashier's check or teller's check refuses to pay the check as an accommodation to its customer or for other reasons, its liability on the check is governed by Section 3-411. There is no right to stop payment after certication of a check or other acceptance of a draft, and this is true no matter who procures the certication. See Sections 3-411 and 4-303. The acceptance is the drawee's own engagement to pay, and it is not required to impair its credit by refusing payment for the convenience of the drawer. 5. Subsection (a) makes clear that if there is more than one person authorized to draw on a customer's account any one of them can stop payment of any check drawn on the account or can order the account closed. Moreover, if there is a customer, such as a corporation, that requires its checks to bear the signatures of more than one person, any of these persons may stop payment on a check. In describing the item, the customer, in the absence of a contrary agreement, must meet the standard of what information allows the bank under the technology then existing to identify the item with reasonable certainty. 6. Under subsection (b), a stop-payment order is eective after the order, whether written or oral, is received by the bank and the bank has a reasonable opportunity to act on it. If the order is written it remains in eect for six months from that time. If the order is oral it lapses after 14 days unless there is written conrmation. If there is written conrmation within the 14-day period, the six-month period dates from the giving of the oral order. A stop-payment order may be renewed any number of times by written notice given during a six-month period while a stop order is in eect. A new stop-payment order may be given after a six-month period expires, but such a notice takes eect from the date given. When a 474

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stop-payment order expires it is as though the order had never been given, and the payor bank may pay the item in good faith under Section 4-404 even though a stop-payment order had once been given. 7. A payment in violation of an eective direction to stop payment is an improper payment, even though it is made by mistake or inadvertence. Any agreement to the contrary is invalid under Section 4-103(a) if in paying the item over the stop-payment order the bank has failed to exercise ordinary care. An agreement to the contrary which is imposed upon a customer as part of a standard form contract would have to be evaluated in the light of the general obligation of good faith. Sections 1-203 and 4-104(c). The drawee is, however, entitled to subrogation to prevent unjust enrichment (Section 4-407); retains common law defenses, e.g., that by conduct in recognizing the payment the customer has ratied the bank's action in paying over a stop-payment order (Section 1-103); and retains common law rights, e.g., to recover money paid under a mistake under Section 3-418. It has sometimes been said that payment cannot be stopped against a holder in due course, but the statement is inaccurate. The payment can be stopped but the drawer remains liable on the instrument to the holder in due course (Sections 3-305, 3-414) and the drawee, if it pays, becomes subrogated to the rights of the holder in due course against the drawer. Section 4-407. The relationship between Sections 4-403 and 4-407 is discussed in the comments to Section 4-407. Any defenses available against a holder in due course remain available to the drawer, but other defenses are cut o to the same extent as if the holder were bringing the action.

4-404. Bank Not Obliged to Pay Check More Than Six Months Old. A bank is under no obligation to a customer having a checking account to pay a check, other than a certied check, which is presented more than six months after its date, but it may charge its customer's account for a payment made thereafter in good faith. Ocial Comment
This section incorporates a type of statute that had been adopted in 26 jurisdictions before the Code. The time limit is set at six months because banking and commercial practice regards a check outstanding for longer than that period as stale, and a bank will normally not pay such a check without consulting the depositor. It is therefore not required to do so, but is given the option to pay because it may be in a position to know, as in the case of dividend checks, that the drawer wants payment made. Certied checks are excluded from the section because they are the primary obligation of the certifying bank (Sections 3-409 and 3-413). The obligation runs directly to the holder of the check. The customer's account was presumably charged when the check was certied.

4-405. Death or Incompetence of Customer. (a) A payor or collecting bank's authority to accept, pay, or collect an item or to account for proceeds of its collection, if otherwise eective, is not rendered ineective by incompetence of a customer of either bank existing at the time the item is issued or its collection is undertaken if the bank does not know of an adjudication of incompetence. Neither death nor incompetence of a customer revokes the authority to accept, pay, collect, or account until the bank knows of the fact of death or of an adjudication of incompetence and has reasonable opportunity to act on it. (b) Even with knowledge, a bank may for 10 days after the date of death pay or certify checks drawn on or before that date unless ordered to stop payment by a person claiming an interest in the account. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.
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Ocial Comment
1. Subsection (a) follows existing decisions holding that a drawee (payor) bank is not liable for the payment of a check before it has notice of the death or incompetence of the drawer. The justice and necessity of the rule are obvious. A check is an order to pay which the bank must obey under penalty of possible liability for dishonor. Further, with the tremendous volume of items handled any rule that required banks to verify the continued life and competency of drawers would be completely unworkable. One or both of these same reasons apply to other phases of the bank collection and payment process and the rule is made wide enough to apply to these other phases. It applies to all kinds of items; to customers who own items as well as customers who draw or make them; to the function of collecting items as well as the function of accepting or paying them; to the carrying out of instructions to account for proceeds even though these may involve transfers to third parties; to depositary and intermediary banks as well as payor banks; and to incompetency existing at the time of the issuance of an item or the commencement of the collection or payment process as well as to incompetency occurring thereafter. Further, the requirement of actual knowledge makes inapplicable the rule of some cases that an adjudication of incompetency is constructive notice to all the world because obviously it is as impossible for banks to keep posted on such adjudications (in the absence of actual knowledge) as it is to keep posted as to death of immediate or remote customers. 2. Subsection (b) provides a limited period after death during which a bank may continue to pay checks (as distinguished from other items) even though it has notice. The purpose of the provision, as of the existing statutes, is to permit holders of checks drawn and issued shortly before death to cash them without the necessity of ling a claim in probate. The justication is that these checks normally are given in immediate payment of an obligation, that there is almost never any reason why they should not be paid, and that ling in probate is a useless formality, burdensome to the holder, the executor, the court and the bank. This section does not prevent an executor or administrator from recovering the payment from the holder of the check. It is not intended to aect the validity of any gift causa mortis or other transfer in contemplation of death, but merely to relieve the bank of liability for the payment. 3. Any surviving relative, creditor or other person who claims an interest in the account may give a direction to the bank not to pay checks, or not to pay a particular check. Such notice has the same eect as a direction to stop payment. The bank has no responsibility to determine the validity of the claim or even whether it is colorable. But obviously anyone who has an interest in the estate, including the person named as executor in a will, even if the will has not yet been admitted to probate, is entitled to claim an interest in the account.

4-406. Customer's Duty to Discover and Report Unauthorized Signature or Alteration. (a) A bank that sends or makes available to a customer a statement of account showing payment of items for the account shall either return or make available to the customer the items paid or provide information in the statement of account sucient to allow the customer reasonably to identify the items paid. The statement of account provides sucient information if the item is described by item number, amount, and date of payment. (b) If the items are not returned to the customer, the person retaining the items shall either retain the items or, if the items are destroyed, maintain the capacity to furnish legible copies of the items until the expiration of seven years after receipt of the items. A customer may request an item from the bank that paid the item, and that bank must provide in a reasonable time either the item or, if the item has been destroyed or is not otherwise obtainable, a legible copy of the item. (c) If a bank sends or makes available a statement of account or items
476

Art. 4

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pursuant to subsection (a), the customer must exercise reasonable promptness in examining the statement or the items to determine whether any payment was not authorized because of an alteration of an item or because a purported signature by or on behalf of the customer was not authorized. If, based on the statement or items provided, the customer should reasonably have discovered the unauthorized payment, the customer must promptly notify the bank of the relevant facts. (d) If the bank proves that the customer failed, with respect to an item, to comply with the duties imposed on the customer by subsection (c), the customer is precluded from asserting against the bank: (1) the customer's unauthorized signature or any alteration on the item, if the bank also proves that it suered a loss by reason of the failure; and (2) the customer's unauthorized signature or alteration by the same wrongdoer on any other item paid in good faith by the bank if the payment was made before the bank received notice from the customer of the unauthorized signature or alteration and after the customer had been aorded a reasonable period of time, not exceeding 30 days, in which to examine the item or statement of account and notify the bank. (e) If subsection (d) applies and the customer proves that the bank failed to exercise ordinary care in paying the item and that the failure substantially contributed to loss, the loss is allocated between the customer precluded and the bank asserting the preclusion according to the extent to which the failure of the customer to comply with subsection (c) and the failure of the bank to exercise ordinary care contributed to the loss. If the customer proves that the bank did not pay the item in good faith, the preclusion under subsection (d) does not apply. (f) Without regard to care or lack of care of either the customer or the bank, a customer who does not within one year after the statement or items are made available to the customer (subsection (a)) discover and report the customer's unauthorized signature on or any alteration on the item is precluded from asserting against the bank the unauthorized signature or alteration. If there is a preclusion under this subsection, the payor bank may not recover for breach of warranty under Section 4-208 with respect to the unauthorized signature or alteration to which the preclusion applies. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Revised Ocial Comment

1. Under subsection (a), if a bank that has paid a check or other item for the account of a customer makes available to the customer a statement of account showing payment of the item, the bank must either return the item to the customer or provide a description of the item sucient to allow the customer to identify it. Under subsection (c), the customer has a duty to exercise reasonable promptness in examining the statement or the returned item to discover any unauthorized signature of the customer or any alteration and to promptly notify the bank if the customer should reasonably have discovered the unauthorized signature or alteration. The duty stated in subsection (c) becomes operative only if the bank sends or makes available a statement of account or items pursuant to subsection (a). A bank is not under a duty to send a statement of account or the paid items to the customer; but, if it does not do 477

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so, the customer does not have any duties under subsection (c). Under subsection (a), a statement of account must provide information sucient to allow the customer reasonably to identify the items paid. If the bank supplies its customer with an image of the paid item, it complies with this standard. But a safe harbor rule is provided. The bank complies with the standard of providing sucient information if the item is described by item number, amount, and date of payment. This means that the customer's duties under subsection (c) are triggered if the bank sends a statement of account complying with the safe harbor rule without returning the paid items. A bank does not have to return the paid items unless it has agreed with the customer to do so. Whether there is such an agreement depends upon the particular circumstances. See Section 1-201(3). If the bank elects to provide the minimum information that is sucient under subsection (a) and, as a consequence, the customer could not reasonably have discovered the unauthorized payment, there is no preclusion under subsection (d). If the customer made a record of the issued checks on the check stub or carbonized copies furnished by the bank in the checkbook, the customer should usually be able to verify the paid items shown on the statement of account and discover any unauthorized or altered checks. But there could be exceptional circumstances. For example, if a check is altered by changing the name of the payee, the customer could not normally detect the fraud unless the customer is given the paid check or the statement of account discloses the name of the payee of the altered check. If the customer could not reasonably have discovered the unauthorized payment under subsection (c) there would not be a preclusion under subsection (d). The safe harbor provided by subsection (a) serves to permit a bank, based on the state of existing technology, to trigger the customer's duties under subsection (c) by providing a statement of account showing payment of items without having to return the paid items, in any case in which the bank has not agreed with the customer to return the paid items. The safe harbor does not, however, preclude a customer under subsection (d) from asserting its unauthorized signature or an alteration against a bank in those circumstances in which under subsection (c) the customer should not reasonably have discovered the unauthorized payment. Whether the customer has failed to comply with its duties under subsection (c) is determined on a case-by-case basis. The provision in subsection (a) that a statement of account contains sucient information if the item is described by item number, amount, and date of payment is based upon the existing state of technology. This information was chosen because it can be obtained by the bank's computer from the check's MICR line without examination of the items involved. The other two items of information that the customer would normally want to knowthe name of the payee and the date of the itemcannot currently be obtained from the MICR line. The safe harbor rule is important in determining the feasibility of payor or collecting bank check retention plans. A customer who keeps a record of checks written, e.g., on the check stubs or carbonized copies of the checks supplied by the bank in the checkbook, will usually have sucient information to identify the items on the basis of item number, amount, and date of payment. But customers who do not utilize these record-keeping methods may not. The policy decision is that accommodating customers who do not keep adequate records is not as desirable as accommodating customers who keep more careful records. This policy results in less cost to the check collection system and thus to all customers of the system. It is expected that technological advances such as image processing may make it possible for banks to give customers more information in the future in a manner that is fully compatible with automation or truncation systems. At that time the Permanent Editorial Board may wish to make recommendations for an amendment revising the safe harbor requirements in the light of those advances. 2. Subsection (d) states the consequences of a failure by the customer to perform its duty under subsection (c) to report an alteration or the customer's unauthorized signature. Subsection (d)(1) applies to the unauthorized payment of the item to which the duty to report under subsection (c) applies. If the bank proves that the customer should reasonably have discovered the unauthorized payment (See Comment 1) and did not notify the bank, the customer is precluded from asserting against the bank the alteration or the customer's unauthorized signature if the bank proves that it suered a loss as a result of the failure of the customer to perform its subsection (c) duty. Subsection (d)(2) applies to cases in which the customer fails to report an unauthorized signature or alteration with respect to an item in breach of the subsection (c) duty (See Comment 1) and the bank subsequently pays other items of the customer with respect to which there is an alteration 478

Art. 4

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or unauthorized signature of the customer and the same wrongdoer is involved. If the payment of the subsequent items occurred after the customer has had a reasonable time (not exceeding 30 days) to report with respect to the rst item and before the bank received notice of the unauthorized signature or alteration of the rst item, the customer is precluded from asserting the alteration or unauthorized signature with respect to the subsequent items. If the customer is precluded in a single or multiple item unauthorized payment situation under subsection (d), but the customer proves that the bank failed to exercise ordinary care in paying the item or items and that the failure substantially contributed to the loss, subsection (e) provides a comparative negligence test for allocating loss between the customer and the bank. Subsection (e) also states that, if the customer proves that the bank did not pay the item in good faith, the preclusion under subsection (d) does not apply. Subsection (d)(2) changes former subsection (2)(b) by adopting a 30-day period in place of a 14-day period. Although the 14-day period may have been sucient when the original version of Article 4 was drafted in the 1950s, given the much greater volume of checks at the time of the revision, a longer period was viewed as more appropriate. The rule of subsection (d)(2) follows pre-Code case law that payment of an additional item or items bearing an unauthorized signature or alteration by the same wrongdoer is a loss suered by the bank traceable to the customer's failure to exercise reasonable care (See Comment 1) in examining the statement and notifying the bank of objections to it. One of the most serious consequences of failure of the customer to comply with the requirements of subsection (c) is the opportunity presented to the wrongdoer to repeat the misdeeds. Conversely, one of the best ways to keep down losses in this type of situation is for the customer to promptly examine the statement and notify the bank of an unauthorized signature or alteration so that the bank will be alerted to stop paying further items. Hence, the rule of subsection (d)(2) is prescribed, and to avoid dispute a specic time limit, 30 days, is designated for cases to which the subsection applies. These considerations are not present if there are no losses resulting from the payment of additional items. In these circumstances, a reasonable period for the customer to comply with its duties under subsection (c) would depend on the circumstances (Section 1-204(2)) and the subsection (d)(2) time limit should not be imported by analogy into subsection (c). 3. Subsection (b) applies if the items are not returned to the customer. Check retention plans may include a simple payor bank check retention plan or the kind of check retention plan that would be authorized by a truncation agreement in which a collecting bank or the payee may retain the items. Even after agreeing to a check retention plan, a customer may need to see one or more checks for litigation or other purposes. The customer's request for the check may always be made to the payor bank. Under subsection (b) retaining banks may destroy items but must maintain the capacity to furnish legible copies for seven years. A legible copy may include an image of an item. This Act does not dene the length of the reasonable period of time for a bank to provide the check or copy of the check. What is reasonable depends on the capacity of the bank and the needs of the customer. This Act does not specify sanctions for failure to retain or furnish the items or legible copies; this is left to other laws regulating banks. See Comment 3 to Section 4-101. Moreover, this Act does not regulate fees that banks charge their customers for furnishing items or copies or other services covered by the Act, but under principles of law such as unconscionability or good faith and fair dealing, courts have reviewed fees and the bank's exercise of a discretion to set fees. Perdue v. Crocker National Bank, 38 Cal.3d 913 (1985) (unconscionability); Best v. United Bank of Oregon, 739 P.2d 554, 562566 (1987) (good faith and fair dealing). In addition, Section 1-203 provides that every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement. 4. Subsection (e) replaces former subsection (3) and poses a modied comparative negligence test for determining liability. See the discussion on this point in the Comments to Sections 3-404, 3-405, and 3-406. The term good faith is dened in Section 1-201(b)(20) as including observance of reasonable commercial standards of fair dealing. The connotation of this standard is fairness and not absence of negligence. The term ordinary care used in subsection (e) is dened in Section 3-103(a)(7), made applicable to Article 4 by Section 4-104(c), to provide that sight examination by a payor bank is not required if its procedure is reasonable and is commonly followed by other comparable banks in the area. The case law is divided on this issue. The denition of ordinary care in Section 3-103 rejects those authorities that hold, in eect, that failure to use sight 479

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examination is negligence as a matter of law. The eect of the denition of ordinary care on Section 4-406 is only to provide that in the small percentage of cases in which a customer's failure to examine its statement or returned items has led to loss under subsection (d) a bank should not have to share that loss solely because it has adopted an automated collection or payment procedure in order to deal with the great volume of items at a lower cost to all customers. 5. Several changes are made in former Section 4-406(5). First, former subsection (5) is deleted and its substance is made applicable only to the one-year notice preclusion in former subsection (4) (subsection (f)). Thus if a drawer has not notied the payor bank of an unauthorized check or material alteration within the one-year period, the payor bank may not choose to recredit the drawer's account and pass the loss to the collecting banks on the theory of breach of warranty. Second, the reference in former subsection (4) to unauthorized indorsements is deleted. Section 4-406 imposes no duties on the drawer to look for unauthorized indorsements. Section 4-111 sets out a statute of limitations allowing a customer a three-year period to seek a credit to an account improperly charged by payment of an item bearing an unauthorized indorsement. Third, subsection (c) is added to Section 4-208 to assure that if a depositary bank is sued for breach of a presentment warranty, it can defend by showing that the drawer is precluded by Section 3-406 or Section 4-406(c) and (d). Revisions approved by the Permanent Editorial Board for the Uniform Commercial Code, March 16, 1991.

As amended in 2002.
See Appendix Q for material relating to changes in Ocial Comment in 2002.

4-407. Payor Bank's Right to Subrogation on Improper Payment. If a payor bank has paid an item over the order of the drawer or maker to stop payment, or after an account has been closed, or otherwise under circumstances giving a basis for objection by the drawer or maker, to prevent unjust enrichment and only to the extent necessary to prevent loss to the bank by reason of its payment of the item, the payor bank is subrogated to the rights (1) of any holder in due course on the item against the drawer or maker; (2) of the payee or any other holder of the item against the drawer or maker either on the item or under the transaction out of which the item arose; and (3) of the drawer or maker against the payee or any other holder of the item with respect to the transaction out of which the item arose. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
1. Section 4-403 states that a stop-payment order or an order to close an account is binding on a bank. If a bank pays an item over such an order it is prima facie liable, but under subsection (c) of Section 4-403 the burden of establishing the fact and amount of loss from such payment is on the customer. A defense frequently interposed by a bank in an action against it for wrongful payment over a stop-payment order is that the drawer or maker suffered no loss because it would have been liable to a holder in due course in any event. On this argument some cases have held that payment cannot be stopped against a holder in due course. Payment can be stopped, but if it is, the drawer or maker is liable and the sound rule is that the bank is subrogated to the rights of the holder in due course. The preamble and paragraph (1) of this section state this rule. 2. Paragraph (2) also subrogates the bank to the rights of the payee or other holder against the drawer or maker either on the item or under the transaction out of which it 480

Art. 4

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arose. It may well be that the payee is not a holder in due course but still has good rights against the drawer. These may be on the check but also may not be as, for example, where the drawer buys goods from the payee and the goods are partially defective so that the payee is not entitled to the full price, but the goods are still worth a portion of the contract price. If the drawer retains the goods it is obligated to pay a part of the agreed price. If the bank has paid the check it should be subrogated to this claim of the payee against the drawer. 3. Paragraph (3) subrogates the bank to the rights of the drawer or maker against the payee or other holder with respect to the transaction out of which the item arose. If, for example, the payee was a fraudulent salesman inducing the drawer to issue a check for defective securities, and the bank pays the check over a stop-payment order but reimburses the drawer for such payment, the bank should have a basis for getting the money back from the fraudulent salesman. 4. The limitations of the preamble prevent the bank itself from getting any double recovery or benets out of its subrogation rights conferred by the section. 5. The spelling out of the armative rights of the bank in this section does not destroy other existing rights (Section 1-103). Among others these may include the defense of a payor bank that by conduct in recognizing the payment a customer has ratied the bank's action in paying in disregard of a stop-payment order or right to recover money paid under a mistake.

PART 5. COLLECTION OF DOCUMENTARY DRAFTS

4-501. Handling of Documentary Drafts; Duty to Send for Presentment and to Notify Customer of Dishonor. A bank that takes a documentary draft for collection shall present or send the draft and accompanying documents for presentment and, upon learning that the draft has not been paid or accepted in due course, shall seasonably notify its customer of the fact even though it may have discounted or bought the draft or extended credit available for withdrawal as of right. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
This section states the duty of a bank handling a documentary draft for a customer. Documentary draft is dened in Section 4-104. The duty stated exists even if the bank has bought the draft. This is because to the customer the draft normally represents an underlying commercial transaction, and if that is not going through as planned the customer should know it promptly. An electronic document of title may be presented through allowing access to the document or delivery of the document. Article 1, Section 1-201 (denition of delivery).

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

4-502. Presentment of On Arrival Drafts. If a draft or the relevant instructions require presentment on arrival, when goods arrive or the like, the collecting bank need not present until in its judgment a reasonable time for arrival of the goods has expired. Refusal to pay or accept because the goods have not arrived is not dishonor; the bank must notify its transferor of the refusal but need not present the draft again until it is instructed to do so or learns of the arrival of the goods.
481

 4-502

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As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
The section is designed to establish a denite rule for on arrival drafts. The term includes not only drafts drawn payable on arrival but also drafts forwarded with instructions to present on arrival. The term refers to the arrival of the relevant goods. Unless a bank has actual knowledge of the arrival of the goods, as for example, when it is the notify party on the bill of lading, the section only requires the exercise of such judgment in estimating time as a bank may be expected to have. Commonly the buyer-drawee will want the goods and will therefore call for the documents and take up the draft when they do arrive.

4-503. Responsibility of Presenting Bank for Documents and Goods; Report of Reasons for Dishonor; Referee in Case of Need. Unless otherwise instructed and except as provided in Article 5, a bank presenting a documentary draft: (1) must deliver the documents to the drawee on acceptance of the draft if it is payable more than three days after presentment; otherwise, only on payment; and (2) upon dishonor, either in the case of presentment for acceptance or presentment for payment, may seek and follow instructions from any referee in case of need designated in the draft or, if the presenting bank does not choose to utilize the referee's services, it must use diligence and good faith to ascertain the reason for dishonor, must notify its transferor of the dishonor and of the results of its eort to ascertain the reasons therefor, and must request instructions. However the presenting bank is under no obligation with respect to goods represented by the documents except to follow any reasonable instructions seasonably received; it has a right to reimbursement for any expense incurred in following instructions and to prepayment of or indemnity for those expenses. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
1. This section states the rules governing, in the absence of instructions, the duty of the presenting bank in case either of honor or of dishonor of a documentary draft. The section should be read in connection with Section 2-514 on when documents are deliverable on acceptance, when on payment. In the case of a dishonor of the draft, the bank, subject to Section 4-504, must return possession or control of the documents to its principal. 2. If the draft is drawn under a letter of credit, Article 5 controls. See Sections 5-109 through 5-114.

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

4-504. Privilege of Presenting Bank to Deal With Goods; Security Interest for Expenses. (a) A presenting bank that, following the dishonor of a documentary draft, has seasonably requested instructions but does not receive them
482

Art. 4

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within a reasonable time may store, sell, or otherwise deal with the goods in any reasonable manner. (b) For its reasonable expenses incurred by action under subsection (a) the presenting bank has a lien upon the goods or their proceeds, which may be foreclosed in the same manner as an unpaid seller's lien. As amended in 1990.
See Appendix I for material relating to changes made in text in 1990.

Ocial Comment
The section gives the presenting bank, after dishonor, a privilege to deal with the goods in any commercially reasonable manner pending instructions from its transferor and, if still unable to communicate with its principal after a reasonable time, a right to realize its expenditures as if foreclosing on an unpaid seller's lien (Section 2-706). The provision includes situations in which storage of goods or other action becomes commercially necessary pending receipt of any requested instructions, even if the requested instructions are later received. The reasonable manner referred to means one reasonable in the light of business factors and the judgment of a business man.

483

ARTICLE 4A. FUNDS TRANSFERS*

PART 1. SUBJECT MATTER AND DEFINITIONS
4A-101. 4A-102. 4A-103. 4A-104. 4A-105. 4A-106. 4A-107. 4A-108. Short Title. Subject Matter. Payment OrderDenitions. Funds TransferDenitions. Other Denitions. Time Payment Order Is Received. Federal Reserve Regulations and Operating Circulars. Exclusion of Consumer Transactions Governed by Federal Law.

PART 2. ISSUE AND ACCEPTANCE OF PAYMENT ORDER

4A-201. 4A-202. 4A-203. 4A-204. Security Procedure. Authorized and Veried Payment Orders. Unenforceability of Certain Veried Payment Orders. Refund of Payment and Duty of Customer to Report With Respect to Unauthorized Payment Order. Erroneous Payment Orders. Transmission of Payment Order Through Funds-Transfer or Other Communication System. Misdescription of Beneciary. Misdescription of Intermediary Bank or Beneciary's Bank. Acceptance of Payment Order. Rejection of Payment Order. Cancellation and Amendment of Payment Order. Liability and Duty of Receiving Bank Regarding Unaccepted Payment Order.

4A-205. 4A-206. 4A-207. 4A-208. 4A-209. 4A-210. 4A-211. 4A-212.

PART 3. EXECUTION OF SENDER'S PAYMENT ORDER BY RECEIVING BANK

4A-301. 4A-302. 4A-303. 4A-304. 4A-305. Execution and Execution Date. Obligations of Receiving Bank in Execution of Payment Order. Erroneous Execution of Payment Order. Duty of Sender to Report Erroneously Executed Payment Order. Liability for Late or Improper Execution or Failure to Execute Payment Order.

PART 4. PAYMENT
*This article was approved by the National Conference of Commissioners on 484 Uniform State Laws and the American Law Institute in 1989.

Art. 4A 4A-401. 4A-402. 4A-403. 4A-404.

Funds Transfers

Payment Date. Obligation of Sender to Pay Receiving Bank. Payment by Sender to Receiving Bank. Obligation of Beneciary's Bank to Pay and Give Notice to Beneciary. 4A-405. Payment by Beneciary's Bank to Beneciary. 4A-406. Payment by Originator to Beneciary; Discharge of Underlying Obligation.

PART 5. MISCELLANEOUS PROVISIONS

4A-501. Variation by Agreement and Eect of Funds-Transfer System Rule. 4A-502. Creditor Process Served on Receiving Bank; Seto by Beneciary's Bank. 4A-503. Injunction or Restraining Order With Respect to Funds Transfer. 4A-504. Order in Which Items and Payment Orders May Be Charged to Account; Order of Withdrawals From Account. 4A-505. Preclusion of Objection to Debit of Customer's Account. 4A-506. Rate of Interest. 4A-507. Choice of Law.

485

NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS

REPORTER Robert L. Jordan, Los Angeles, California William D. Warren, Los Angeles, California DRAFTING COMMITTEE CO-CHAIRMEN Carlyle C. Ring, Jr., Alexandria, Virginia Robert Haydock, Jr., Boston, Massachusetts MEMBERS Boris Auerbach, Cincinnati, Ohio Richard F. Dole, Jr., Houston, Texas William E. Hogan, New York, New York Charles W. Joiner, Ann Arbor, Michigan Frederick H. Miller, Norman, Oklahoma Donald J. Rapson, Livingston, New Jersey, The American Law Institute Representative Michael P. Sullivan, Minneapolis, Minnesota, President, (Member Ex Ocio) Neal Ossen, Hartford, Connecticut, Chairman, Division C, (Member Ex Ocio) REVIEW COMMITTEE CHAIRMAN Frank F. Jestrab, Chevy Chase, Maryland MEMBERS Rupert R. Bullivant, Portland, Oregon Michael Franck, Lansing, Michigan CONSULTANT Fairfax Leary, Jr., Villanova, Pennsylvania ADVISORS Thomas C. Baxter, Jr., Federal Reserve Bank of New York Roland E. Brandel, American Bar Association Leon P. Ciferni, National Westminster Bank, U.S.A. William B. Davenport, American Bar Association, Section of Business Law, Ad Hoc Committee on Payment Systems Carl Felsenfeld, Association of the Bar of the City of New York J. Kevin French, Exxon Company, U.S.A. Thomas J. Greco, American Bankers Association Arthur L. Herold, National Corporate Cash Management Association John R. H. Kimball, Federal Reserve Bank of Boston John F. Lee, New York Clearing House Association W. Robert Moore, American Bankers Association Ernest T. Patrikis, Federal Reserve Bank of New York Richard B. Wagner, General Motors Corporation ADDITIONAL PARTICIPANTS Dean Bitner, Sears, Roebuck & Company Henry N. Dyhouse, U.S. Central Credit Union James Foorman, First Chicago Corporation Richard M. Gottlieb, Manufacturers Hanover Trust Company 486

Art. 4A

Funds Transfers

Shirley Holder, Atlantic Richeld Company Paul E. Homrighausen, Bankers Clearing House Association and National Automated Clearing House Association Gail M. Inaba, Morgan Guaranty Trust Company of New York Oliver I. Ireland, Board of Governors of Federal Reserve System Richard P. Kessler, Jr., Credit Union National Association James W. Kopp, Shell Oil Company Robert M. MacAllister, Chase Manhattan Bank NA Thomas E. Montgomery, California Bankers Association Norman R. Nelson, New York Clearing House Association Samuel Newman, Manufacturers Hanover Trust Company Nena Nodge, National Corporate Cash Management Association Robert J. Pisapia, Occidental Petroleum Corporation Deborah S. Prutzman, Arnold & Porter Robert M. Rosenblith, Manufacturers Hanover Trust Company Paul S. Turner, Occidental Petroleum Corporation Irma Villarreal, Aon Corporation Suzanne Weakley, Atlantic Richeld Company PREFATORY NOTE The National Conference of Commissioners on Uniform State laws and The American Law Institute have approved a new Article 4A to the Uniform Commercial Code. Comments that follow each of the sections of the statute are intended as ocial comments. They explain in detail the purpose and meaning of the various sections and the policy considerations on which they are based. Description of transaction covered by Article 4A. There are a number of mechanisms for making payments through the banking system. Most of these mechanisms are covered in whole or part by state or federal statutes. In terms of number of transactions, payments made by check or credit card are the most common payment methods. Payment by check is covered by Articles 3 and 4 of the UCC and some aspects of payment by credit card are covered by federal law. In recent years electronic funds transfers have been increasingly common in consumer transactions. For example, in some cases a retail customer can pay for purchases by use of an access or debit card inserted in a terminal at the retail store that allows the bank account of the customer to be instantly debited. Some aspects of these point-of-sale transactions and other consumer payments that are eected electronically are covered by a federal statute, the Electronic Fund Transfer Act (EFTA). If any part of a funds transfer is covered by EFTA, the entire funds transfer is excluded from Article 4A. Another type of payment, commonly referred to as a wholesale wire transfer, is the primary focus of Article 4A. Payments that are covered by Article 4A are overwhelmingly between business or nancial institutions. The dollar volume of payments made by wire transfer far exceeds the dollar volume of payments made by other means. The volume of payments by wire transfer over the two principal wire payment systemsthe Federal Reserve wire transfer network (Fedwire) and the New York Clearing House Interbank Payments Systems (CHIPS)exceeds one trillion dollars per day. Most payments carried out by use of automated clearing houses are consumer payments covered by EFTA and therefore not covered by Article 4A. There is, however, a signicant volume of nonconsumer ACH payments that closely resemble wholesale wire transfers. These payments are also covered by Article 4A. There is some resemblance between payments made by wire transfer and payments made by other means such as paper-based checks and credit cards or electronically-based consumer payments, but there are also many dierences. Article 4A excludes from its coverage these other payment mechanisms. Article 4A follows a policy of treating the transaction that it coversa funds transferas a unique method of payment that is governed by unique principles of law that address the operational and policy issues presented by this kind of payment. The funds transfer that is covered by Article 4A is not a complex transaction and can be 487

Uniform Commercial Code

Art. 4A

illustrated by the following example which is used throughout the Prefatory Note as a basis for discussion. X, a debtor, wants to pay an obligation owed to Y. Instead of delivering to Y a negotiable instrument such as a check or some other writing such as a credit card slip that enables Y to obtain payment from a bank, X transmits an instruction to X's bank to credit a sum of money to the bank account of Y. In most cases X's bank and Y's bank are dierent banks. X's bank may carry out X's instruction by instructing Y's bank to credit Y's account in the amount that X requested. The instruction that X issues to its bank is a payment order. X is the sender of the payment order and X's bank is the receiving bank with respect to X's order. Y is the beneciary of X's order. When X's bank issues an instruction to Y's bank to carry out X's payment order, X's bank executes X's order. The instruction of X's bank to Y's bank is also a payment order. With respect to that order, X's bank is the sender, Y's bank is the receiving bank, and Y is the beneciary. The entire series of transactions by which X pays Y is knows as the funds transfer. With respect to the funds transfer, X is the originator, X's bank is the originator's bank, Y is the beneciary and Y's bank is the beneciary's bank. In more complex transactions there are one or more additional banks known as intermediary banks between X's bank and Y's bank. In the funds transfer the instruction contained in the payment order of X to its bank is carried out by a series of payment orders by each bank in the transmission chain to the next bank in the chain until Y's bank receives a payment order to make the credit to Y's account. In most cases, the payment order of each bank to the next bank in the chain is transmitted electronically, and often the payment order of X to its bank is also transmitted electronically, but the means of transmission does not have any legal signicance. A payment order may be transmitted by any means, and in some cases the payment order is transmitted by a slow means such as rst class mail. To reect this fact, the broader term funds transfer rather than the narrower term wire transfer is used in Article 4A to describe the overall payment transaction. Funds transfers are divided into two categories determined by whether the instruction to pay is given by the person making payment or the person receiving payment. If the instruction is given by the person making the payment, the transfer is commonly referred to as a credit transfer. If the instruction is given by the person receiving payment, the transfer is commonly referred to as a debit transfer. Article 4A governs credit transfers and excludes debit transfers. Why is Article 4A needed? There is no comprehensive body of law that denes the rights and obligations that arise from wire transfers. Some aspects of wire transfers are governed by rules of the principal transfer systems. Transfers made by Fedwire are governed by Federal Reserve Regulation J and transfers over CHIPS are governed by the CHIPS rules. Transfers made by means of automated clearing houses are governed by uniform rules adopted by various associations of banks in various parts of the nation or by Federal Reserve rules or operating circulars. But the various funds transfer system rules apply to only limited aspects of wire transfer transactions. The resolution of the many issues that are not covered by funds transfer system rules depends on contracts of the parties, to the extent that they exist, or principles of law applicable to other payment mechanisms that might be applied by analogy. The result is a great deal of uncertainty. There is no consensus about the juridical nature of a wire transfer and consequently of the rights and obligations that are created. Article 4A is intended to provide the comprehensive body of law that we do not have today. Characteristics of a funds transfer. There are a number of characteristics of funds transfers covered by Article 4A that have inuenced the drafting of the statute. The typical funds transfer involves a large amount of money. Multimillion dollar transactions are commonplace. The originator of the transfer and the beneciary are typically sophisticated business or nancial organizations. High speed is another predominant characteristic. Most funds transfers are completed on the same day, even in complex transactions in which there are several intermediary banks in the transmission chain. A funds transfer is a highly ecient substitute for payments made by the delivery of paper instruments. Another characteristic is extremely low cost. A transfer that involves many millions of dollars can be made for a price of a few dollars. Price does not normally vary very much or at all with the amount of the transfer. This system of pricing may not be feasible if the bank is exposed to very large liabilities in connection with the transaction. The pricing system assumes that the price reects primarily 488

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the cost of the mechanical operation performed by the bank, but in fact, a bank may have more or less potential liability with respect to a funds transfer depending upon the amount of the transfer. Risk of loss to banks carrying out a funds transfer may arise from a variety of causes. In some funds transfers, there may be extensions of very large amounts of credit for short periods of time by the banks that carry out a funds transfer. If a payment order is issued to the beneciary's bank, it is normal for the bank to release funds to the beneciary immediately. Sometimes, payment to the beneciary's bank by the bank that issued the order to the beneciary's bank is delayed until the end of the day. If that payment is not received because of the insolvency of the bank that is obliged to pay, the beneciary's bank may suer a loss. There is also risk of loss if a bank fails to execute the payment order of a customer, or if the order is executed late. There also may be an error in the payment order issued by a bank that is executing the payment order of its customer. For example, the error might relate to the amount to be paid or to the identity of the person to be paid. Because the dollar amounts involved in funds transfers are so large, the risk of loss if something goes wrong in a transaction may also be very large. A major policy issue in the drafting of Article 4A is that of determining how risk of loss is to be allocated given the price structure in the industry. Concept of acceptance and eect of acceptance by the beneciary's bank. Rights and obligations under Article 4A arise as the result of acceptance of a payment order by the bank to which the order is addressed. Section 4A-209. The eect of acceptance varies depending upon whether the payment order is issued to the beneciary's bank or to a bank other than the beneciary's bank. Acceptance by the beneciary's bank is particularly important because it denes when the beneciary's bank becomes obligated to the beneciary to pay the amount of the payment order. Although Article 4A follows convention in using the term funds transfer to identify the payment from X to Y that is described above, no money or property right of X is actually transferred to Y. X pays Y by causing Y's bank to become indebted to Y in the amount of the payment. This debt arises when Y's bank accepts the payment order that X's bank issued to Y's bank to execute X's order. If the funds transfer was carried out by use of one or more intermediary banks between X's bank and Y's bank, Y's bank becomes indebted to Y when Y's bank accepts the payment order issued to it by an intermediary bank. The funds transfer is completed when this debt is incurred. Acceptance, the event that determines when the debt of Y's bank to Y arises, occurs (i) when Y's bank pays Y or noties Y of receipt of the payment order, or (ii) when Y's bank receives payment from the bank that issued a payment order to Y's bank. The only obligation of the beneciary's bank that results from acceptance of a payment order is to pay the amount of the order to the beneciary. No obligation is owed to either the sender of the payment order accepted by the beneciary's bank or to the originator of the funds transfer. The obligation created by acceptance by the beneciary's bank is for the benet of the beneciary. The purpose of the sender's payment order is to eect payment by the originator to the beneciary and that purpose is achieved when the beneciary's bank accepts the payment order. Section 4A-405 states rules for determining when the obligation of the beneciary's bank to the beneciary has been paid. Acceptance by a bank other than the beneciary's bank. In the funds transfer described above, what is the obligation of X's bank when it receives X's payment order? Funds transfers by a bank on behalf of its customer are made pursuant to an agreement or arrangement that may or may not be reduced to a formal document signed by the parties. It is probably true that in most cases there is either no express agreement or the agreement addresses only some aspects of the transaction. Substantial risk is involved in funds transfers and a bank may not be willing to give this service to all customers, and may not be willing to oer it to any customer unless certain safeguards against loss such as security procedures are in eect. Funds transfers often involve the giving of credit by the receiving bank to the customer, and that also may involve an agreement. These considerations are reected in Article 4A by the principle that, in the absence of a contrary agreement, a receiving bank does not incur liability with respect to a payment order until it accepts it. If X and X's bank in the hypothetical case had an agreement that obliged the bank to act on X's payment orders and the bank failed to comply with the agreement, the bank can be held liable for breach of the agreement. But apart from any obligation arising by agreement, the bank does not incur any liability with respect to X's payment order until the bank accepts the order. X's payment order is treated by Article 4A 489

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as a request by X to the bank to take action that will cause X's payment order to be carried out. That request can be accepted by X's bank by executing X's payment order. Execution occurs when X's bank sends a payment order to Y's bank intended by X's bank to carry out the payment order of X. X's bank could also execute X's payment order by issuing a payment order to an intermediary bank instructing the intermediary bank to instruct Y's bank to make the credit to Y's account. In that case execution and acceptance of X's order occur when the payment order of X's bank is sent to the intermediary bank. When X's bank executes X's payment order the bank is entitled to receive payment from X and may debit an authorized account of X. If X's bank does not execute X's order and the amount of the order is covered by a withdrawable credit balance in X's authorized account, the bank must pay X interest on the money represented by X's order unless X is given prompt notice of rejection of the order. Section 4A-210(b). Bank error in funds transfers. If a bank, other than the beneciary's bank, accepts a payment order, the obligations and liabilities are owed to the originator of the funds transfer. Assume in the example stated above, that X's bank executes X's payment order by issuing a payment order to an intermediary bank that executes the order of X's bank by issuing a payment order to Y's bank. The obligations of X's bank with respect to execution are owed to X. The obligations of the intermediary bank with respect to execution are also owed to X. Section 4A-302 states standards with respect to the time and manner of execution of payment orders. Section 4A-305 states the measure of damages for improper execution. It also states that a receiving bank is liable for damages if it fails to execute a payment order that it was obliged by express agreement to execute. In each case consequential damages are not recoverable unless an express agreement of the receiving bank provides for them. The policy basis for this limitation is discussed in Comment 2 to Section 4A-305. Error in the consummation of a funds transfer is not uncommon. There may be a discrepancy in the amount that the originator orders to be paid to the beneciary and the amount that the beneciary's bank is ordered to pay. For example, if the originator's payment order instructs payment of $100,000 and the payment order of the originator's bank instructs payment of $1,000,000, the originator's bank is entitled to receive only $100,000 from the originator and has the burden of recovering the additional $900,000 paid to the beneciary by mistake. In some cases the originator's bank or an intermediary bank instructs payment to a beneciary other than the beneciary stated in the originator's payment order. If the wrong beneciary is paid the bank that issued the erroneous payment order is not entitled to receive payment of the payment order that it executed and has the burden of recovering the mistaken payment. The originator is not obliged to pay its payment order. Section 4A-303 and Section 4A-207 state rules for determining the rights and obligations of the various parties to the funds transfer in these cases and in other typical cases in which error is made. Pursuant to Section 4A-402(c) the originator is excused from the obligation to pay the originator's bank if the funds transfer is not completed, i.e. payment by the originator to the beneciary is not made. Payment by the originator to the beneciary occurs when the beneciary's bank accepts a payment order for the benet of the beneciary of the originator's payment order. Section 4A-406. If for any reason that acceptance does not occur, the originator is not required to pay the payment order that it issued or, if it already paid, is entitled to refund of the payment with interest. This money-back guarantee is an important protection of the originator of a funds transfer. The same rule applies to any other sender in the funds transfer. Each sender's obligation to pay is excused if the beneciary's bank does not accept a payment order for the benet of the beneciary of that sender's order. There is an important exception to this rule. It is common practice for the originator of a funds transfer to designate the intermediary bank or banks through which the funds transfer is to be routed. The originator's bank is required by Section 4A-302 to follow the instruction of the originator with respect to intermediary banks. If the originator's bank sends a payment order to the intermediary bank designated in the originator's order and the intermediary bank causes the funds transfer to miscarry by failing to execute the payment order or by instructing payment to the wrong beneciary, the originator's bank is not required to pay its payment order and if it has already paid it is entitled to recover payment from the intermediary bank. This remedy is normally adequate, but if the originator's bank already paid its order and the intermediary bank has 490

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suspended payments or is not permitted by law to refund payment, the originator's bank will suer a loss. Since the originator required the originator's bank to use the failed intermediary bank, Section 4A-402(e) provides that in this case the originator is obliged to pay its payment order and has a claim against the intermediary bank for the amount of the order. The same principle applies to any other sender that designates a subsequent intermediary bank. Unauthorized payment orders. An important issue addressed in Section 4A-202 and Section 4A-203 is how the risk of loss from unauthorized payment orders is to be allocated. In a large percentage of cases, the payment order of the originator of the funds transfer is transmitted electronically to the originator's bank. In these cases it may not be possible for the bank to know whether the electronic message has been authorized by its customer. To ensure that no unauthorized person is transmitting messages to the bank, the normal practice is to establish security procedures that usually involve the use of codes or identifying numbers or words. If the bank accepts a payment order that purports to be that of its customer after verifying its authenticity by complying with a security procedure agreed to by the customer and the bank, the customer is bound to pay the order even if it was not authorized. But there is an important limitation on this rule. The bank is entitled to payment in the case of an unauthorized order only if the court nds that the security procedure was a commercially reasonable method of providing security against unauthorized payment orders. The customer can also avoid liability if it can prove that the unauthorized order was not initiated by an employee or other agent of the customer having access to condential security information or by a person who obtained that information from a source controlled by the customer. The policy issues are discussed in the comments following Section 4A-203. If the bank accepts an unauthorized payment order without verifying it in compliance with a security procedure, the loss falls on the bank. Security procedures are also important in cases of error in the transmission of payment orders. There may be an error by the sender in the amount of the order, or a sender may transmit a payment order and then erroneously transmit a duplicate of the order. Normally, the sender is bound by the payment order even if it is issued by mistake. But in some cases an error of this kind can be detected by a security procedure. Although the receiving bank is not obliged to provide a security procedure for the detection of error, if such a procedure is agreed to by the bank Section 4A-205 provides that if the error is not detected because the receiving bank does not comply with the procedure, any resulting loss is borne by the bank failing to comply with the security procedure. Insolvency losses. Some payment orders do not involve the granting of credit to the sender by the receiving bank. In those cases, the receiving bank accepts the sender's order at the same time the bank receives payment of the order. This is true of a transfer of funds by Fedwire or of cases in which the receiving bank can debit a funded account of the sender. But in some cases the granting of credit is the norm. This is true of a payment order over CHIPS. In a CHIPS transaction the receiving bank usually will accept the order before receiving payment from the sending bank. Payment is delayed until the end of the day when settlement is made through the Federal Reserve System. If the receiving bank is an intermediary bank, it will accept by issuing a payment order to another bank and the intermediary bank is obliged to pay that payment order. If the receiving bank is the beneciary's bank, the bank usually will accept by releasing funds to the beneciary before the bank has received payment. If a sending bank suspends payments before settling its liabilities at the end of the day, the nancial stability of banks that are net creditors of the insolvent bank may also be put into jeopardy, because the dollar volume of funds transfers between the banks may be extremely large. With respect to two banks that are dealing with each other in a series of transactions in which each bank is sometimes a receiving bank and sometimes a sender, the risk of insolvency can be managed if amounts payable as a sender and amounts receivable as a receiving bank are roughly equal. But if these amounts are signicantly out of balance, a net creditor bank may have a very signicant credit risk during the day before settlement occurs. The Federal Reserve System and the banking community are greatly concerned with this risk, and various measures have been instituted to reduce this credit exposure. Article 4A also addresses this problem. A receiving bank can always avoid this risk by delaying acceptance of a payment order until after the bank has received payment. 491

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For example, if the beneciary's bank credits the beneciary's account it can avoid acceptance by not notifying the beneciary of the receipt of the order or by notifying the beneciary that the credit may not be withdrawn until the beneciary's bank receives payment. But if the beneciary's bank releases funds to the beneciary before receiving settlement, the result in a funds transfer other than a transfer by means of an automated clearing house or similar provisional settlement system is that the beneciary's bank may not recover the funds if it fails to receive settlement. This rule encourages the banking system to impose credit limitations on banks that issue payment orders. These limitations are already in eect. CHIPS has also proposed a loss-sharing plan to be adopted for implementation in the second half of 1990 under which CHIPS participants will be required to provide funds necessary to complete settlement of the obligations of one or more participants that are unable to meet settlement obligations. Under this plan, it will be a virtual certainty that there will be settlement on CHIPS in the event of failure by a single bank. Section 4A-403(b) and (c) are also addressed to reducing risks of insolvency. Under these provisions the amount owed by a failed bank with respect to payment orders it issued is the net amount owing after setting o amounts owed to the failed bank with respect to payment orders it received. This rule allows credit exposure to be managed by limitations on the net debit position of a bank. International transfers. The major international legal document dealing with the subject of electronic funds transfers is the Model Law on International Credit Transfers adopted in 1992 by the United Nations Commission on International Trade Law. It covers basically the same type of transaction as does Article 4A, although it requires the funds transferred to have an international component. The Model Law and Article 4A basically live together in harmony, but to the extent there are dierences they must be recognized and, to the extent possible, avoided or adjusted by agreement. See PEB Commentary No. 13, dated February 16, 1994 [Appendix A, infra].

PART 1. SUBJECT MATTER AND DEFINITIONS

4A-101. Short Title. This Article may be cited as Uniform Commercial CodeFunds Transfers. 4A-102. Subject Matter. Except as otherwise provided in Section 4A-108, this Article applies to funds transfers dened in Section 4A-104. Ocial Comment
Article 4A governs a specialized method of payment referred to in the Article as a funds transfer but also commonly referred to in the commercial community as a wholesale wire transfer. A funds transfer is made by means of one or more payment orders. The scope of Article 4A is determined by the denitions of payment order and funds transfer found in Section 4A-103 and Section 4A-104. The funds transfer governed by Article 4A is in large part a product of recent and developing technological changes. Before this Article was drafted there was no comprehensive body of lawstatutory or judicialthat dened the juridical nature of a funds transfer or the rights and obligations owing from payment orders. Judicial authority with respect to funds transfers is sparse, undeveloped and not uniform. Judges have had to resolve disputes by referring to general principles of common law or equity, or they have sought guidance in statutes such as Article 4 which are applicable to other payment methods. But attempts to dene rights and obligations in funds transfers by general principles or by analogy to rights and obligations in negotiable instrument law or the law of check collection have not been satisfactory. In the drafting of Article 4A, a deliberate decision was made to write on a clean slate and to treat a funds transfer as a unique method of payment to be governed by unique rules that address the particular issues raised by this method of payment. A deliberate decision 492

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was also made to use precise and detailed rules to assign responsibility, dene behavioral norms, allocate risks and establish limits on liability, rather than to rely on broadly stated, exible principles. In the drafting of these rules, a critical consideration was that the various parties to funds transfers need to be able to predict risk with certainty, to insure against risk, to adjust operational and security procedures, and to price funds transfer services appropriately. This consideration is particularly important given the very large amounts of money that are involved in funds transfers. Funds transfers involve competing intereststhose of the banks that provide funds transfer services and the commercial and nancial organizations that use the services, as well as the public interest. These competing interests were represented in the drafting process and they were thoroughly considered. The rules that emerged represent a careful and delicate balancing of those interests and are intended to be the exclusive means of determining the rights, duties and liabilities of the aected parties in any situation covered by particular provisions of the Article. Consequently, resort to principles of law or equity outside of Article 4A is not appropriate to create rights, duties and liabilities inconsistent with those stated in this Article.

4A-103. Payment OrderDenitions. (a) In this Article: (1) Payment order means an instruction of a sender to a receiving bank, transmitted orally, electronically, or in writing, to pay, or to cause another bank to pay, a xed or determinable amount of money to a beneciary if: (i) the instruction does not state a condition to payment to the beneciary other than time of payment, (ii) the receiving bank is to be reimbursed by debiting an account of, or otherwise receiving payment from, the sender, and (iii) the instruction is transmitted by the sender directly to the receiving bank or to an agent, funds-transfer system, or communication system for transmittal to the receiving bank. (2) Beneciary means the person to be paid by the beneciary's bank. (3) Beneciary's bank means the bank identied in a payment order in which an account of the beneciary is to be credited pursuant to the order or which otherwise is to make payment to the beneciary if the order does not provide for payment to an account. (4) Receiving bank means the bank to which the sender's instruction is addressed. (5) Sender means the person giving the instruction to the receiving bank. (b) If an instruction complying with subsection (a)(1) is to make more than one payment to a beneciary, the instruction is a separate payment order with respect to each payment. (c) A payment order is issued when it is sent to the receiving bank. Ocial Comment
This section is discussed in the Comment following Section 4A-104.

4A-104. Funds TransferDenitions. In this Article: (a) Funds transfer means the series of transactions, beginning with the originator's payment order, made for the purpose of making payment to the beneciary of the order. The term includes any payment or493

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der issued by the originator's bank or an intermediary bank intended to carry out the originator's payment order. A funds transfer is completed by acceptance by the beneciary's bank of a payment order for the benet of the beneciary of the originator's payment order. (b) Intermediary bank means a receiving bank other than the originator's bank or the beneciary's bank. (c) Originator means the sender of the rst payment order in a funds transfer. (d) Originator's bank means (i) the receiving bank to which the payment order of the originator is issued if the originator is not a bank, or (ii) the originator if the originator is a bank. Ocial Comment
1. Article 4A governs a method of payment in which the person making payment (the originator) directly transmits an instruction to a bank either to make payment to the person receiving payment (the beneciary) or to instruct some other bank to make payment to the beneciary. The payment from the originator to the beneciary occurs when the bank that is to pay the beneciary becomes obligated to pay the beneciary. There are two basic denitions: Payment order stated in Section 4A-103 and Funds transfer stated in Section 4A-104. These denitions, other related denitions, and the scope of Article 4A can best be understood in the context of specic fact situations. Consider the following cases: Case #1. X, which has an account in Bank A, instructs that bank to pay $1,000,000 to Y's account in Bank A. Bank A carries out X's instruction by making a credit of $1,000,000 to Y's account and notifying Y that the credit is available for immediate withdrawal. The instruction by X to Bank A is a payment order which was issued when it was sent to Bank A. Section 4A-103(a)(1) and (c). X is the sender of the payment order and Bank A is the receiving bank. Section 4A-103(a)(5) and (a)(4). Y is the beneciary of the payment order and Bank A is the beneciary's bank. Section 4A-103(a)(2) and (a)(3). When Bank A notied Y of receipt of the payment order, Bank A accepted the payment order. Section 4A-209(b)(1). When Bank A accepted the order it incurred an obligation to Y to pay the amount of the order. Section 4A-404(a). When Bank A accepted X's order, X incurred an obligation to pay Bank A the amount of the order. Section 4A-402(b). Payment from X to Bank A would normally be made by a debit to X's account in Bank A. Section 4A-403(a)(3). At the time Bank A incurred the obligation to pay Y, payment of $1,000,000 by X to Y was also made. Section 4A-406(a). Bank A paid Y when it gave notice to Y of a withdrawable credit of $1,000,000 to Y's account. Section 4A-405(a). The overall transaction, which comprises the acts of X and Bank A, in which the payment by X to Y is accomplished is referred to as the funds transfer. Section 4A-104(a). In this case only one payment order was involved in the funds transfer. A one-payment-order funds transfer is usually referred to as a book transfer because the payment is accomplished by the receiving bank's debiting the account of the sender and crediting the account of the beneciary in the same bank. X, in addition to being the sender of the payment order to Bank A, is the originator of the funds transfer. Section 4A-104(c). Bank A is the originator's bank in the funds transfer as well as the beneciary's bank. Section 4A-104(d). Case #2. Assume the same facts as in Case #1 except that X instructs Bank A to pay $1,000,000 to Y's account in Bank B. With respect to this payment order, X is the sender, Y is the beneciary, and Bank A is the receiving bank. Bank A carries out X's order by instructing Bank B to pay $1,000,000 to Y's account. This instruction is a payment order in which Bank A is the sender, Bank B is the receiving bank, and Y is the beneciary. When Bank A issued its payment order to Bank B, Bank A executed X's order. Section 4A301(a). In the funds transfer, X is the originator, Bank A is the originator's bank, and Bank B is the beneciary's bank. When Bank A executed X's order, X incurred an obligation to pay Bank A the amount of the order. Section 4A-402(c). When Bank B accepts the payment order issued to it by Bank A, Bank B incurs an obligation to Y to pay the amount of the order (Section 4A-404(a)) and Bank A incurs an obligation to pay Bank B. Section 4A-402(b). Acceptance by Bank B also results in payment of $1,000,000 by X to Y. Section 4A-406(a). 494

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In this case two payment orders are involved in the funds transfer. Case #3. Assume the same facts as in Case #2 except that Bank A does not execute X's payment order by issuing a payment order to Bank B. One bank will not normally act to carry out a funds transfer for another bank unless there is a preexisting arrangement between the banks for transmittal of payment orders and settlement of accounts. For example, if Bank B is a foreign bank with which Bank A has no relationship, Bank A can utilize a bank that is a correspondent of both Bank A and Bank B. Assume Bank A issues a payment order to Bank C to pay $1,000,000 to Y's account in Bank B. With respect to this order, Bank A is the sender, Bank C is the receiving bank, and Y is the beneciary. Bank C will execute the payment order of Bank A by issuing a payment order to Bank B to pay $1,000,000 to Y's account in Bank B. With respect to Bank C's payment order, Bank C is the sender, Bank B is the receiving bank, and Y is the beneciary. Payment of $1,000,000 by X to Y occurs when Bank B accepts the payment order issued to it by Bank C. In this case the funds transfer involves three payment orders. In the funds transfer, X is the originator, Bank A is the originator's bank, Bank B is the beneciary's bank, and Bank C is an intermediary bank. Section 4A-104(b). In some cases there may be more than one intermediary bank, and in those cases each intermediary bank is treated like Bank C in Case #3. As the three cases demonstrate, a payment under Article 4A involves an overall transaction, the funds transfer, in which the originator, X, is making payment to the beneciary, Y, but the funds transfer may encompass a series of payment orders that are issued in order to eect the payment initiated by the originator's payment order. In some cases the originator and the beneciary may be the same person. This will occur, for example, when a corporation orders a bank to transfer funds from an account of the corporation in that bank to another account of the corporation in that bank or in some other bank. In some funds transfers the rst bank to issue a payment order is a bank that is executing a payment order of a customer that is not a bank. In this case the customer is the originator. In other cases, the rst bank to issue a payment order is not acting for a customer, but is making a payment for its own account. In that event the rst bank to issue a payment order is the originator as well as the originator's bank. 2. Payment order is dened in Section 4A-103(a)(1) as an instruction to a bank to pay, or to cause another bank to pay, a xed or determinable amount of money. The bank to which the instruction is addressed is known as the receiving bank. Section 4A-103(a)(4). Bank is dened in Section 4A-105(a)(2). The eect of this denition is to limit Article 4A to payments made through the banking system. A transfer of funds made by an entity outside the banking system is excluded. A transfer of funds through an entity other than a bank is usually a consumer transaction involving relatively small amounts of money and a single contract carried out by transfers of cash or a cash equivalent such as a check. Typically, the transferor delivers cash or a check to the company making the transfer, which agrees to pay a like amount to a person designated by the transferor. Transactions covered by Article 4A typically involve very large amounts of money in which several transactions involving several banks may be necessary to carry out the payment. Payments are normally made by debits or credits to bank accounts. Originators and beneciaries are almost always business organizations and the transfers are usually made to pay obligations. Moreover, these transactions are frequently done on the basis of very short-term credit granted by the receiving bank to the sender of the payment order. Wholesale wire transfers involve policy questions that are distinct from those involved in consumer-based transactions by nonbanks. 3. Further limitations on the scope of Article 4A are found in the three requirements found in subparagraphs (i), (ii), and (iii) of Section 4A-103(a)(1). Subparagraph (i) states that the instruction to pay is a payment order only if it does not state a condition to payment to the beneciary other than time of payment. An instruction to pay a beneciary sometimes is subject to a requirement that the beneciary perform some act such as delivery of documents. For example, a New York bank may have issued a letter of credit in favor of X, a California seller of goods to be shipped to the New York bank's customer in New York. The terms of the letter of credit provide for payment to X if documents are presented to prove shipment of the goods. Instead of providing for presentment of the documents to the New York bank, the letter of credit states that they may be presented to a California bank that acts as an agent for payment. The New York bank sends an instruction to the California bank to pay X upon presentation of the required documents. The 495

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instruction is not covered by Article 4A because payment to the beneciary is conditional upon receipt of shipping documents. The function of banks in a funds transfer under Article 4A is comparable to the role of banks in the collection and payment of checks in that it is essentially mechanical in nature. The low price and high speed that characterize funds transfers reect this fact. Conditions to payment by the California bank other than time of payment impose responsibilities on that bank that go beyond those in Article 4A funds transfers. Although the payment by the New York bank to X under the letter of credit is not covered by Article 4A, if X is paid by the California bank, payment of the obligation of the New York bank to reimburse the California bank could be made by an Article 4A funds transfer. In such a case there is a distinction between the payment by the New York bank to X under the letter of credit and the payment by the New York bank to the California bank. For example, if the New York bank pays its reimbursement obligation to the California bank by a Fedwire naming the California bank as beneciary (see Comment 1 to Section 4A-107), payment is made to the California bank rather than to X. That payment is governed by Article 4A and it could be made either before or after payment by the California bank to X. The payment by the New York bank to X under the letter of credit is not governed by Article 4A and it occurs when the California bank, as agent of the New York bank, pays X. No payment order was involved in that transaction. In this example, if the New York bank had erroneously sent an instruction to the California bank unconditionally instructing payment to X, the instruction would have been an Article 4A payment order. If the payment order was accepted (Section 4A-209(b)) by the California bank, a payment by the New York bank to X would have resulted (Section 4A-406(a)). But Article 4A would not prevent recovery of funds from X on the basis that X was not entitled to retain the funds under the law of mistake and restitution, letter of credit law or other applicable law. 4. Transfers of funds made through the banking system are commonly referred to as either credit transfers or debit transfers. In a credit transfer the instruction to pay is given by the person making payment. In a debit transfer the instruction to pay is given by the person receiving payment. The purpose of subparagraph (ii) of subsection (a)(1) of Section 4A-103 is to include credit transfers in Article 4A and to exclude debit transfers. All of the instructions to pay in the three cases described in Comment 1 fall within subparagraph (ii). Take Case #2 as an example. With respect to X's instruction given to Bank A, Bank A will be reimbursed by debiting X's account or otherwise receiving payment from X. With respect to Bank A's instruction to Bank B, Bank B will be reimbursed by receiving payment from Bank A. In a debit transfer, a creditor, pursuant to authority from the debtor, is enabled to draw on the debtor's bank account by issuing an instruction to pay to the debtor's bank. If the debtor's bank pays, it will be reimbursed by the debtor rather than by the person giving the instruction. For example, the holder of an insurance policy may pay premiums by authorizing the insurance company to order the policyholder's bank to pay the insurance company. The order to pay may be in the form of a draft covered by Article 3, or it might be an instruction to pay that is not an instrument under that Article. The bank receives reimbursement by debiting the policyholder's account. Or, a subsidiary corporation may make payments to its parent by authorizing the parent to order the subsidiary's bank to pay the parent from the subsidiary's account. These transactions are not covered by Article 4A because subparagraph (2) is not satised. Article 4A is limited to transactions in which the account to be debited by the receiving bank is that of the person in whose name the instruction is given. If the beneciary of a funds transfer is the originator of the transfer, the transfer is governed by Article 4A if it is a credit transfer in form. If it is in the form of a debit transfer it is not governed by Article 4A. For example, Corporation has accounts in Bank A and Bank B. Corporation instructs Bank A to pay to Corporation's account in Bank B. The funds transfer is governed by Article 4A. Sometimes, Corporation will authorize Bank B to draw on Corporation's account in Bank A for the purpose of transferring funds into Corporation's account in Bank B. If Corporation also makes an agreement with Bank A under which Bank A is authorized to follow instructions of Bank B, as agent of Corporation, to transfer funds from Customer's account in Bank A, the instruction of Bank B is a payment order of Customer and is governed by Article 4A. This kind of transaction is known in the wire-transfer business as a drawdown transfer. If Corporation does not make such an agreement with Bank A and Bank B instructs Bank A to make the transfer, the order is in form a debit transfer and is not governed by Article 4A. These debit transfers are normally ACH transactions in which Bank A relies on Bank B's warranties pursuant to 496

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ACH rules, including the warranty that the transfer is authorized. 5. The principal eect of subparagraph (iii) of subsection (a) of Section 4A-103 is to exclude from Article 4A payments made by check or credit card. In those cases the instruction of the debtor to the bank on which the check is drawn or to which the credit card slip is to be presented is contained in the check or credit card slip signed by the debtor. The instruction is not transmitted by the debtor directly to the debtor's bank. Rather, the instruction is delivered or otherwise transmitted by the debtor to the creditor who then presents it to the bank either directly or through bank collection channels. These payments are governed by Articles 3 and 4 and federal law. There are, however, limited instances in which the paper on which a check is printed can be used as the means of transmitting a payment order that is covered by Article 4A. Assume that Originator instructs Originator's Bank to pay $10,000 to the account of Beneciary in Beneciary's Bank. Since the amount of Originator's payment order is small, if Originator's Bank and Beneciary's Bank do not have an account relationship, Originator's Bank may execute Originator's order by issuing a teller's check payable to Beneciary's Bank for $10,000 along with instructions to credit Beneciary's account in that amount. The instruction to Beneciary's Bank to credit Beneciary's account is a payment order. The check is the means by which Originator's Bank pays its obligation as sender of the payment order. The instruction of Originator's Bank to Beneciary's Bank might be given in a letter accompanying the check or it may be written on the check itself. In either case the instruction to Beneciary's Bank is a payment order but the check itself (which is an order to pay addressed to the drawee rather than to Beneciary's Bank) is an instrument under Article 3 and is not a payment order. The check can be both the means by which Originator's Bank pays its obligation under 4A-402(b) to Beneciary's Bank and the means by which the instruction to Beneciary's Bank is transmitted. 6. Most payments covered by Article 4A are commonly referred to as wire transfers and usually involve some kind of electronic transmission, but the applicability of Article 4A does not depend upon the means used to transmit the instruction of the sender. Transmission may be by letter or other written communication, oral communication or electronic communication. An oral communication is normally given by telephone. Frequently the message is recorded by the receiving bank to provide evidence of the transaction, but apart from problems of proof there is no need to record the oral instruction. Transmission of an instruction may be a direct communication between the sender and the receiving bank or through an intermediary such as an agent of the sender, a communication system such as international cable, or a funds transfer system such as CHIPS, SWIFT or an automated clearing house.

4A-105. Other Denitions. (a) In this Article: (1) Authorized account means a deposit account of a customer in a bank designated by the customer as a source of payment of payment orders issued by the customer to the bank. If a customer does not so designate an account, any account of the customer is an authorized account if payment of a payment order from that account is not inconsistent with a restriction on the use of that account. (2) Bank means a person engaged in the business of banking and includes a savings bank, savings and loan association, credit union, and trust company. A branch or separate oce of a bank is a separate bank for purposes of this Article. (3) Customer means a person, including a bank, having an account with a bank or from whom a bank has agreed to receive payment orders. (4) Funds-transfer business day of a receiving bank means the part of a day during which the receiving bank is open for the receipt, processing, and transmittal of payment orders and cancellations and amendments of payment orders.
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(5) Funds-transfer system means a wire transfer network, automated clearing house, or other communication system of a clearing house or other association of banks through which a payment order by a bank may be transmitted to the bank to which the order is addressed. (6) [reserved] (7) Prove with respect to a fact means to meet the burden of establishing the fact (Section 1-201(b)(8)). (b) Other denitions applying to this Article and the sections in which they appear are: Acceptance Beneciary Beneciary's bank Executed Execution date Funds transfer Funds-transfer system rule Intermediary bank Originator Originator's bank Payment by beneciary's bank to beneciary Payment by originator to beneciary Payment by sender to receiving bank Payment date Payment order Receiving bank Security procedure Sender Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section 4A-209 4A-103 4A-103 4A-301 4A-301 4A-104 4A-501 4A-104 4A-104 4A-104 4A-405 4A-406 4A-403 4A-401 4A-103 4A-103 4A-201 4A-103

(c) The following denitions in Article 4 apply to this Article: Clearing house Item Suspends payments Section 4-104 Section 4-104 Section 4-104

(d) In addition Article 1 contains general denitions and principles of construction and interpretation applicable throughout this Article. As amended in 2001.
See Appendix I contained within revised Article 1 for material relating to changes made in text in 2001.

Ocial Comment
1. The denition of bank in subsection (a)(2) includes some institutions that are not commercial banks. The denition reects the fact that many nancial institutions now perform functions previously restricted to commercial banks, including acting on behalf of customers in funds transfers. Since many funds transfers involve payment orders to or from foreign countries the denition also covers foreign banks. The denition also includes 498

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Federal Reserve Banks. Funds transfers carried out by Federal Reserve Banks are described in Comments 1 and 2 to Section 4A-107. 2. Funds transfer business is frequently transacted by banks outside of general banking hours. Thus, the denition of banking day in Section 4-104(1)(c) cannot be used to describe when a bank is open for funds transfer business. Subsection (a)(4) denes a new term, funds transfer business day, which is applicable to Article 4A. The denition states, is open for the receipt, processing, and transmittal of payment orders and cancellations and amendments of payment orders. In some cases it is possible to electronically transmit payment orders and other communications to a receiving bank at any time. If the receiving bank is not open for the processing of an order when it is received, the communication is stored in the receiving bank's computer for retrieval when the receiving bank is open for processing. The use of the conjunctive makes clear that the dened term is limited to the period during which all functions of the receiving bank can be performed, i.e., receipt, processing, and transmittal of payment orders, cancellations and amendments. 3. Subsection (a)(5) denes funds transfer system. The term includes a system such as CHIPS which provides for transmission of a payment order as well as settlement of the obligation of the sender to pay the order. It also includes automated clearing houses, operated by a clearing house or other association of banks, which process and transmit payment orders of banks to other banks. In addition the term includes organizations that provide only transmission services such as SWIFT. The denition also includes the wire transfer network and automated clearing houses of Federal Reserve Banks. Systems of the Federal Reserve Banks, however, are treated dierently from systems of other associations of banks. Funds transfer systems other than systems of the Federal Reserve Banks are treated in Article 4A as a means of communication of payment orders between participating banks. Section 4A-206. The Comment to that section and the Comment to Section 4A-107 explain how Federal Reserve Banks function under Article 4A. Funds transfer systems are also able to promulgate rules binding on participating banks that, under Section 4A-501, may supplement or in some cases may even override provisions of Article 4A. 4. Subsection (d) incorporates denitions stated in Article 1 as well as principles of construction and interpretation stated in that Article. Included is Section 1-103. The last paragraph of the Comment to Section 4A-102 is addressed to the issue of the extent to which general principles of law and equity should apply to situations covered by provisions of Article 4A.

4A-106. Time Payment Order Is Received. (a) The time of receipt of a payment order or communication cancelling or amending a payment order is determined by the rules applicable to receipt of a notice stated in Section 1-202. A receiving bank may x a cuto time or times on a funds-transfer business day for the receipt and processing of payment orders and communications cancelling or amending payment orders. Dierent cut-o times may apply to payment orders, cancellations, or amendments, or to dierent categories of payment orders, cancellations, or amendments. A cut-o time may apply to senders generally or dierent cut-o times may apply to dierent senders or categories of payment orders. If a payment order or communication cancelling or amending a payment order is received after the close of a funds-transfer business day or after the appropriate cut-o time on a funds-transfer business day, the receiving bank may treat the payment order or communication as received at the opening of the next funds-transfer business day. (b) If this Article refers to an execution date or payment date or states a day on which a receiving bank is required to take action, and the date or day does not fall on a funds-transfer business day, the next day that is a funds-transfer business day is treated as the date or day stated, unless the contrary is stated in this Article.
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As amended in 2001.
See Appendix I contained within revised Article 1 for material relating to changes made in text in 2001.

Ocial Comment
The time that a payment order is received by a receiving bank usually denes the payment date or the execution date of a payment order. Section 4A-401 and Section 4A-301. The time of receipt of a payment order, or communication cancelling or amending a payment order is dened in subsection (a) by reference to the rules stated in Section 1-202. Thus, time of receipt is determined by the same rules that determine when a notice is received. Time of receipt, however, may be altered by a cut-o time.

As amended in 2001.
See Appendix I contained within revised Article 1 for material relating to changes made in Ocial Comment in 2001.

4A-107. Federal Reserve Regulations and Operating Circulars. Regulations of the Board of Governors of the Federal Reserve System and operating circulars of the Federal Reserve Banks supersede any inconsistent provision of this Article to the extent of the inconsistency. Ocial Comment
1. Funds transfers under Article 4A may be made, in whole or in part, by payment orders through a Federal Reserve Bank in what is usually referred to as a transfer by Fedwire. If Bank A, which has an account in Federal Reserve Bank X, wants to pay $1,000,000 to Bank B, which has an account in Federal Reserve Bank Y, Bank A can issue an instruction to Reserve Bank X requesting a debit of $1,000,000 to Bank A's Reserve account and an equal credit to Bank B's Reserve account. Reserve Bank X will debit Bank A's account and will credit the account of Reserve Bank Y. Reserve Bank X will issue an instruction to Reserve Bank Y requesting a debit of $1,000,000 to the account of Reserve Bank X and an equal credit to Bank B's account in Reserve Bank Y. Reserve Bank Y will make the requested debit and credit and will give Bank B an advice of credit. The denition of bank in Section 4A-105(a)(2) includes both Reserve Bank X and Reserve Bank Y. Bank A's instruction to Reserve Bank X to pay money to Bank B is a payment order under Section 4A-103(a)(1). Bank A is the sender and Reserve Bank X is the receiving bank. Bank B is the beneciary of Bank A's order and of the funds transfer. Bank A is the originator of the funds transfer and is also the originator's bank. Section 4A-104(c) and (d). Reserve Bank X, an intermediary bank under Section 4A-104(b), executes Bank A's order by sending a payment order to Reserve Bank Y instructing that bank to credit the Federal Reserve account of Bank B. Reserve Bank Y is the beneciary's bank. Suppose the transfer of funds from Bank A to Bank B is part of a larger transaction in which Originator, a customer of Bank A, wants to pay Beneciary, a customer of Bank B. Originator issues a payment order to Bank A to pay $1,000,000 to the account of Beneciary in Bank B. Bank A may execute Originator's order by means of Fedwire which simultaneously transfers $1,000,000 from Bank A to Bank B and carries a message instructing Bank B to pay $1,000,000 to the account of Y. The Fedwire transfer is carried out as described in the previous paragraph, except that the beneciary of the funds transfer is Beneciary rather than Bank B. Reserve Bank X and Reserve Bank Y are intermediary banks. When Reserve Bank Y advises Bank B of the credit to its Federal Reserve account it will also instruct Bank B to pay to the account of Beneciary. The instruction is a payment order to Bank B which is the beneciary's bank. When Reserve Bank Y advises Bank B of the credit to its Federal Reserve account Bank B receives payment of the payment order issued to it by Reserve Bank Y. Section 4A-403(a)(1). The payment order is automatically accepted by Bank B at the time it receives the payment order of Reserve Bank Y. Section 4A209(b)(2). At the time of acceptance by Bank B payment by Originator to Beneciary also occurs. Thus, in a Fedwire transfer, payment to the beneciary's bank, acceptance by the beneciary's bank and payment by the originator to the beneciary all occur simultaneously by operation of law at the time the payment order to the beneciary's bank is received. If Originator orders payment to the account of Beneciary in Bank C rather than Bank 500

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B, the analysis is somewhat modied. Bank A may not have any relationship with Bank C and may not be able to make payment directly to Bank C. In that case, Bank A could send a Fedwire instructing Bank B to instruct Bank C to pay Beneciary. The analysis is the same as the previous case except that Bank B is an intermediary bank and Bank C is the beneciary's bank. 2. A funds transfer can also be made through a Federal Reserve Bank in an automated clearing house transaction. In a typical case, Originator instructs Originator's Bank to pay to the account of Beneciary in Beneciary's Bank. Originator's instruction to pay a particular beneciary is transmitted to Originator's Bank along with many other instructions for payment to other beneciaries by many dierent beneciary's banks. All of these instructions are contained in a magnetic tape or other electronic device. Transmission of instructions to the various beneciary's banks requires that Originator's instructions be processed and repackaged with instructions of other originators so that all instructions to a particular beneciary's bank are transmitted together to that bank. The repackaging is done in processing centers usually referred to as automated clearing houses. Automated clearing houses are operated either by Federal Reserve Banks or by other associations of banks. If Originator's Bank chooses to execute Originator's instructions by transmitting them to a Federal Reserve Bank for processing by the Federal Reserve Bank, the transmission to the Federal Reserve Bank results in the issuance of payment orders by Originator's Bank to the Federal Reserve Bank, which is an intermediary bank. Processing by the Federal Reserve Bank will result in the issuance of payment orders by the Federal Reserve Bank to Beneciary's Bank as well as payment orders to other beneciary's banks making payments to carry out Originator's instructions. 3. Although the terms of Article 4A apply to funds transfers involving Federal Reserve Banks, federal preemption would make ineective any Article 4A provision that conicts with federal law. The payments activities of the Federal Reserve Banks are governed by regulations of the Federal Reserve Board and by operating circulars issued by the Reserve Banks themselves. In some instances, the operating circulars are issued pursuant to a Federal Reserve Board regulation. In other cases, the Reserve Bank issues the operating circular under its own authority under the Federal Reserve Act, subject to review by the Federal Reserve Board. Section 4A-107 states that Federal Reserve Board regulations and operating circulars of the Federal Reserve Banks supersede any inconsistent provision of Article 4A to the extent of the inconsistency. Federal Reserve Board regulations, being valid exercises of regulatory authority pursuant to a federal statute, take precedence over state law if there is an inconsistency. Childs v. Federal Reserve Bank of Dallas, 719 F.2d 812 (5th Cir.1983), reh. den. 724 F.2d 127 (5th Cir.1984). Section 4A-107 treats operating circulars as having the same eect whether issued under the Reserve Bank's own authority or under a Federal Reserve Board regulation.

4A-108. Exclusion of Consumer Transactions Governed by Federal Law. This Article does not apply to a funds transfer any part of which is governed by the Electronic Fund Transfer Act of 1978 (Title XX, Public Law 95-630, 92 Stat. 3728, 15 U.S.C. 1693 et seq.) as amended from time to time. Ocial Comment
The Electronic Fund Transfer Act of 1978 is a federal statute that covers a wide variety of electronic funds transfers involving consumers. The types of transfers covered by the federal statute are essentially dierent from the wholesale wire transfers that are the primary focus of Article 4A. Section 4A-108 excludes a funds transfer from Article 4A if any part of the transfer is covered by the federal law. Existing procedures designed to comply with federal law will not be aected by Article 4A. The eect of Section 4A-108 is to make Article 4A and EFTA mutually exclusive. For example, if a funds transfer is to a consumer account in the beneciary's bank and the funds transfer is made in part by use of Fedwire and in part by means of an automated clearing house, EFTA applies to the ACH part of the transfer but not to the Fedwire part. Under Section 4A-108, Article 4A does not apply to any part of the transfer. However, in the absence of any law to govern the part of the funds transfer that is not subject to EFTA, a court might apply appropriate principles from 501

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PART 2. ISSUE AND ACCEPTANCE OF PAYMENT ORDER

4A-201. Security Procedure. Security procedure means a procedure established by agreement of a customer and a receiving bank for the purpose of (i) verifying that a payment order or communication amending or cancelling a payment order is that of the customer, or (ii) detecting error in the transmission or the content of the payment order or communication. A security procedure may require the use of algorithms or other codes, identifying words or numbers, encryption, callback procedures, or similar security devices. Comparison of a signature on a payment order or communication with an authorized specimen signature of the customer is not by itself a security procedure. Ocial Comment
A large percentage of payment orders and communications amending or cancelling payment orders are transmitted electronically and it is standard practice to use security procedures that are designed to assure the authenticity of the message. Security procedures can also be used to detect error in the content of messages or to detect payment orders that are transmitted by mistake as in the case of multiple transmission of the same payment order. Security procedures might also apply to communications that are transmitted by telephone or in writing. Section 4A-201 denes these security procedures. The denition of security procedure limits the term to a procedure established by agreement of a customer and a receiving bank. The term does not apply to procedures that the receiving bank may follow unilaterally in processing payment orders. The question of whether loss that may result from the transmission of a spurious or erroneous payment order will be borne by the receiving bank or the sender or purported sender is aected by whether a security procedure was or was not in eect and whether there was or was not compliance with the procedure. Security procedures are referred to in Sections 4A-202 and 4A-203, which deal with authorized and veried payment orders, and Section 4A-205, which deals with erroneous payment orders.

4A-202. Authorized and Veried Payment Orders. (a) A payment order received by the receiving bank is the authorized order of the person identied as sender if that person authorized the order or is otherwise bound by it under the law of agency. (b) If a bank and its customer have agreed that the authenticity of payment orders issued to the bank in the name of the customer as sender will be veried pursuant to a security procedure, a payment order received by the receiving bank is eective as the order of the customer, whether or not authorized, if (i) the security procedure is a commercially reasonable method of providing security against unauthorized payment orders, and (ii) the bank proves that it accepted the payment order in good faith and in compliance with the security procedure and any written agreement or instruction of the customer restricting acceptance of payment orders issued in the name of the customer. The bank is not required to follow an instruction that violates a written agreement with the customer or notice of which is not received at a time and in a manner aording the bank a reasonable opportunity to act on it before the payment order is accepted. (c) Commercial reasonableness of a security procedure is a question of law to be determined by considering the wishes of the customer expressed
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to the bank, the circumstances of the customer known to the bank, including the size, type, and frequency of payment orders normally issued by the customer to the bank, alternative security procedures oered to the customer, and security procedures in general use by customers and receiving banks similarly situated. A security procedure is deemed to be commercially reasonable if (i) the security procedure was chosen by the customer after the bank oered, and the customer refused, a security procedure that was commercially reasonable for that customer, and (ii) the customer expressly agreed in writing to be bound by any payment order, whether or not authorized, issued in its name and accepted by the bank in compliance with the security procedure chosen by the customer. (d) The term sender in this Article includes the customer in whose name a payment order is issued if the order is the authorized order of the customer under subsection (a), or it is eective as the order of the customer under subsection (b). (e) This section applies to amendments and cancellations of payment orders to the same extent it applies to payment orders. (f) Except as provided in this section and in Section 4A-203(a)(1), rights and obligations arising under this section or Section 4A-203 may not be varied by agreement. Ocial Comment
This section is discussed in the Comment following Section 4A-203.

4A-203. Unenforceability of Certain Veried Payment Orders. (a) If an accepted payment order is not, under Section 4A-202(a), an authorized order of a customer identied as sender, but is eective as an order of the customer pursuant to Section 4A-202(b), the following rules apply: (1) By express written agreement, the receiving bank may limit the extent to which it is entitled to enforce or retain payment of the payment order. (2) The receiving bank is not entitled to enforce or retain payment of the payment order if the customer proves that the order was not caused, directly or indirectly, by a person (i) entrusted at any time with duties to act for the customer with respect to payment orders or the security procedure, or (ii) who obtained access to transmitting facilities of the customer or who obtained, from a source controlled by the customer and without authority of the receiving bank, information facilitating breach of the security procedure, regardless of how the information was obtained or whether the customer was at fault. Information includes any access device, computer software, or the like. (b) This section applies to amendments of payment orders to the same extent it applies to payment orders. Ocial Comment
1. Some person will always be identied as the sender of a payment order. Acceptance of the order by the receiving bank is based on a belief by the bank that the order was authorized by the person identied as the sender. If the receiving bank is the beneciary's bank acceptance means that the receiving bank is obliged to pay the beneciary. If the receiving bank is not the beneciary's bank, acceptance means that the receiving bank has executed 503

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the sender's order and is obliged to pay the bank that accepted the order issued in execution of the sender's order. In either case the receiving bank may suer a loss unless it is entitled to enforce payment of the payment order that it accepted. If the person identied as the sender of the order refuses to pay on the ground that the order was not authorized by that person, what are the rights of the receiving bank? In the absence of a statute or agreement that specically addresses the issue, the question usually will be resolved by the law of agency. In some cases, the law of agency works well. For example, suppose the receiving bank executes a payment order given by means of a letter apparently written by a corporation that is a customer of the bank and apparently signed by an ocer of the corporation. If the receiving bank acts solely on the basis of the letter, the corporation is not bound as the sender of the payment order unless the signature was that of the ocer and the ocer was authorized to act for the corporation in the issuance of payment orders, or some other agency doctrine such as apparent authority or estoppel causes the corporation to be bound. Estoppel can be illustrated by the following example. Suppose P is aware that A, who is unauthorized to act for P, has fraudulently misrepresented to T that A is authorized to act for P. T believes A and is about to rely on the misrepresentation. If P does not notify T of the true facts although P could easily do so, P may be estopped from denying A's lack of authority. A similar result could follow if the failure to notify T is the result of negligence rather than a deliberate decision. Restatement, Second, Agency 8B. Other equitable principles such as subrogation or restitution might also allow a receiving bank to recover with respect to an unauthorized payment order that it accepted. In Gatoil (U.S.A.), Inc. v. Forest Hill State Bank, 1 U.C.C.Rep.Serv.2d 171 (D.Md.1986), a joint venturer not authorized to order payments from the account of the joint venture, ordered a funds transfer from the account. The transfer paid a bona de debt of the joint venture. Although the transfer was unauthorized the court refused to require recredit of the account because the joint venture suered no loss. The result can be rationalized on the basis of subrogation of the receiving bank to the right of the beneciary of the funds transfer to receive the payment from the joint venture. But in most cases these legal principles give the receiving bank very little protection in the case of an authorized payment order. Cases like those just discussed are not typical of the way that most payment orders are transmitted and accepted, and such cases are likely to become even less common. Given the large amount of the typical payment order, a prudent receiving bank will be unwilling to accept a payment order unless it has assurance that the order is what it purports to be. This assurance is normally provided by security procedures described in Section 4A-201. In a very large percentage of cases covered by Article 4A, transmission of the payment order is made electronically. The receiving bank may be required to act on the basis of a message that appears on a computer screen. Common law concepts of authority of agent to bind principal are not helpful. There is no way of determining the identity or the authority of the person who caused the message to be sent. The receiving bank is not relying on the authority of any particular person to act for the purported sender. The case is not comparable to payment of a check by the drawee bank on the basis of a signature that is forged. Rather, the receiving bank relies on a security procedure pursuant to which the authenticity of the message can be tested by various devices which are designed to provide certainty that the message is that of the sender identied in the payment order. In the wire transfer business the concept of authorized is dierent from that found in agency law. In that business a payment order is treated as the order of the person in whose name it is issued if it is properly tested pursuant to a security procedure and the order passes the test. Section 4A-202 reects the reality of the wire transfer business. A person in whose name a payment order is issued is considered to be the sender of the order if the order is authorized as stated in subsection (a) or if the order is veried pursuant to a security procedure in compliance with subsection (b). If subsection (b) does not apply, the question of whether the customer is responsible for the order is determined by the law of agency. The issue is one of actual or apparent authority of the person who caused the order to be issued in the name of the customer. In some cases the law of agency might allow the customer to be bound by an unauthorized order if conduct of the customer can be used to nd an estoppel against the customer to deny that the order was unauthorized. If the customer is bound by the order under any of these agency doctrines, subsection (a) treats the order as authorized and thus the customer is deemed to be the sender of the order. In most cases, however, subsection (b) will apply. In that event there is no need to make an agency law analysis to 504

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determine authority. Under Section 4A-202, the issue of liability of the purported sender of the payment order will be determined by agency law only if the receiving bank did not comply with subsection (b). 2. The scope of Section 4A-202 can be illustrated by the following cases. Case #1. A payment order purporting to be that of Customer is received by Receiving Bank but the order was fraudulently transmitted by a person who had no authority to act for Customer. Case #2. An authentic payment order was sent by Customer, but before the order was received by Receiving Bank the order was fraudulently altered by an unauthorized person to change the beneciary. Case #3. An authentic payment order was received by Receiving Bank, but before the order was executed by Receiving Bank a person who had no authority to act for Customer fraudulently sent a communication purporting to amend the order by changing the beneciary. In each case Receiving Bank acted on the fraudulent communication by accepting the payment order. These cases are all essentially similar and they are treated identically by Section 4A-202. In each case Receiving Bank acted on a communication that it thought was authorized by Customer when in fact the communication was fraudulent. No distinction is made between Case #1 in which Customer took no part at all in the transaction and Case #2 and Case #3 in which an authentic order was fraudulently altered or amended by an unauthorized person. If subsection (b) does not apply, each case is governed by subsection (a). If there are no additional facts on which an estoppel might be found, Customer is not responsible in Case #1 for the fraudulently issued payment order, in Case #2 for the fraudulent alteration or in Case #3 for the fraudulent amendment. Thus, in each case Customer is not liable to pay the order and Receiving Bank takes the loss. The only remedy of Receiving Bank is to seek recovery from the person who received payment as beneciary of the fraudulent order. If there was verication in compliance with subsection (b), Customer will take the loss unless Section 4A-203 applies. 3. Subsection (b) of Section 4A-202 is based on the assumption that losses due to fraudulent payment orders can best be avoided by the use of commercially reasonable security procedures, and that the use of such procedures should be encouraged. The subsection is designed to protect both the customer and the receiving bank. A receiving bank needs to be able to rely on objective criteria to determine whether it can safely act on a payment order. Employees of the bank can be trained to test a payment order according to the various steps specied in the security procedure. The bank is responsible for the acts of these employees. Subsection (b)(ii) requires the bank to prove that it accepted the payment order in good faith and in compliance with the security procedure. If the fraud was not detected because the bank's employee did not perform the acts required by the security procedure, the bank has not complied. Subsection (b)(ii) also requires the bank to prove that it complied with any agreement or instruction that restricts acceptance of payment orders issued in the name of the customer. A customer may want to protect itself by imposing limitations on acceptance of payment orders by the bank. For example, the customer may prohibit the bank from accepting a payment order that is not payable from an authorized account, that exceeds the credit balance in specied accounts of the customer, or that exceeds some other amount. Another limitation may relate to the beneciary. The customer may provide the bank with a list of authorized beneciaries and prohibit acceptance of any payment order to a beneciary not appearing on the list. Such limitations may be incorporated into the security procedure itself or they may be covered by a separate agreement or instruction. In either case, the bank must comply with the limitations if the conditions stated in subsection (b) are met. Normally limitations on acceptance would be incorporated into an agreement between the customer and the receiving bank, but in some cases the instruction might be unilaterally given by the customer. If standing instructions or an agreement state limitations on the ability of the receiving bank to act, provision must be made for later modication of the limitations. Normally this would be done by an agreement that species particular procedures to be followed. Thus, subsection (b) states that the receiving bank is not required to follow an instruction that violates a written agreement. The receiving bank is not bound by an instruction unless it has adequate notice of it. Subsections (25), (26) and (27) of Section 1-201 apply. Subsection (b)(i) assures that the interests of the customer will be protected by providing an incentive to a bank to make available to the customer a security procedure that is commercially reasonable. If a commercially reasonable security procedure is not made available to the customer, subsection (b) does not apply. The result is that subsection (a) applies and the bank acts at its peril in accepting a payment order that may be unauthorized. Prudent 505

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banking practice may require that security procedures be utilized in virtually all cases except for those in which personal contact between the customer and the bank eliminates the possibility of an unauthorized order. The burden of making available commercially reasonable security procedures is imposed on receiving banks because they generally determine what security procedures can be used and are in the best position to evaluate the ecacy of procedures oered to customers to combat fraud. The burden on the customer is to supervise its employees to assure compliance with the security procedure and to safeguard condential security information and access to transmitting facilities so that the security procedure cannot be breached. 4. The principal issue that is likely to arise in litigation involving subsection (b) is whether the security procedure in eect when a fraudulent payment order was accepted was commercially reasonable. The concept of what is commercially reasonable in a given case is exible. Verication entails labor and equipment costs that can vary greatly depending upon the degree of security that is sought. A customer that transmits very large numbers of payment orders in very large amounts may desire and may reasonably expect to be provided with state-of-the-art procedures that provide maximum security. But the expense involved may make use of a state-of-the-art procedure infeasible for a customer that normally transmits payment orders infrequently or in relatively low amounts. Another variable is the type of receiving bank. It is reasonable to require large money center banks to make available state-of-the-art security procedures. On the other hand, the same requirement may not be reasonable for a small country bank. A receiving bank might have several security procedures that are designed to meet the varying needs of dierent customers. The type of payment order is another variable. For example, in a wholesale wire transfer, each payment order is normally transmitted electronically and individually. A testing procedure will be individually applied to each payment order. In funds transfers to be made by means of an automated clearing house many payment orders are incorporated into an electronic device such as a magnetic tape that is physically delivered. Testing of the individual payment orders is not feasible. Thus, a dierent kind of security procedure must be adopted to take into account the dierent mode of transmission. The issue of whether a particular security procedure is commercially reasonable is a question of law. Whether the receiving bank complied with the procedure is a question of fact. It is appropriate to make the nding concerning commercial reasonability a matter of law because security procedures are likely to be standardized in the banking industry and a question of law standard leads to more predictability concerning the level of security that a bank must oer to its customers. The purpose of subsection (b) is to encourage banks to institute reasonable safeguards against fraud but not to make them insurers against fraud. A security procedure is not commercially unreasonable simply because another procedure might have been better or because the judge deciding the question would have opted for a more stringent procedure. The standard is not whether the security procedure is the best available. Rather it is whether the procedure is reasonable for the particular customer and the particular bank, which is a lower standard. On the other hand, a security procedure that fails to meet prevailing standards of good banking practice applicable to the particular bank should not be held to be commercially reasonable. Subsection (c) states factors to be considered by the judge in making the determination of commercial reasonableness. Sometimes an informed customer refuses a security procedure that is commercially reasonable and suitable for that customer and insists on using a higher-risk procedure because it is more convenient or cheaper. In that case, under the last sentence of subsection (c), the customer has voluntarily assumed the risk of failure of the procedure and cannot shift the loss to the bank. But this result follows only if the customer expressly agrees in writing to assume that risk. It is implicit in the last sentence of subsection (c) that a bank that accedes to the wishes of its customer in this regard is not acting in bad faith by so doing so long as the customer is made aware of the risk. In all cases, however, a receiving bank cannot get the benet of subsection (b) unless it has made available to the customer a security procedure that is commercially reasonable and suitable for use by that customer. In most cases, the mutual interest of bank and customer to protect against fraud should lead to agreement to a security procedure which is commercially reasonable. 5. The eect of Section 4a-202(b) is to place the risk of loss on the customer if an unauthorized payment order is accepted by the receiving bank after verication by the bank in compliance with a commercially reasonable security procedure. An exception to this result is provided by Section 4A-203(a)(2). The customer may avoid the loss resulting from such a 506

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payment order if the customer can prove that the fraud was not committed by a person described in that subsection. Breach of a commercially reasonable security procedure requires that the person committing the fraud have knowledge of how the procedure works and knowledge of codes, identifying devices, and the like. That person may also need access to transmitting facilities through an access device or other software in order to breach the security procedure. This condential information must be obtained either from a source controlled by the customer or from a source controlled by the receiving bank. If the customer can prove that the person committing the fraud did not obtain the condential information from an agent or former agent of the customer or from a source controlled by the customer, the loss is shifted to the bank. Prove is dened in Section 4A-105(a)(7). Because of bank regulation requirements, in this kind of case there will always be a criminal investigation as well as an internal investigation of the bank to determine the probable explanation for the breach of security. Because a funds transfer fraud usually will involve a very large amount of money, both the criminal investigation and the internal investigation are likely to be thorough. In some cases there may be an investigation by bank examiners as well. Frequently, these investigations will develop evidence of who is at fault and the cause of the loss. The customer will have access to evidence developed in these investigations and that evidence can be used by the customer in meeting its burden of proof. 6. The eect of Section 4A-202(b) may also be changed by an agreement meeting the requirements of Section 4A-203(a)(1). Some customers may be unwilling to take all or part of the risk of loss with respect to unauthorized payment orders even if all of the requirements of Section 4A-202(b) are met. By virtue of Section 4A-203(a)(1), a receiving bank may assume all of the risk of loss with respect to unauthorized payment orders or the customer and bank may agree that losses from unauthorized payment orders are to be divided as provided in the agreement. 7. In a large majority of cases the sender of a payment order is a bank. In many cases in which there is a bank sender, both the sender and the receiving bank will be members of a funds transfer system over which the payment order is transmitted. Since Section 4A-202(f) does not prohibit a funds transfer system rule from varying rights and obligations under Section 4A-202, a rule of the funds transfer system can determine how loss due to an unauthorized payment order from a participating bank to another participating bank is to be allocated. A funds transfer system rule, however, cannot change the rights of a customer that is not a participating bank. 4A-501(b). Section 4A-202(f) also prevents variation by agreement except to the extent stated.

4A-204. Refund of Payment and Duty of Customer to Report With Respect to Unauthorized Payment Order. (a) If a receiving bank accepts a payment order issued in the name of its customer as sender which is (i) not authorized and not eective as the order of the customer under Section 4A-202, or (ii) not enforceable, in whole or in part, against the customer under Section 4A-203, the bank shall refund any payment of the payment order received from the customer to the extent the bank is not entitled to enforce payment and shall pay interest on the refundable amount calculated from the date the bank received payment to the date of the refund. However, the customer is not entitled to interest from the bank on the amount to be refunded if the customer fails to exercise ordinary care to determine that the order was not authorized by the customer and to notify the bank of the relevant facts within a reasonable time not exceeding 90 days after the date the customer received notication from the bank that the order was accepted or that the customer's account was debited with respect to the order. The bank is not entitled to any recovery from the customer on account of a failure by the customer to give notication as stated in this section. (b) Reasonable time under subsection (a) may be xed by agreement as stated in Section 1-302(b), but the obligation of a receiving bank to refund payment as stated in subsection (a) may not otherwise be varied by agreement.
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As amended in 2001.
See Appendix I contained within revised Article 1 for material relating to changes made in text in 2001.

Ocial Comment
1. With respect to unauthorized payment orders, in a very large percentage of cases a commercially reasonable security procedure will be in eect. Section 4A-204 applies only to cases in which (i) no commercially reasonable security procedure is in eect, (ii) the bank did not comply with a commercially reasonable security procedure that was in eect, (iii) the sender can prove, pursuant to Section 4A-203(a)(2), that the culprit did not obtain condential security information controlled by the customer, or (iv) the bank, pursuant to Section 4A-203(a)(1) agreed to take all or part of the loss resulting from an unauthorized payment order. In each of these cases the bank takes the risk of loss with respect to an unauthorized payment order because the bank is not entitled to payment from the customer with respect to the order. The bank normally debits the customer's account or otherwise receives payment from the customer shortly after acceptance of the payment order. Subsection (a) of Section 4A-204 states that the bank must recredit the account or refund payment to the extent the bank is not entitled to enforce payment. 2. Section 4A-204 is designed to encourage a customer to promptly notify the receiving bank that it has accepted an unauthorized payment order. Since cases of unauthorized payment orders will almost always involve fraud, the bank's remedy is normally to recover from the beneciary of the unauthorized order if the beneciary was party to the fraud. This remedy may not be worth very much and it may not make any dierence whether or not the bank promptly learns about the fraud. But in some cases prompt notication may make it easier for the bank to recover some part of its loss from the culprit. The customer will routinely be notied of the debit to its account with respect to an unauthorized order or will otherwise be notied of acceptance of the order. The customer has a duty to exercise ordinary care to determine that the order was unauthorized after it has received notication from the bank, and to advise the bank of the relevant facts within a reasonable time not exceeding 90 days after receipt of notication. Reasonable time is not dened and it may depend on the facts of the particular case. If a payment order for $1,000,000 is wholly unauthorized, the customer should normally discover it in far less than 90 days. If a $1,000,000 payment order was authorized but the name of the beneciary was fraudulently changed, a much longer period may be necessary to discover the fraud. But in any event, if the customer delays more than 90 days the customer's duty has not been met. The only consequence of a failure of the customer to perform this duty is a loss of interest on the refund payable by the bank. A customer that acts promptly is entitled to interest from the time the customer's account was debited or the customer otherwise made payment. The rate of interest is stated in Section 4A-506. If the customer fails to perform the duty, no interest is recoverable for any part of the period before the bank learns that it accepted an unauthorized order. But the bank is not entitled to any recovery from the customer based on negligence for failure to inform the bank. Loss of interest is in the nature of a penalty on the customer designed to provide an incentive for the customer to police its account. There is no intention to impose a duty on the customer that might result in shifting loss from the unauthorized order to the customer.

4A-205. Erroneous Payment Orders. (a) If an accepted payment order was transmitted pursuant to a security procedure for the detection of error and the payment order (i) erroneously instructed payment to a beneciary not intended by the sender, (ii) erroneously instructed payment in an amount greater than the amount intended by the sender, or (iii) was an erroneously transmitted duplicate of a payment order previously sent by the sender, the following rules apply: (1) If the sender proves that the sender or a person acting on behalf of the sender pursuant to Section 4A-206 complied with the security procedure and that the error would have been detected if the receiving bank had also complied, the sender is not obliged to pay the order to the extent stated in paragraphs (2) and (3).
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(2) If the funds transfer is completed on the basis of an erroneous payment order described in clause (i) or (iii) of subsection (a), the sender is not obliged to pay the order and the receiving bank is entitled to recover from the beneciary any amount paid to the beneciary to the extent allowed by the law governing mistake and restitution. (3) If the funds transfer is completed on the basis of a payment order described in clause (ii) of subsection (a), the sender is not obliged to pay the order to the extent the amount received by the beneciary is greater than the amount intended by the sender. In that case, the receiving bank is entitled to recover from the beneciary the excess amount received to the extent allowed by the law governing mistake and restitution. (b) If (i) the sender of an erroneous payment order described in subsection (a) is not obliged to pay all or part of the order, and (ii) the sender receives notication from the receiving bank that the order was accepted by the bank or that the sender's account was debited with respect to the order, the sender has a duty to exercise ordinary care, on the basis of information available to the sender, to discover the error with respect to the order and to advise the bank of the relevant facts within a reasonable time, not exceeding 90 days, after the bank's notication was received by the sender. If the bank proves that the sender failed to perform that duty, the sender is liable to the bank for the loss the bank proves it incurred as a result of the failure, but the liability of the sender may not exceed the amount of the sender's order. (c) This section applies to amendments to payment orders to the same extent it applies to payment orders. Ocial Comment
1. This section concerns error in the content or in the transmission of payment orders. It deals with three kinds of error. Case #1. The order identies a beneciary not intended by the sender. For example, Sender intends to wire funds to a beneciary identied only by an account number. The wrong account number is stated in the order. Case #2. The error is in the amount of the order. For example, Sender intends to wire $1,000 to Beneciary. Through error, the payment order instructs payment of $1,000,000. Case #3. A payment order is sent to the receiving bank and then, by mistake, the same payment order is sent to the receiving bank again. In Case #3, the receiving bank may have no way of knowing whether the second order is a duplicate of the rst or is another order. Similarly, in Case #1 and Case #2, the receiving bank may have no way of knowing that the error exists. In each case, if this section does not apply and the funds transfer is completed, Sender is obliged to pay the order. Section 4A-402. Sender's remedy, based on payment by mistake, is to recover from the beneciary that received payment. Sometimes, however, transmission of payment orders of the sender to the receiving bank is made pursuant to a security procedure designed to detect one or more of the errors described above. Since security procedure is dened by Section 4A-201 as a procedure established by agreement of a customer and a receiving bank for the purpose of * * * detecting error * * *, Section 4A-205 does not apply if the receiving bank and the customer did not agree to the establishment of a procedure for detecting error. A security procedure may be designed to detect an account number that is not one to which Sender normally makes payment. In that case, the security procedure may require a special verication that payment to the stated account number was intended. In the case of dollar amounts, the security procedure may require dierent codes for dierent dollar amounts. If a $1,000,000 payment order contains a code that is inappropriate for that amount, the error in amount should be detected. In the case of duplicate orders, the security procedure may require that each payment order be identied by a number or code that applies to no other order. If the number or code of each payment order received is registered in a computer base, the receiv509

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ing bank can quickly identify a duplicate order. The three cases covered by this section are essentially similar. In each, if the error is not detected, some beneciary will receive funds that the beneciary was not intended to receive. If this section applies, the risk of loss with respect to the error of the sender is shifted to the bank which has the burden of recovering the funds from the beneciary. The risk of loss is shifted to the bank only if the sender proves that the error would have been detected if there had been compliance with the procedure and that the sender (or an agent under Section 4A-206) complied. In the case of a duplicate order or a wrong beneciary, the sender doesn't have to pay the order. In the case of an overpayment, the sender does not have to pay the order to the extent of the overpayment. If subsection (a)(1) applies, the position of the receiving bank is comparable to that of a receiving bank that erroneously executes a payment order as stated in Section 4A-303. However, failure of the sender to timely report the error is covered by Section 4A-205(b) rather than by Section 4A-304 which applies only to erroneous execution under Section 4A-303. A receiving bank to which the risk of loss is shifted by subsection (a)(1) or (2) is entitled to recover the amount erroneously paid to the beneciary to the extent allowed by the law of mistake and restitution. Rights of the receiving bank against the beneciary are similar to those of a receiving bank that erroneously executes a payment order as stated in Section 4A-303. Those rights are discussed in Comment 2 to Section 4A-303. 2. A security procedure established for the purpose of detecting error is not eective unless both sender and receiving bank comply with the procedure. Thus, the bank undertakes a duty of complying with the procedure for the benet of the sender. This duty is recognized in subsection (a)(1). The loss with respect to the sender's error is shifted to the bank if the bank fails to comply with the procedure and the sender (or an agent under Section 4A-206) does comply. Although the customer may have been negligent in transmitting the erroneous payment order, the loss is put on the bank on a last-clear-chance theory. A similar analysis applies to subsection (b). If the loss with respect to an error is shifted to the receiving bank and the sender is notied by the bank that the erroneous payment order was accepted, the sender has a duty to exercise ordinary care to discover the error and notify the bank of the relevant facts within a reasonable time not exceeding 90 days. If the bank can prove that the sender failed in this duty it is entitled to compensation for the loss incurred as a result of the failure. Whether the bank is entitled to recover from the sender depends upon whether the failure to give timely notice would have made any dierence. If the bank could not have recovered from the beneciary that received payment under the erroneous payment order even if timely notice had been given, the sender's failure to notify did not cause any loss of the bank. 3. Section 4A-205 is subject to variation by agreement under Section 4A-501. Thus, if a receiving bank and its customer have agreed to a security procedure for detection of error, the liability of the receiving bank for failing to detect an error of the customer as provided in Section 4A-205 may be varied as provided in an agreement of the bank and the customer.

4A-206. Transmission of Payment Order Through FundsTransfer or Other Communication System. (a) If a payment order addressed to a receiving bank is transmitted to a funds-transfer system or other third-party communication system for transmittal to the bank, the system is deemed to be an agent of the sender for the purpose of transmitting the payment order to the bank. If there is a discrepancy between the terms of the payment order transmitted to the system and the terms of the payment order transmitted by the system to the bank, the terms of the payment order of the sender are those transmitted by the system. This section does not apply to a funds-transfer system of the Federal Reserve Banks. (b) This section applies to cancellations and amendments of payment orders to the same extent it applies to payment orders. Ocial Comment
1. A payment order may be issued to a receiving bank directly by delivery of a writing or electronic device or by an oral or electronic communication. If an agent of the sender is 510

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employed to transmit orders on behalf of the sender, the sender is bound by the order transmitted by the agent on the basis of agency law. Section 4A-206 is an application of that principle to cases in which a funds transfer or communication system acts as an intermediary in transmitting the sender's order to the receiving bank. The intermediary is deemed to be an agent of the sender for the purpose of transmitting payment orders and related messages for the sender. Section 4A-206 deals with error by the intermediary. 2. Transmission by an automated clearing house of an association of banks other than the Federal Reserve Banks is an example of a transaction covered by Section 4A-206. Suppose Originator orders Originator's Bank to cause a large number of payments to be made to many accounts in banks in various parts of the country. These payment orders are electronically transmitted to Originator's Bank and stored in an electronic device that is held by Originator's Bank. Or, transmission of the various payment orders is made by delivery to Originator's Bank of an electronic device containing the instruction to the bank. In either case the terms of the various payment orders by Originator are determined by the information contained in the electronic device. In order to execute the various orders, the information in the electronic device must be processed. For example, if some of the orders are for payments to accounts in Bank X and some to accounts in Bank Y, Originator's Bank will execute these orders of Originator by issuing a series of payment orders to Bank X covering all payments to accounts in that bank, and by issuing a series of payment orders to Bank Y covering all payments to accounts in that bank. The orders to Bank X may be transmitted together by means of an electronic device, and those to Bank Y may be included in another electronic device. Typically, this processing is done by an automated clearing house acting for a group of banks including Originator's Bank. The automated clearing house is a funds transfer system. Section 4A-105(a)(5). Originator's Bank delivers Originator's electronic device or transmits the information contained in the device to the funds transfer system for processing into payment orders of Originator's Bank to the appropriate beneciary's banks. The processing may result in an erroneous payment order. Originator's Bank, by use of Originator's electronic device, may have given information to the funds transfer system instructing payment of $100,000 to an account in Bank X, but because of human error or an equipment malfunction the processing may have converted that instruction into an instruction to Bank X to make a payment of $1,000,000. Under Section 4A-206, Originator's Bank issued a payment order for $1,000,000 to Bank X when the erroneous information was sent to Bank X. Originator's Bank is responsible for the error of the automated clearing house. The liability of the funds transfer system that made the error is not governed by Article 4A. It is left to the law of contract, a funds transfer system rule, or other applicable law. In the hypothetical case just discussed, if the automated clearing house is operated by a Federal Reserve Bank, the analysis is dierent. Section 4A-206 does not apply. Originator's Bank will execute Originator's payment orders by delivery or transmission of the electronic information to the Federal Reserve Bank for processing. The result is that Originator's Bank has issued payment orders to the Federal Reserve Bank which, in this case, is acting as an intermediary bank. When the Federal Reserve Bank has processed the information given to it by Originator's Bank it will issue payment orders to the various beneciary's banks. If the processing results in an erroneous payment order, the Federal Reserve Bank has erroneously executed the payment order of Originator's Bank and the case is governed by Section 4A-303.

4A-207. Misdescription of Beneciary. (a) Subject to subsection (b), if, in a payment order received by the beneciary's bank, the name, bank account number, or other identication of the beneciary refers to a nonexistent or unidentiable person or account, no person has rights as a beneciary of the order and acceptance of the order cannot occur. (b) If a payment order received by the beneciary's bank identies the beneciary both by name and by an identifying or bank account number and the name and number identify dierent persons, the following rules apply: (1) Except as otherwise provided in subsection (c), if the beneciary's
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bank does not know that the name and number refer to dierent persons, it may rely on the number as the proper identication of the beneciary of the order. The beneciary's bank need not determine whether the name and number refer to the same person. (2) If the beneciary's bank pays the person identied by name or knows that the name and number identify dierent persons, no person has rights as beneciary except the person paid by the beneciary's bank if that person was entitled to receive payment from the originator of the funds transfer. If no person has rights as beneciary, acceptance of the order cannot occur. (c) If (i) a payment order described in subsection (b) is accepted, (ii) the originator's payment order described the beneciary inconsistently by name and number, and (iii) the beneciary's bank pays the person identied by number as permitted by subsection (b)(1), the following rules apply: (1) If the originator is a bank, the originator is obliged to pay its order. (2) If the originator is not a bank and proves that the person identied by number was not entitled to receive payment from the originator, the originator is not obliged to pay its order unless the originator's bank proves that the originator, before acceptance of the originator's order, had notice that payment of a payment order issued by the originator might be made by the beneciary's bank on the basis of an identifying or bank account number even if it identies a person dierent from the named beneciary. Proof of notice may be made by any admissible evidence. The originator's bank satises the burden of proof if it proves that the originator, before the payment order was accepted, signed a writing stating the information to which the notice relates. (d) In a case governed by subsection (b)(1), if the beneciary's bank rightfully pays the person identied by number and that person was not entitled to receive payment from the originator, the amount paid may be recovered from that person to the extent allowed by the law governing mistake and restitution as follows: (1) If the originator is obliged to pay its payment order as stated in subsection (c), the originator has the right to recover. (2) If the originator is not a bank and is not obliged to pay its payment order, the originator's bank has the right to recover. Ocial Comment
1. Subsection (a) deals with the problem of payment orders issued to the beneciary's bank for payment to nonexistent or unidentiable persons or accounts. Since it is not possible in that case for the funds transfer to be completed, subsection (a) states that the order cannot be accepted. Under Section 4A-402(c), a sender of a payment order is not obliged to pay its order unless the beneciary's bank accepts a payment order instructing payment to the beneciary of that sender's order. Thus, if the beneciary of a funds transfer is nonexistent or unidentiable, each sender in the funds transfer that has paid its payment order is entitled to get its money back. 2. Subsection (b), which takes precedence over subsection (a), deals with the problem of payment orders in which the description of the beneciary does not allow identication of the beneciary because the beneciary is described by name and by an identifying number or an account number and the name and number refer to dierent persons. A very large percentage of payment orders issued to the beneciary's bank by another bank are processed by automated means using machines capable of reading orders on standard formats that identify the beneciary by an identifying number or the number of a bank account. The 512

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processing of the order by the beneciary's bank and the crediting of the beneciary's account are done by use of the identifying or bank account number without human reading of the payment order itself. The process is comparable to that used in automated payment of checks. The standard format, however, may also allow the inclusion of the name of the beneciary and other information which can be useful to the beneciary's bank and the beneciary but which plays no part in the process of payment. If the beneciary's bank has both the account number and name of the beneciary supplied by the originator of the funds transfer, it is possible for the beneciary's bank to determine whether the name and number refer to the same person, but if a duty to make that determination is imposed on the beneciary's bank the benets of automated payment are lost. Manual handling of payment orders is both expensive and subject to human error. If payment orders can be handled on an automated basis there are substantial economies of operation and the possibility of clerical error is reduced. Subsection (b) allows banks to utilize automated processing by allowing banks to act on the basis of the number without regard to the name if the bank does not know that the name and number refer to dierent persons. Know is dened in Section 1-201(25) to mean actual knowledge, and Section 1-201(27) states rules for determining when an organization has knowledge of information received by the organization. The time of payment is the pertinent time at which knowledge or lack of knowledge must be determined. Although the clear trend is for beneciary's banks to process payment orders by automated means, Section 4A-207 is not limited to cases in which processing is done by automated means. A bank that processes by semi-automated means or even manually may rely on number as stated in Section 4A-207. In cases covered by subsection (b) the erroneous identication would in virtually all cases be the identifying or bank account number. In the typical case the error is made by the originator of the funds transfer. The originator should know the name of the person who is to receive payment and can further identify that person by an address that would normally be known to the originator. It is not unlikely, however, that the originator may not be sure whether the identifying or account number refers to the person the originator intends to pay. Subsection (b)(1) deals with the typical case in which the beneciary's bank pays on the basis of the account number and is not aware at the time of payment that the named beneciary is not the holder of the account which was paid. In some cases the false number will be the result of error by the originator. In other cases fraud is involved. For example, Doe is the holder of shares in Mutual Fund. Thief, impersonating Doe, requests redemption of the shares and directs Mutual Fund to wire the redemption proceeds to Doe's account #12345 in Beneciary's Bank. Mutual Fund originates a funds transfer by issuing a payment order to Originator's Bank to make the payment to Doe's account #12345 in Beneciary's Bank. Originator's Bank executes the order by issuing a conforming payment order to Beneciary's Bank which makes payment to account #12345. That account is the account of Roe rather than Doe. Roe might be a person acting in concert with Thief or Roe might be an innocent third party. Assume that Roe is a gem merchant that agreed to sell gems to Thief who agreed to wire the purchase price to Roe's account in Beneciary's Bank. Roe believed that the credit to Roe's account was a transfer of funds from Thief and released the gems to Thief in good faith in reliance on the payment. The case law is unclear on the responsibility of a beneciary's bank in carrying out a payment order in which the identication of the beneciary by name and number is conicting. See Securities Fund Services, Inc. v. American National Bank, 542 F.Supp. 323 (N.D.Ill.1982) and Bradford Trust Co. v. Texas American Bank, 790 F.2d 407 (5th Cir.1986). Section 4A-207 resolves the issue. If Beneciary's Bank did not know about the conict between the name and number, subsection (b)(1) applies. Beneciary's Bank has no duty to determine whether there is a conict and it may rely on the number as the proper identication of the beneciary of the order. When it accepts the order, it is entitled to payment from Originator's Bank. Section 4A-402(b). On the other hand, if Beneciary's Bank knew about the conict between the name and number and nevertheless paid Roe, subsection (b)(2) applies. Under that provision, acceptance of the payment order of Originator's Bank did not occur because there is no beneciary of that order. Since acceptance did not occur Originator's Bank is not obliged to pay Beneciary's Bank. Section 4A-402(b). Similarly, Mutual Fund is excused from its obligation to pay Originator's Bank. Section 4A-402(c). Thus, Beneciary's Bank takes the loss. Its only cause of action is against Thief. Roe is not obliged to return the payment to 513

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the beneciary's bank because Roe received the payment in good faith and for value. Article 4A makes irrelevant the issue of whether Mutual Fund was or was not negligent in issuing its payment order. 3. Normally, subsection (b)(1) will apply to the hypothetical case discussed in Comment 2. Beneciary's Bank will pay on the basis of the number without knowledge of the conict. In that case subsection (c) places the loss on either Mutual Fund or Originator's Bank. It is not unfair to assign the loss to Mutual Fund because it is the person who dealt with the imposter and it supplied the wrong account number. It could have avoided the loss if it had not used an account number that it was not sure was that of Doe. Mutual Fund, however, may not have been aware of the risk involved in giving both name and number. Subsection (c) is designed to protect the originator, Mutual Fund, in this case. Under that subsection, the originator is responsible for the inconsistent description of the beneciary if it had notice that the order might be paid by the beneciary's bank on the basis of the number. If the originator is a bank, the originator always has that responsibility. The rationale is that any bank should know how payment orders are processed and paid. If the originator is not a bank, the originator's bank must prove that its customer, the originator, had notice. Notice can be proved by any admissible evidence, but the bank can always prove notice by providing the customer with a written statement of the required information and obtaining the customer's signature to the statement. That statement will then apply to any payment order accepted by the bank thereafter. The information need not be supplied more than once. In the hypothetical case if Originator's Bank made the disclosure stated in the last sentence of subsection (c)(2), Mutual Fund must pay Originator's Bank. Under subsection (d)(1), Mutual Fund has an action to recover from Roe if recovery from Roe is permitted by the law governing mistake and restitution. Under the assumed facts Roe should be entitled to keep the money as a person who took it in good faith and for value since it was taken as payment for the gems. In that case, Mutual Fund's only remedy is against Thief. If Roe was not acting in good faith, Roe has to return the money to Mutual Fund. If Originator's Bank does not prove that Mutual Fund had notice as stated in subsection (c)(2), Mutual Fund is not required to pay Originator's Bank. Thus, the risk of loss falls on Originator's Bank whose remedy is against Roe or Thief as stated above. Subsection (d)(2).

4A-208. Misdescription of Intermediary Bank or Beneciary's Bank. (a) This subsection applies to a payment order identifying an intermediary bank or the beneciary's bank only by an identifying number. (1) The receiving bank may rely on the number as the proper identication of the intermediary or beneciary's bank and need not determine whether the number identies a bank. (2) The sender is obliged to compensate the receiving bank for any loss and expenses incurred by the receiving bank as a result of its reliance on the number in executing or attempting to execute the order. (b) This subsection applies to a payment order identifying an intermediary bank or the beneciary's bank both by name and an identifying number if the name and number identify dierent persons. (1) If the sender is a bank, the receiving bank may rely on the number as the proper identication of the intermediary or beneciary's bank if the receiving bank, when it executes the sender's order, does not know that the name and number identify dierent persons. The receiving bank need not determine whether the name and number refer to the same person or whether the number refers to a bank. The sender is obliged to compensate the receiving bank for any loss and expenses incurred by the receiving bank as a result of its reliance on the number in executing or attempting to execute the order. (2) If the sender is not a bank and the receiving bank proves that the
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sender, before the payment order was accepted, had notice that the receiving bank might rely on the number as the proper identication of the intermediary or beneciary's bank even if it identies a person different from the bank identied by name, the rights and obligations of the sender and the receiving bank are governed by subsection (b)(1), as though the sender were a bank. Proof of notice may be made by any admissible evidence. The receiving bank satises the burden of proof if it proves that the sender, before the payment order was accepted, signed a writing stating the information to which the notice relates. (3) Regardless of whether the sender is a bank, the receiving bank may rely on the name as the proper identication of the intermediary or beneciary's bank if the receiving bank, at the time it executes the sender's order, does not know that the name and number identify dierent persons. The receiving bank need not determine whether the name and number refer to the same person. (4) If the receiving bank knows that the name and number identify dierent persons, reliance on either the name or the number in executing the sender's payment order is a breach of the obligation stated in Section 4A-302(a)(1). Ocial Comment
1. This section addresses an issue similar to that addressed by Section 4A-207. Because of automation in the processing of payment orders, a payment order may identify the beneciary's bank or an intermediary bank by an identifying number. The bank identied by number might or might not also be identied by name. The following two cases illustrate Section 4A-208(a) and (b): Case #1. Originator's payment order to Originator's Bank identies the beneciary's bank as Bank A and instructs payment to Account #12345 in that bank. Originator's Bank executes Originator's order by issuing a payment order to Intermediary Bank. In the payment order of Originator's Bank the beneciary's bank is identied as Bank A but is also identied by number, #67890. The identifying number refers to Bank B rather than Bank A. If processing by Intermediary Bank of the payment order of Originator's Bank is done by automated means, Intermediary Bank, in executing the order, will rely on the identifying number and will issue a payment order to Bank B rather than Bank A. If there is an Account #12345 in Bank B, the payment order of Intermediary Bank would normally be accepted and payment would be made to a person not intended by Originator. In this case, Section 4A-208(b)(1) puts the risk of loss on Originator's Bank. Intermediary Bank may rely on the number #67890 as the proper identication of the beneciary's bank. Intermediary Bank has properly executed the payment order of Originator's Bank. By using the wrong number to describe the beneciary's bank, Originator's Bank has improperly executed Originator's payment order because the payment order of Originator's Bank provides for payment to the wrong beneciary, the holder of Account #12345 in Bank B rather than the holder of Account #12345 in Bank A. Section 4A-302(a)(1) and Section 4A-303(c). Originator's Bank is not entitled to payment from Originator but is required to pay Intermediary Bank. Section 4A-303(c) and Section 4A-402(c). Intermediary Bank is also entitled to compensation for any loss and expenses resulting from the error by Originator's Bank. If there is no Account #12345 in Bank B, the result is that there is no beneciary of the payment order issued by Originator's Bank and the funds transfer will not be completed. Originator's Bank is not entitled to payment from Originator and Intermediary Bank is not entitled to payment from Originator's Bank. Section 4A-402(c). Since Originator's Bank improperly executed Originator's payment order it may be liable for damages under Section 4A-305. As stated above, Intermediary Bank is entitled to compensation for loss and expenses resulting from the error by Originator's Bank. Case #2. Suppose the same payment order by Originator to Originator's Bank as in Case #1. In executing the payment order Originator's Bank issues a payment order to Intermedi515

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ary Bank in which the beneciary's bank is identied only by number, #67890. That number does not refer to Bank A. Rather, it identies a person that is not a bank. If processing by Intermediary Bank of the payment order of Originator's Bank is done by automated means, Intermediary Bank will rely on the number #67890 to identify the beneciary's bank. Intermediary Bank has no duty to determine whether the number identies a bank. The funds transfer cannot be completed in this case because no bank is identied as the beneciary's bank. Subsection (a) puts the risk of loss on Originator's Bank. Originator's Bank is not entitled to payment from Originator. Section 4A-402(c). Originator's Bank has improperly executed Originator's payment order and may be liable for damages under Section 4A-305. Originator's Bank is obliged to compensate Intermediary Bank for loss and expenses resulting from the error by Originator's Bank. Subsection (a) also applies if #67890 identies a bank, but the bank is not Bank A. Intermediary Bank may rely on the number as the proper identication of the beneciary's bank. If the bank to which Intermediary Bank sends its payment order accepts the order, Intermediary Bank is entitled to payment from Originator's Bank, but Originator's Bank is not entitled to payment from Originator. The analysis is similar to that in Case #1. 2. Subsection (b)(2) of Section 4A-208 addresses cases in which an erroneous identication of a beneciary's bank or intermediary bank by name and number is made in a payment order of a sender that is not a bank. Suppose Originator issues a payment order to Originator's Bank that instructs that bank to use an intermediary bank identied as Bank A and by an identifying number, #67890. The identifying number refers to Bank B. Originator intended to identify Bank A as intermediary bank. If Originator's Bank relied on the number and issued a payment order to Bank B the rights of Originator's Bank depend upon whether the proof of notice stated in subsection (b)(2) is made by Originator's Bank. If proof is made, Originator's Bank's rights are governed by subsection (b)(1) of Section 4A208. Originator's Bank is not liable for breach of Section 4A-302(a)(1) and is entitled to compensation from Originator for any loss and expenses resulting from Originator's error. If notice is not proved, Originator's Bank may not rely on the number in executing Originator's payment order. Since Originator's Bank does not get the benet of subsection (b)(1) in that case, Originator's Bank improperly executed Originator's payment order and is in breach of the obligation stated in Section 4A-302(a)(1). If notice is not given, Originator's Bank can rely on the name if it is not aware of the conict in name and number. Subsection (b)(3). 3. Although the principal purpose of Section 4A-208 is to accommodate automated processing of payment orders, Section 4A-208 applies regardless of whether processing is done by automation, semiautomated means or manually.

4A-209. Acceptance of Payment Order. (a) Subject to subsection (d), a receiving bank other than the beneciary's bank accepts a payment order when it executes the order. (b) Subject to subsections (c) and (d), a beneciary's bank accepts a payment order at the earliest of the following times: (1) when the bank (i) pays the beneciary as stated in Section 4A-405(a) or 4A-405(b), or (ii) noties the beneciary of receipt of the order or that the account of the beneciary has been credited with respect to the order unless the notice indicates that the bank is rejecting the order or that funds with respect to the order may not be withdrawn or used until receipt of payment from the sender of the order; (2) when the bank receives payment of the entire amount of the sender's order pursuant to Section 4A-403(a)(1) or 4A-403(a)(2); or (3) the opening of the next funds-transfer business day of the bank following the payment date of the order if, at that time, the amount of the sender's order is fully covered by a withdrawable credit balance in an authorized account of the sender or the bank has otherwise received full payment from the sender, unless the order was rejected before that time
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or is rejected within (i) one hour after that time, or (ii) one hour after the opening of the next business day of the sender following the payment date if that time is later. If notice of rejection is received by the sender after the payment date and the authorized account of the sender does not bear interest, the bank is obliged to pay interest to the sender on the amount of the order for the number of days elapsing after the payment date to the day the sender receives notice or learns that the order was not accepted, counting that day as an elapsed day. If the withdrawable credit balance during that period falls below the amount of the order, the amount of interest payable is reduced accordingly. (c) Acceptance of a payment order cannot occur before the order is received by the receiving bank. Acceptance does not occur under subsection (b)(2) or (b)(3) if the beneciary of the payment order does not have an account with the receiving bank, the account has been closed, or the receiving bank is not permitted by law to receive credits for the beneciary's account. (d) A payment order issued to the originator's bank cannot be accepted until the payment date if the bank is the beneciary's bank, or the execution date if the bank is not the beneciary's bank. If the originator's bank executes the originator's payment order before the execution date or pays the beneciary of the originator's payment order before the payment date and the payment order is subsequently canceled pursuant to Section 4A211(b), the bank may recover from the beneciary any payment received to the extent allowed by the law governing mistake and restitution. Ocial Comment
1. This section treats the sender's payment order as a request by the sender to the receiving bank to execute or pay the order and that request can be accepted or rejected by the receiving bank. Section 4A-209 denes when acceptance occurs. Section 4A-210 covers rejection. Acceptance of the payment order imposes an obligation on the receiving bank to the sender if the receiving bank is not the beneciary's bank, or to the beneciary if the receiving bank is the beneciary's bank. These obligations are stated in Section 4A-302 and Section 4A-404. 2. Acceptance by a receiving bank other than the beneciary's bank is dened in Section 4A-209(a). That subsection states the only way that a bank other than the beneciary's bank can accept a payment order. A payment order to a bank other than the beneciary's bank is, in eect, a request that the receiving bank execute the sender's order by issuing a payment order to the beneciary's bank or to an intermediary bank. Normally, acceptance occurs at the time of execution, but there is an exception stated in subsection (d) and discussed in Comment 9. Execution occurs when the receiving bank issues a payment order intended to carry out the sender's order. Section 4A-301(a). In some cases the payment order issued by the receiving bank may not conform to the sender's order. For example, the receiving bank might make a mistake in the amount of its order, or the order might be issued to the wrong beneciary's bank or for the benet of the wrong beneciary. In all of these cases there is acceptance of the sender's order by the bank when the receiving bank issues its order intended to carry out the sender's order, even though the bank's payment order does not in fact carry out the instruction of the sender. Improper execution of the sender's order may lead to liability to the sender for damages or it may mean that the sender is not obliged to pay its payment order. These matters are covered in Section 4A303, Section 4A-305, and Section 4A-402. 3. A receiving bank has no duty to accept a payment order unless the bank makes an agreement, either before or after issuance of the payment order, to accept it, or acceptance is required by a funds transfer system rule. If the bank makes such an agreement it incurs a contractual obligation based on the agreement and may be held liable for breach of contract if a failure to execute violates the agreement. In many cases a bank will enter into 517

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an agreement with its customer to govern the rights and obligations of the parties with respect to payment orders issued to the bank by the customer or, in cases in which the sender is also a bank, there may be a funds transfer system rule that governs the obligations of a receiving bank with respect to payment orders transmitted over the system. Such agreements or rules can specify the circumstances under which a receiving bank is obliged to execute a payment order and can dene the extent of liability of the receiving bank for breach of the agreement or rule. Section 4A-305(d) states the liability for breach of an agreement to execute a payment order. 4. In the case of a payment order issued to the beneciary's bank, acceptance is dened in Section 4A-209(b). The function of a beneciary's bank that receives a payment order is dierent from that of a receiving bank that receives a payment order for execution. In the typical case, the beneciary's bank simply receives payment from the sender of the order, credits the account of the beneciary and noties the beneciary of the credit. Acceptance by the beneciary's bank does not create any obligation to the sender. Acceptance by the beneciary's bank means that the bank is liable to the beneciary for the amount of the order. Section 4A-404(a). There are three ways in which the beneciary's bank can accept a payment order which are described in the following comments. 5. Under Section 4A-209(b)(1), the beneciary's bank can accept a payment order by paying the beneciary. In the normal case of crediting an account of the beneciary, payment occurs when the beneciary is given notice of the right to withdraw the credit, the credit is applied to a debt of the beneciary, or funds with respect to the order are otherwise made available to the beneciary. Section 4A-405(a). The quoted phrase covers cases in which funds are made available to the beneciary as a result of receipt of a payment order for the benet of the beneciary but the release of funds is not expressed as payment of the order. For example, the beneciary's bank might express a release of funds equal to the amount of the order as a loan that will be automatically repaid when the beneciary's bank receives payment by the sender of the order. If the release of funds is designated as a loan pursuant to a routine practice of the bank, the release is conditional payment of the order rather than a loan, particularly if normal incidents of a loan such as the signing of a loan agreement or note and the payment of interest are not present. Such a release of funds is payment to the beneciary under Section 4A-405(a). Under Section 4A-405(c) the bank cannot recover the money from the beneciary if the bank does not receive payment from the sender of the payment order that it accepted. Exceptions to this rule are stated in 4A-405(d) and (e). The beneciary's bank may also accept by notifying the beneciary that the order has been received. Noties is dened in Section 1-201(26). In some cases a beneciary's bank will receive a payment order during the day but settlement of the sender's obligation to pay the order will not occur until the end of the day. If the beneciary's bank wants to defer incurring liability to the beneciary until the beneciary's bank receives payment, it can do so. The beneciary's bank incurs no liability to the beneciary with respect to a payment order that it receives until it accepts the order. If the bank does not accept pursuant to subsection (b)(1), acceptance does not occur until the end of the day when the beneciary's bank receives settlement. If the sender settles, the payment order will be accepted under subsection (b)(2) and the funds will be released to the beneciary the next morning. If the sender doesn't settle, no acceptance occurs. In either case the beneciary's bank suers no loss. 6. In most cases the beneciary's bank will receive a payment order from another bank. If the sender is a bank and the beneciary's bank receives payment from the sender by nal settlement through the Federal Reserve System or a funds transfer system (Section 4A-403(a)(1)) or, less commonly, through credit to an account of the beneciary's bank with the sender or another bank (Section 4A-403(a)(2)), acceptance by the beneciary's bank occurs at the time payment is made. Section 4A-209(b)(2). A minor exception to this rule is stated in Section 4A-209(c). Section 4A-209(b)(2) results in automatic acceptance of payment orders issued to a beneciary's bank by means of Fedwire because the Federal Reserve account of the beneciary's bank is credited and nal payment is made to that bank when the payment order is received. Subsection (b)(2) would also apply to cases in which the beneciary's bank mistakenly pays a person who is not the beneciary of the payment order issued to the beneciary's bank. For example, suppose the payment order provides for immediate payment to Account #12345. The beneciary's bank erroneously credits Account #12346 and noties the holder of that account of the credit. No acceptance occurs in this case under subsection (b)(1) 518

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because the beneciary of the order has not been paid or notied. The holder of Account #12345 is the beneciary of the order issued to the beneciary's bank. But acceptance will normally occur if the beneciary's bank takes no other action, because the bank will normally receive settlement with respect to the payment order. At that time the bank has accepted because the sender paid its payment order. The bank is liable to pay the holder of Account #12345. The bank has paid the holder of Account #12346 by mistake, and has a right to recover the payment if the credit is withdrawn, to the extent provided in the law governing mistake and restitution. 7. Subsection (b)(3) covers cases of inaction by the beneciary's bank. It applies whether or not the sender is a bank and covers a case in which the sender and the beneciary both have accounts with the receiving bank and payment will be made by debiting the account of the sender and crediting the account of the beneciary. Subsection (b)(3) is similar to subsection (b)(2) in that it bases acceptance by the beneciary's bank on payment by the sender. Payment by the sender is eected by a debit to the sender's account if the account balance is sucient to cover the amount of the order. On the payment date (Section 4A401) of the order the beneciary's bank will normally credit the beneciary's account and notify the beneciary of receipt of the order if it is satised that the sender's account balance covers the order or is willing to give credit to the sender. In some cases, however, the bank may not be willing to give credit to the sender and it may not be possible for the bank to determine until the end of the day on the payment date whether there are sucient good funds in the sender's account. There may be various transactions during the day involving funds going into and out of the account. Some of these transactions may occur late in the day or after the close of the banking day. To accommodate this situation, subsection (b)(3) provides that the status of the account is determined at the opening of the next funds transfer business day of the beneciary's bank after the payment date of the order. If the sender's account balance is sucient to cover the order, the beneciary's bank has a source of payment and the result in almost all cases is that the bank accepts the order at that time if it did not previously accept under subsection (b)(1). In rare cases, a bank may want to avoid acceptance under subsection (b)(3) by rejecting the order as discussed in Comment 8. 8. Section 4A-209 is based on a general principle that a receiving bank is not obliged to accept a payment order unless it has agreed or is bound by a funds transfer system rule to do so. Thus, provision is made to allow the receiving bank to prevent acceptance of the order. This principle is consistently followed if the receiving bank is not the beneciary's bank. If the receiving bank is not the beneciary's bank, acceptance is in the control of the receiving bank because it occurs only if the order is executed. But in the case of the beneciary's bank acceptance can occur by passive receipt of payment under subsection (b)(2) or (3). In the case of a payment made by Fedwire acceptance cannot be prevented. In other cases the beneciary's bank can prevent acceptance by giving notice of rejection to the sender before payment occurs under Section 4A-403(a)(1) or (2). A minor exception to the ability of the beneciary's bank to reject is stated in Section 4A-502(c)(3). Under subsection (b)(3) acceptance occurs at the opening of the next funds transfer business day of the beneciary's bank following the payment date unless the bank rejected the order before that time or it rejects within one hour after that time. In some cases the sender and the beneciary's bank may not be in the same time zone or the beginning of the business day of the sender and the funds transfer business day of the beneciary's bank may not coincide. For example, the sender may be located in California and the beneciary's bank in New York. Since in most cases notice of rejection would be communicated electronically or by telephone, it might not be feasible for the bank to give notice before one hour after the opening of the funds transfer business day in New York because at that hour, the sender's business day may not have started in California. For that reason, there are alternative deadlines stated in subsection (b)(3). In the case stated, the bank acts in time if it gives notice within one hour after the opening of the business day of the sender. But if the notice of rejection is received by the sender after the payment date, the bank is obliged to pay interest to the sender if the sender's account does not bear interest. In that case the bank had the use of funds of the sender that the sender could reasonably assume would be used to pay the beneciary. The rate of interest is stated in Section 4A-506. If the sender receives notice on the day after the payment date the sender is entitled to one day's interest. If receipt of notice is delayed for more than one day, the sender is entitled to interest for each additional day of delay. 519

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9. Subsection (d) applies only to a payment order by the originator of a funds transfer to the originator's bank and it refers to the following situation. On April 1, Originator instructs Bank A to make a payment on April 15 to the account of Beneciary in Bank B. By mistake, on April 1, Bank A executes Originator's payment order by issuing a payment order to Bank B instructing immediate payment to Beneciary. Bank B credited Beneciary's account and immediately released the funds to Beneciary. Under subsection (d) no acceptance by Bank A occurred on April 1 when Originator's payment order was executed because acceptance cannot occur before the execution date which in this case would be April 15 or shortly before that date. Section 4A-301(b). Under Section 4A-402(c), Originator is not obliged to pay Bank A until the order is accepted and that can't occur until the execution date. But Bank A is required to pay Bank B when Bank B accepted Bank A's order on April 1. Unless Originator and Beneciary are the same person, in almost all cases Originator is paying a debt owed to Beneciary and early payment does not injure Originator because Originator does not have to pay Bank A until the execution date. Section 4A-402(c). Bank A takes the interest loss. But suppose that on April 3, Originator concludes that no debt was owed to Beneciary or that the debt was less than the amount of the payment order. Under Section 4A-211(b) Originator can cancel its payment order if Bank A has not accepted. If early execution of Originator's payment order is acceptance, Originator can suer a loss because cancellation after acceptance is not possible without the consent of Bank A and Bank B. Section 4A-211(c). If Originator has to pay Bank A, Originator would be required to seek recovery of the money from Beneciary. Subsection (d) prevents this result and puts the risk of loss on Bank A by providing that the early execution does not result in acceptance until the execution date. Since on April 3 Originator's order was not yet accepted, Originator can cancel it under Section 4A-211(b). The result is that Bank A is not entitled to payment from Originator but is obliged to pay Bank B. Bank A has paid Beneciary by mistake. If Originator's payment order is cancelled, Bank A becomes the originator of an erroneous funds transfer to Beneciary. Bank A has the burden of recovering payment from Beneciary on the basis of a payment by mistake. If Beneciary received the money in good faith in payment of a debt owed to Beneciary by Originator, the law of mistake and restitution may allow Beneciary to keep all or part of the money received. If Originator owed money to Beneciary, Bank A has paid Originator's debt and, under the law of restitution, which applies pursuant to Section 1-103, Bank A is subrogated to Beneciary's rights against Originator on the debt. If Bank A is the Beneciary's bank and Bank A credited Beneciary's account and released the funds to Beneciary on April 1, the analysis is similar. If Originator's order is cancelled, Bank A has paid Beneciary by mistake. The right of Bank A to recover the payment from Beneciary is similar to Bank A's rights in the preceding paragraph.

4A-210. Rejection of Payment Order. (a) A payment order is rejected by the receiving bank by a notice of rejection transmitted to the sender orally, electronically, or in writing. A notice of rejection need not use any particular words and is sucient if it indicates that the receiving bank is rejecting the order or will not execute or pay the order. Rejection is eective when the notice is given if transmission is by a means that is reasonable in the circumstances. If notice of rejection is given by a means that is not reasonable, rejection is eective when the notice is received. If an agreement of the sender and receiving bank establishes the means to be used to reject a payment order, (i) any means complying with the agreement is reasonable and (ii) any means not complying is not reasonable unless no signicant delay in receipt of the notice resulted from the use of the noncomplying means. (b) This subsection applies if a receiving bank other than the beneciary's bank fails to execute a payment order despite the existence on the execution date of a withdrawable credit balance in an authorized account of the sender sucient to cover the order. If the sender does not receive notice of rejection of the order on the execution date and the authorized account of
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the sender does not bear interest, the bank is obliged to pay interest to the sender on the amount of the order for the number of days elapsing after the execution date to the earlier of the day the order is canceled pursuant to Section 4A-211(d) or the day the sender receives notice or learns that the order was not executed, counting the nal day of the period as an elapsed day. If the withdrawable credit balance during that period falls below the amount of the order, the amount of interest is reduced accordingly. (c) If a receiving bank suspends payments, all unaccepted payment orders issued to it are deemed rejected at the time the bank suspends payments. (d) Acceptance of a payment order precludes a later rejection of the order. Rejection of a payment order precludes a later acceptance of the order. Ocial Comment
1. With respect to payment orders issued to a receiving bank other than the beneciary's bank, notice of rejection is not necessary to prevent acceptance of the order. Acceptance can occur only if the receiving bank executes the order. Section 4A-209(a). But notice of rejection will routinely be given by such a bank in cases in which the bank cannot or is not willing to execute the order for some reason. There are many reasons why a bank doesn't execute an order. The payment order may not clearly instruct the receiving bank because of some ambiguity in the order or an internal inconsistency. In some cases, the receiving bank may not be able to carry out the instruction because of equipment failure, credit limitations on the receiving bank, or some other factor which makes proper execution of the order infeasible. In those cases notice of rejection is a means of informing the sender of the facts so that a corrected payment order can be transmitted or the sender can seek alternate means of completing the funds transfer. The other major reason for not executing an order is that the sender's account is insucient to cover the order and the receiving bank is not willing to give credit to the sender. If the sender's account is sucient to cover the order and the receiving bank chooses not to execute the order, notice of rejection is necessary to prevent liability to pay interest to the sender if the case falls within Section 4A-210(b) which is discussed in Comment 3. 2. A payment order to the beneciary's bank can be accepted by inaction of the bank. Section 4A-209(b)(2) and (3). To prevent acceptance under those provisions it is necessary for the receiving bank to send notice of rejection before acceptance occurs. Subsection (a) of Section 4A-210 states the rule that rejection is accomplished by giving notice of rejection. This incorporates the denitions in Section 1-201(26). Rejection is eective when notice is given if it is given by a means that is reasonable in the circumstances. Otherwise, it is effective when the notice is received. The question of when rejection is eective is important only in the relatively few cases under subsection (b)(2) and (3) in which a notice of rejection is necessary to prevent acceptance. The question of whether a particular means is reasonable depends on the facts in a particular case. In a very large percentage of cases the sender and the receiving bank will be in direct electronic contact with each other and in those cases a notice of rejection can be transmitted instantaneously. Since time is of the essence in a large proportion of funds transfers, some quick means of transmission would usually be required, but this is not always the case. The parties may specify by agreement the means by which communication between the parties is to be made. 3. Subsection (b) deals with cases in which a sender does not learn until after the execution date that the sender's order has not been executed. It applies only to cases in which the receiving bank was assured of payment because the sender's account was sucient to cover the order. Normally, the receiving bank will accept the sender's order if it is assured of payment, but there may be some cases in which the bank chooses to reject. Unless the receiving bank had obligated itself by agreement to accept, the failure to accept is not wrongful. There is no duty of the receiving bank to accept the payment order unless it is obliged to accept by express agreement. Section 4A-212. But even if the bank has not acted wrongfully, the receiving bank had the use of the sender's money that the sender could rea521

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sonably assume was to be the source of payment of the funds transfer. Until the sender learns that the order was not accepted the sender is denied the use of that money. Subsection (b) obliges the receiving bank to pay interest to the sender as restitution unless the sender receives notice of rejection on the execution date. The time of receipt of notice is determined pursuant to 1-201(27). The rate of interest is stated in Section 4A-506. If the sender receives notice on the day after the execution date, the sender is entitled to one day's interest. If receipt of notice is delayed for more than one day, the sender is entitled to interest for each additional day of delay. 4. Subsection (d) treats acceptance and rejection as mutually exclusive. If a payment order has been accepted, rejection of that order becomes impossible. If a payment order has been rejected it cannot be accepted later by the receiving bank. Once notice of rejection has been given, the sender may have acted on the notice by making the payment through other channels. If the receiving bank wants to act on a payment order that it has rejected it has to obtain the consent of the sender. In that case the consent of the sender would amount to the giving of a second payment order that substitutes for the rejected rst order. If the receiving bank suspends payments (Section 4-104(1)(k)), subsection (c) provides that unaccepted payment orders are deemed rejected at the time suspension of payments occurs. This prevents acceptance by passage of time under Section 4A-209(b)(3).

4A-211. Cancellation and Amendment of Payment Order. (a) A communication of the sender of a payment order cancelling or amending the order may be transmitted to the receiving bank orally, electronically, or in writing. If a security procedure is in eect between the sender and the receiving bank, the communication is not eective to cancel or amend the order unless the communication is veried pursuant to the security procedure or the bank agrees to the cancellation or amendment. (b) Subject to subsection (a), a communication by the sender cancelling or amending a payment order is eective to cancel or amend the order if notice of the communication is received at a time and in a manner aording the receiving bank a reasonable opportunity to act on the communication before the bank accepts the payment order. (c) After a payment order has been accepted, cancellation or amendment of the order is not eective unless the receiving bank agrees or a fundstransfer system rule allows cancellation or amendment without agreement of the bank. (1) With respect to a payment order accepted by a receiving bank other than the beneciary's bank, cancellation or amendment is not effective unless a conforming cancellation or amendment of the payment order issued by the receiving bank is also made. (2) With respect to a payment order accepted by the beneciary's bank, cancellation or amendment is not eective unless the order was issued in execution of an unauthorized payment order, or because of a mistake by a sender in the funds transfer which resulted in the issuance of a payment order (i) that is a duplicate of a payment order previously issued by the sender, (ii) that orders payment to a beneciary not entitled to receive payment from the originator, or (iii) that orders payment in an amount greater than the amount the beneciary was entitled to receive from the originator. If the payment order is canceled or amended, the beneciary's bank is entitled to recover from the beneciary any amount paid to the beneciary to the extent allowed by the law governing mistake and restitution. (d) An unaccepted payment order is canceled by operation of law at the
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close of the fth funds-transfer business day of the receiving bank after the execution date or payment date of the order. (e) A canceled payment order cannot be accepted. If an accepted payment order is canceled, the acceptance is nullied and no person has any right or obligation based on the acceptance. Amendment of a payment order is deemed to be cancellation of the original order at the time of amendment and issue of a new payment order in the amended form at the same time. (f) Unless otherwise provided in an agreement of the parties or in a funds-transfer system rule, if the receiving bank, after accepting a payment order, agrees to cancellation or amendment of the order by the sender or is bound by a funds-transfer system rule allowing cancellation or amendment without the bank's agreement, the sender, whether or not cancellation or amendment is eective, is liable to the bank for any loss and expenses, including reasonable attorney's fees, incurred by the bank as a result of the cancellation or amendment or attempted cancellation or amendment. (g) A payment order is not revoked by the death or legal incapacity of the sender unless the receiving bank knows of the death or of an adjudication of incapacity by a court of competent jurisdiction and has reasonable opportunity to act before acceptance of the order. (h) A funds-transfer system rule is not eective to the extent it conicts with subsection (c)(2). Ocial Comment
1. This section deals with cancellation and amendment of payment orders. It states the conditions under which cancellation or amendment is both eective and rightful. There is no concept of wrongful cancellation or amendment of a payment order. If the conditions stated in this section are not met the attempted cancellation or amendment is not eective. If the stated conditions are met the cancellation or amendment is eective and rightful. The sender of a payment order may want to withdraw or change the order because the sender has had a change of mind about the transaction or because the payment order was erroneously issued or for any other reason. One common situation is that of multiple transmission of the same order. The sender that mistakenly transmits the same order twice wants to correct the mistake by cancelling the duplicate order. Or, a sender may have intended to order a payment of $1,000,000 but mistakenly issued an order to pay $10,000,000. In this case the sender might try to correct the mistake by cancelling the order and issuing another order in the proper amount. Or, the mistake could be corrected by amending the order to change it to the proper amount. Whether the error is corrected by amendment or cancellation and reissue the net result is the same. This result is stated in the last sentence of subsection (e). 2. Subsection (a) allows a cancellation or amendment of a payment order to be communicated to the receiving bank orally, electronically, or in writing. The quoted phrase is consistent with the language of Section 4A-103(a) applicable to payment orders. Cancellations and amendments are normally subject to verication pursuant to security procedures to the same extent as payment orders. Subsection (a) recognizes this fact by providing that in cases in which there is a security procedure in eect between the sender and the receiving bank the bank is not bound by a communication cancelling or amending an order unless verication has been made. This is necessary to protect the bank because under subsection (b) a cancellation or amendment can be eective by unilateral action of the sender. Without verication the bank cannot be sure whether the communication was or was not eective to cancel or amend a previously veried payment order. 3. If the receiving bank has not yet accepted the order, there is no reason why the sender should not be able to cancel or amend the order unilaterally so long as the requirements of subsections (a) and (b) are met. If the receiving bank has accepted the order, it is possible to cancel or amend but only if the requirements of subsection (c) are met. 523

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First consider the case of a receiving bank other than the beneciary's bank. If the bank has not yet accepted the order, the sender can unilaterally cancel or amend. The communication amending or cancelling the payment order must be received in time to allow the bank to act on it before the bank issues its payment order in execution of the sender's order. The time that the sender's communication is received is governed by Section 4a-106. If a payment order does not specify a delayed payment date or execution date, the order will normally be executed shortly after receipt. Thus, as a practical matter, the sender will have very little time in which to instruct cancellation or amendment before acceptance. In addition, a receiving bank will normally have cut-o times for receipt of such communications, and the receiving bank is not obliged to act on communications received after the cuto hour. Cancellation by the sender after execution of the order by the receiving bank requires the agreement of the bank unless a funds transfer rule otherwise provides. Subsection (c). Although execution of the sender's order by the receiving bank does not itself impose liability on the receiving bank (under Section 4A-402 no liability is incurred by the receiving bank to pay its order until it is accepted), it would commonly be the case that acceptance follows shortly after issuance. Thus, as a practical matter, a receiving bank that has executed a payment order will incur a liability to the next bank in the chain before it would be able to act on the cancellation request of its customer. It is unreasonable to impose on the receiving bank a risk of loss with respect to a cancellation request without the consent of the receiving bank. The statute does not state how or when the agreement of the receiving bank must be obtained for cancellation after execution. The receiving bank's consent could be obtained at the time cancellation occurs or it could be based on a preexisting agreement. Or, a funds transfer system rule could provide that cancellation can be made unilaterally by the sender. By virtue of that rule any receiving bank covered by the rule is bound. Section 4A-501. If the receiving bank has already executed the sender's order, the bank would not consent to cancellation unless the bank to which the receiving bank has issued its payment order consents to cancellation of that order. It makes no sense to allow cancellation of a payment order unless all subsequent payment orders in the funds transfer that were issued because of the cancelled payment order are also cancelled. Under subsection (c)(1), if a receiving bank consents to cancellation of the payment order after it has executed, the cancellation is not eective unless the receiving bank also cancels the payment order issued by the bank. 4. With respect to a payment order issued to the beneciary's bank, acceptance is particularly important because it creates liability to pay the beneciary, it denes when the originator pays its obligation to the beneciary, and it denes when any obligation for which the payment is made is discharged. Since acceptance aects the rights of the originator and the beneciary it is not appropriate to allow the beneciary's bank to agree to cancellation or amendment except in unusual cases. Except as provided in subsection (c)(2), cancellation or amendment after acceptance by the beneciary's bank is not possible unless all parties aected by the order agree. Under subsection (c)(2), cancellation or amendment is possible only in the four cases stated. The following examples illustrate subsection (c)(2): Case #1. Originator's Bank executed a payment order issued in the name of its customer as sender. The order was not authorized by the customer and was fraudulently issued. Beneciary's Bank accepted the payment order issued by Originator's Bank. Under subsection (c)(2) Originator's Bank can cancel the order if Beneciary's Bank consents. It doesn't make any dierence whether the payment order that Originator's Bank accepted was or was not enforceable against the customer under Section 4A-202(b). Verication under that provision is important in determining whether Originator's Bank or the customer has the risk of loss, but it has no relevance under Section 4A-211(c)(2). Whether or not veried, the payment order was not authorized by the customer. Cancellation of the payment order to Beneciary's Bank causes the acceptance of Beneciary's Bank to be nullied. Subsection (e). Beneciary's Bank is entitled to recover payment from the beneciary to the extent allowed by the law of mistake and restitution. In this kind of case the beneciary is usually a party to the fraud who has no right to receive or retain payment of the order. Case #2. Originator owed Beneciary $1,000,000 and ordered Bank A to pay that amount to the account of Beneciary in Bank B. Bank A issued a complying order to Bank B, but by mistake issued a duplicate order as well. Bank B accepted both orders. Under subsection (c)(2)(i) cancellation of the duplicate order could be made by Bank A with the consent of Bank B. Beneciary has no right to receive or retain payment of the duplicate payment order if only $1,000,000 was owed by Originator to Beneciary. If Originator owed $2,000,000 524

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to Beneciary, the law of restitution might allow Beneciary to retain the $1,000,000 paid by Bank B on the duplicate order. In that case Bank B is entitled to reimbursement from Bank A under subsection (f). Case #3. Originator owed $1,000,000 to X. Intending to pay X, Originator ordered Bank A to pay $1,000,000 to Y's account in Bank B. Bank A issued a complying payment order to Bank B which Bank B accepted by releasing the $1,000,000 to Y. Under subsection (c)(2)(ii) Bank A can cancel its payment order to Bank B with the consent of Bank B if Y was not entitled to receive payment from Originator. Originator can also cancel its order to Bank A with Bank A's consent. Subsection (c)(1). Bank B may recover the $1,000,000 from Y unless the law of mistake and restitution allows Y to retain some or all of the amount paid. If no debt was owed to Y, Bank B should have a right of recovery. Case #4. Originator owed Beneciary $10,000. By mistake Originator ordered Bank A to pay $1,000,000 to the account of Beneciary in Bank B. Bank A issued a complying order to Bank B which accepted by notifying Beneciary of its right to withdraw $1,000,000. Cancellation is permitted in this case under subsection (c)(2)(iii). If Bank B paid Beneciary it is entitled to recover the payment except to the extent the law of mistake and restitution allows Beneciary to retain payment. In this case Beneciary might be entitled to retain $10,000, the amount of the debt owed to Beneciary. If Beneciary may retain $10,000, Bank B would be entitled to $10,000 from Bank A pursuant to subsection (f). In this case Originator also cancelled its order. Thus Bank A would be entitled to $10,000 from Originator pursuant to subsection (f). 5. Unless constrained by a funds transfer system rule, a receiving bank may agree to cancellation or amendment of the payment order under subsection (c) but is not required to do so regardless of the circumstances. If the receiving bank has incurred liability as a result of its acceptance of the sender's order, there are substantial risks in agreeing to cancellation or amendment. This is particularly true for a beneciary's bank. Cancellation or amendment after acceptance by the beneciary's bank can be made only in the four cases stated and the beneciary's bank may not have any way of knowing whether the requirements of subsection (c) have been met or whether it will be able to recover payment from the beneciary that received payment. Even with indemnity the beneciary's bank may be reluctant to alienate its customer, the beneciary, by denying the customer the funds. Subsection (c) leaves the decision to the beneciary's bank unless the consent of the beneciary's bank is not required under a funds transfer system rule or other interbank agreement. If a receiving bank agrees to cancellation or amendment under subsection (c)(1) or (2), it is automatically entitled to indemnication from the sender under subsection (f). The indemnication provision recognizes that a sender has no right to cancel a payment order after it is accepted by the receiving bank. If the receiving bank agrees to cancellation, it is doing so as an accommodation to the sender and it should not incur a risk of loss in doing so. 6. Acceptance by the receiving bank of a payment order issued by the sender is comparable to acceptance of an oer under the law of contracts. Under that law the death or legal incapacity of an oeror terminates the oer even though the oeree has no notice of the death or incapacity. Restatement Second, Contracts 48. Comment a. to that section states that the rule seems to be a relic of the obsolete view that a contract requires a meeting of minds, and it is out of harmony with the modern doctrine that a manifestation of assent is eective without regard to actual mental assent. Subsection (g), which reverses the Restatement rule in the case of a payment order, is similar to Section 4-405(1) which applies to checks. Subsection (g) does not address the eect of the bankruptcy of the sender of a payment order before the order is accepted, but the principle of subsection (g) has been recognized in Bank of Marin v. England, 385 U.S. 99 (1966). Although Bankruptcy Code Section 542(c) may not have been drafted with wire transfers in mind, its language can be read to allow the receiving bank to charge the sender's account for the amount of the payment order if the receiving bank executed it in ignorance of the bankruptcy. 7. Subsection (d) deals with stale payment orders. Payment orders normally are executed on the execution date or the day after. An order issued to the beneciary's bank is normally accepted on the payment date or the day after. If a payment order is not accepted on its execution or payment date or shortly thereafter, it is probable that there was some problem with the terms of the order or the sender did not have sucient funds or credit to cover the amount of the order. Delayed acceptance of such an order is normally not contemplated, but the order may not have been cancelled by the sender. Subsection (d) provides for 525

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cancellation by operation of law to prevent an unexpected delayed acceptance. 8. A funds transfer system rule can govern rights and obligations between banks that are parties to payment orders transmitted over the system even if the rule conicts with Article 4A. In some cases, however, a rule governing a transaction between two banks can aect a third party in an unacceptable way. Subsection (h) deals with such a case. A funds transfer system rule cannot allow cancellation of a payment order accepted by the beneciary's bank if the rule conicts with subsection (c)(2). Because rights of the beneciary and the originator are directly aected by acceptance, subsection (c)(2) severely limits cancellation. These limitations cannot be altered by funds transfer system rule.

4A-212. Liability and Duty of Receiving Bank Regarding Unaccepted Payment Order. If a receiving bank fails to accept a payment order that it is obliged by express agreement to accept, the bank is liable for breach of the agreement to the extent provided in the agreement or in this Article, but does not otherwise have any duty to accept a payment order or, before acceptance, to take any action, or refrain from taking action, with respect to the order except as provided in this Article or by express agreement. Liability based on acceptance arises only when acceptance occurs as stated in Section 4A209, and liability is limited to that provided in this Article. A receiving bank is not the agent of the sender or beneciary of the payment order it accepts, or of any other party to the funds transfer, and the bank owes no duty to any party to the funds transfer except as provided in this Article or by express agreement. Ocial Comment
With limited exceptions stated in this Article, the duties and obligations of receiving banks that carry out a funds transfer arise only as a result of acceptance of payment orders or of agreements made by receiving banks. Exceptions are stated in Section 4A-209(b)(3) and Section 4A-210(b). A receiving bank is not like a collecting bank under Article 4. No receiving bank, whether it be an originator's bank, an intermediary bank or a beneciary's bank, is an agent for any other party in the funds transfer.

PART 3. EXECUTION OF SENDER'S PAYMENT ORDER BY RECEIVING BANK

4A-301. Execution and Execution Date. (a) A payment order is executed by the receiving bank when it issues a payment order intended to carry out the payment order received by the bank. A payment order received by the beneciary's bank can be accepted but cannot be executed. (b) Execution date of a payment order means the day on which the receiving bank may properly issue a payment order in execution of the sender's order. The execution date may be determined by instruction of the sender but cannot be earlier than the day the order is received and, unless otherwise determined, is the day the order is received. If the sender's instruction states a payment date, the execution date is the payment date or an earlier date on which execution is reasonably necessary to allow payment to the beneciary on the payment date. Ocial Comment
1. The terms executed, execution and execution date are used only with respect to a payment order to a receiving bank other than the beneciary's bank. The beneciary's bank 526

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can accept the payment order that it receives, but it does not execute the order. Execution refers to the act of the receiving bank in issuing a payment order intended to carry out the payment order that the bank received. A receiving bank has executed an order even if the order issued by the bank does not carry out the order received by the bank. For example, the bank may have erroneously issued an order to the wrong beneciary, or in the wrong amount or to the wrong beneciary's bank. In each of these cases execution has occurred but the execution is erroneous. Erroneous execution is covered in Section 4A-303. 2. Execution date refers to the time a payment order should be executed rather than the day it is actually executed. Normally the sender will not specify an execution date, but most payment orders are meant to be executed immediately. Thus, the execution date is normally the day the order is received by the receiving bank. It is common for the sender to specify a payment date which is dened in Section 4A-401 as the day on which the amount of the order is payable to the beneciary by the beneciary's bank. Except for automated clearing house transfers, if a funds transfer is entirely within the United States and the payment is to be carried out electronically, the execution date is the payment date unless the order is received after the payment date. If the payment is to be carried out through an automated clearing house, execution may occur before the payment date. In an ACH transfer the beneciary is usually paid one or two days after issue of the originator's payment order. The execution date is determined by the stated payment date and is a day before the payment date on which execution is reasonably necessary to allow payment on the payment date. A funds transfer system rule could also determine the execution date of orders received by the receiving bank if both the sender and the receiving bank are participants in the funds transfer system. The execution date can be determined by the payment order itself or by separate instructions of the sender or an agreement of the sender and the receiving bank. The second sentence of subsection (b) must be read in the light of Section 4A-106 which states that if a payment order is received after the cut-o time of the receiving bank it may be treated by the bank as received at the opening of the next funds transfer business day. 3. Execution on the execution date is timely, but the order can be executed before or after the execution date. Section 4A-209(d) and Section 4A-402(c) state the consequences of early execution and Section 4A-305(a) states the consequences of late execution.

4A-302. Obligations of Receiving Bank in Execution of Payment Order. (a) Except as provided in subsections (b) through (d), if the receiving bank accepts a payment order pursuant to Section 4A-209(a), the bank has the following obligations in executing the order: (1) The receiving bank is obliged to issue, on the execution date, a payment order complying with the sender's order and to follow the sender's instructions concerning (i) any intermediary bank or funds-transfer system to be used in carrying out the funds transfer, or (ii) the means by which payment orders are to be transmitted in the funds transfer. If the originator's bank issues a payment order to an intermediary bank, the originator's bank is obliged to instruct the intermediary bank according to the instruction of the originator. An intermediary bank in the funds transfer is similarly bound by an instruction given to it by the sender of the payment order it accepts. (2) If the sender's instruction states that the funds transfer is to be carried out telephonically or by wire transfer or otherwise indicates that the funds transfer is to be carried out by the most expeditious means, the receiving bank is obliged to transmit its payment order by the most expeditious available means, and to instruct any intermediary bank accordingly. If a sender's instruction states a payment date, the receiving bank is obliged to transmit its payment order at a time and by means reasonably necessary to allow payment to the beneciary on the payment date or as soon thereafter as is feasible.
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(b) Unless otherwise instructed, a receiving bank executing a payment order may (i) use any funds-transfer system if use of that system is reasonable in the circumstances, and (ii) issue a payment order to the beneciary's bank or to an intermediary bank through which a payment order conforming to the sender's order can expeditiously be issued to the beneciary's bank if the receiving bank exercises ordinary care in the selection of the intermediary bank. A receiving bank is not required to follow an instruction of the sender designating a funds-transfer system to be used in carrying out the funds transfer if the receiving bank, in good faith, determines that it is not feasible to follow the instruction or that following the instruction would unduly delay completion of the funds transfer. (c) Unless subsection (a)(2) applies or the receiving bank is otherwise instructed, the bank may execute a payment order by transmitting its payment order by rst class mail or by any means reasonable in the circumstances. If the receiving bank is instructed to execute the sender's order by transmitting its payment order by a particular means, the receiving bank may issue its payment order by the means stated or by any means as expeditious as the means stated. (d) Unless instructed by the sender, (i) the receiving bank may not obtain payment of its charges for services and expenses in connection with the execution of the sender's order by issuing a payment order in an amount equal to the amount of the sender's order less the amount of the charges, and (ii) may not instruct a subsequent receiving bank to obtain payment of its charges in the same manner. Ocial Comment
1. In the absence of agreement, the receiving bank is not obliged to execute an order of the sender. Section 4A-212. Section 4A-302 states the manner in which the receiving bank may execute the sender's order if execution occurs. Subsection (a)(1) states the residual rule. The payment order issued by the receiving bank must comply with the sender's order and, unless some other rule is stated in the section, the receiving bank is obliged to follow any instruction of the sender concerning which funds transfer system is to be used, which intermediary banks are to be used, and what means of transmission is to be used. The instruction of the sender may be incorporated in the payment order itself or may be given separately. For example, there may be a master agreement between the sender and receiving bank containing instructions governing payment orders to be issued from time to time by the sender to the receiving bank. In most funds transfers, speed is a paramount consideration. A sender that wants assurance that the funds transfer will be expeditiously completed can specify the means to be used. The receiving bank can follow the instructions literally or it can use an equivalent means. For example, if the sender instructs the receiving bank to transmit by telex, the receiving bank could use telephone instead. Subsection (c). In most cases the sender will not specify a particular means but will use a general term such as by wire or wire transfer or as soon as possible. These words signify that the sender wants a same-day transfer. In these cases the receiving bank is required to use a telephonic or electronic communication to transmit its order and is also required to instruct any intermediary bank to which it issues its order to transmit by similar means. Subsection (a)(2). In other cases, such as an automated clearing house transfer, a same-day transfer is not contemplated. Normally the sender's instruction or the context in which the payment order is received makes clear the type of funds transfer that is appropriate. If the sender states a payment date with respect to the payment order, the receiving bank is obliged to execute the order at a time and in a manner to meet the payment date if that is feasible. Subsection (a)(2). This provision would apply to many ACH transfers made to pay recurring debts of the sender. In other cases, involving relatively small amounts, time may not be an important factor and cost may be a more important element. Fast means, such as telephone or electronic transmission, are more expensive than slow means such as mailing. 528

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Subsection (c) states that in the absence of instructions the receiving bank is given discretion to decide. It may issue its payment order by rst class mail or by any means reasonable in the circumstances. Section 4A-305 states the liability of a receiving bank for breach of the obligations stated in Section 4A-302. 2. Subsection (b) concerns the choice of intermediary banks to be used in completing the funds transfer, and the funds transfer system to be used. If the receiving bank is not instructed about the matter, it can issue an order directly to the beneciary's bank or can issue an order to an intermediary bank. The receiving bank also has discretion concerning use of a funds transfer system. In some cases it may be reasonable to use either an automated clearing house system or a wire transfer system such as Fedwire or CHIPS. Normally, the receiving bank will follow the instruction of the sender in these matters, but in some cases it may be prudent for the bank not to follow instructions. The sender may have designated a funds transfer system to be used in carrying out the funds transfer, but it may not be feasible to use the designated system because of some impediment such as a computer breakdown which prevents prompt execution of the order. The receiving bank is permitted to use an alternate means of transmittal in a good faith eort to execute the order expeditiously. The same leeway is not given to the receiving bank if the sender designates an intermediary bank through which the funds transfer is to be routed. The sender's designation of that intermediary bank may mean that the beneciary's bank is expecting to obtain a credit from that intermediary bank and may have relied on that anticipated credit. If the receiving bank uses another intermediary bank the expectations of the beneciary's bank may not be realized. The receiving bank could choose to route the transfer to another intermediary bank and then to the designated intermediary bank if there were some reason such as a lack of a correspondent-bank relationship or a bilateral credit limitation, but the designated intermediary bank cannot be circumvented. To do so violates the sender's instructions. 3. The normal rule, under subsection (a)(1), is that the receiving bank, in executing a payment order, is required to issue a payment order that complies as to amount with that of the sender's order. In most cases the receiving bank issues an order equal to the amount of the sender's order and makes a separate charge for services and expenses in executing the sender's order. In some cases, particularly if it is an intermediary bank that is executing an order, charges are collected by deducting them from the amount of the payment order issued by the executing bank. If that is done, the amount of the payment order accepted by the beneciary's bank will be slightly less than the amount of the originator's payment order. For example, Originator, in order to pay an obligation of $1,000,000 owed to Beneciary, issues a payment order to Originator's Bank to pay $1,000,000 to the account of Beneciary in Beneciary's Bank. Originator's Bank issues a payment order to Intermediary Bank for $1,000,000 and debits Originator's account for $1,000,010. The extra $10 is the fee of Originator's Bank. Intermediary Bank executes the payment order of Originator's Bank by issuing a payment order to Beneciary's Bank for $999,990, but under 4A-402(c) is entitled to receive $1,000,000 from Originator's Bank. The $10 dierence is the fee of Intermediary Bank. Beneciary's Bank credits Beneciary's account for $999,990. When Beneciary's Bank accepts the payment order of Intermediary Bank the result is a payment of $999,990 from Originator to Beneciary. Section 4A-406(a). If that payment discharges the $1,000,000 debt, the eect is that Beneciary has paid the charges of Intermediary Bank and Originator has paid the charges of Originator's Bank. Subsection (d) of Section 4A-302 allows Intermediary Bank to collect its charges by deducting them from the amount of the payment order, but only if instructed to do so by Originator's Bank. Originator's Bank is not authorized to give that instruction to Intermediary Bank unless Originator authorized the instruction. Thus, Originator can control how the charges of Originator's Bank and Intermediary Bank are to be paid. Subsection (d) does not apply to charges of Beneciary's Bank to Beneciary. In the case discussed in the preceding paragraph the $10 charge is trivial in relation to the amount of the payment and it may not be important to Beneciary how the charge is paid. But it may be very important if the $1,000,000 obligation represented the price of exercising a right such as an option favorable to Originator and unfavorable to Beneciary. Beneciary might well argue that it was entitled to receive $1,000,000. If the option was exercised shortly before its expiration date, the result could be loss of the option benet because the required payment of $1,000,000 was not made before the option expired. Section 4A-406(c) allows Originator to preserve the option benet. The amount received by 529

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Beneciary is deemed to be $1,000,000 unless Beneciary demands the $10 and Originator does not pay it.

4A-303. Erroneous Execution of Payment Order. (a) A receiving bank that (i) executes the payment order of the sender by issuing a payment order in an amount greater than the amount of the sender's order, or (ii) issues a payment order in execution of the sender's order and then issues a duplicate order, is entitled to payment of the amount of the sender's order under Section 4A-402(c) if that subsection is otherwise satised. The bank is entitled to recover from the beneciary of the erroneous order the excess payment received to the extent allowed by the law governing mistake and restitution. (b) A receiving bank that executes the payment order of the sender by issuing a payment order in an amount less than the amount of the sender's order is entitled to payment of the amount of the sender's order under Section 4A-402(c) if (i) that subsection is otherwise satised and (ii) the bank corrects its mistake by issuing an additional payment order for the benet of the beneciary of the sender's order. If the error is not corrected, the issuer of the erroneous order is entitled to receive or retain payment from the sender of the order it accepted only to the extent of the amount of the erroneous order. This subsection does not apply if the receiving bank executes the sender's payment order by issuing a payment order in an amount less than the amount of the sender's order for the purpose of obtaining payment of its charges for services and expenses pursuant to instruction of the sender. (c) If a receiving bank executes the payment order of the sender by issuing a payment order to a beneciary dierent from the beneciary of the sender's order and the funds transfer is completed on the basis of that error, the sender of the payment order that was erroneously executed and all previous senders in the funds transfer are not obliged to pay the payment orders they issued. The issuer of the erroneous order is entitled to recover from the beneciary of the order the payment received to the extent allowed by the law governing mistake and restitution. Ocial Comment
1. Section 4A-303 states the eect of erroneous execution of a payment order by the receiving bank. Under Section 4A-402(c) the sender of a payment order is obliged to pay the amount of the order to the receiving bank if the bank executes the order, but the obligation to pay is excused if the beneciary's bank does not accept a payment order instructing payment to the beneciary of the sender's order. If erroneous execution of the sender's order causes the wrong beneciary to be paid, the sender is not required to pay. If erroneous execution causes the wrong amount to be paid the sender is not obliged to pay the receiving bank an amount in excess of the amount of the sender's order. Section 4A-303 takes precedence over Section 4A-402(c) and states the liability of the sender and the rights of the receiving bank in various cases of erroneous execution. 2. Subsections (a) and (b) deal with cases in which the receiving bank executes by issuing a payment order in the wrong amount. If Originator ordered Originator's Bank to pay $1,000,000 to the account of Beneciary in Beneciary's Bank, but Originator's Bank erroneously instructed Beneciary's Bank to pay $2,000,000 to Beneciary's account, subsection (a) applies. If Beneciary's Bank accepts the order of Originator's Bank, Beneciary's Bank is entitled to receive $2,000,000 from Originator's Bank, but Originator's Bank is entitled to receive only $1,000,000 from Originator. Originator's Bank is entitled to recover the overpayment from Beneciary to the extent allowed by the law governing mistake and restitution. Originator's Bank would normally have a right to recover the overpayment 530

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from Beneciary, but in unusual cases the law of restitution might allow Beneciary to keep all or part of the overpayment. For example, if Originator owed $2,000,000 to Beneciary and Beneciary received the extra $1,000,000 in good faith in discharge of the debt, Beneciary may be allowed to keep it. In this case Originator's Bank has paid an obligation of Originator and under the law of restitution, which applies through Section 1-103, Originator's Bank would be subrogated to Beneciary's rights against Originator on the obligation paid by Originator's Bank. If Originator's Bank erroneously executed Originator's order by instructing Beneciary's Bank to pay less than $1,000,000, subsection (b) applies. If Originator's Bank corrects its error by issuing another payment order to Beneciary's Bank that results in payment of $1,000,000 to Beneciary, Originator's Bank is entitled to payment of $1,000,000 from Originator. If the mistake is not corrected, Originator's Bank is entitled to payment from Originator only in the amount of the order issued by Originator's Bank. 3. Subsection (a) also applies to duplicate payment orders. Assume Originator's Bank properly executes Originator's $1,000,000 payment order and then by mistake issues a second $1,000,000 payment order in execution of Originator's order. If Beneciary's Bank accepts both orders issued by Originator's Bank, Beneciary's Bank is entitled to receive $2,000,000 from Originator's Bank but Originator's Bank is entitled to receive only $1,000,000 from Originator. The remedy of Originator's Bank is the same as that of a receiving bank that executes by issuing an order in an amount greater than the sender's order. It may recover the overpayment from Beneciary to the extent allowed by the law governing mistake and restitution and in a proper case as stated in Comment 2 may have subrogation rights if it is not entitled to recover from Beneciary. 4. Suppose Originator instructs Originator's Bank to pay $1,000,000 to Account #12345 in Beneciary's Bank. Originator's Bank erroneously instructs Beneciary's Bank to pay $1,000,000 to Account #12346 and Beneciary's Bank accepted. Subsection (c) covers this case. Originator is not obliged to pay its payment order, but Originator's Bank is required to pay $1,000,000 to Beneciary's Bank. The remedy of Originator's Bank is to recover $1,000,000 from the holder of Account #12346 that received payment by mistake. Recovery based on the law of mistake and restitution is described in Comment 2.

4A-304. Duty of Sender to Report Erroneously Executed Payment Order. If the sender of a payment order that is erroneously executed as stated in Section 4A-303 receives notication from the receiving bank that the order was executed or that the sender's account was debited with respect to the order, the sender has a duty to exercise ordinary care to determine, on the basis of information available to the sender, that the order was erroneously executed and to notify the bank of the relevant facts within a reasonable time not exceeding 90 days after the notication from the bank was received by the sender. If the sender fails to perform that duty, the bank is not obliged to pay interest on any amount refundable to the sender under Section 4A-402(d) for the period before the bank learns of the execution error. The bank is not entitled to any recovery from the sender on account of a failure by the sender to perform the duty stated in this section. Ocial Comment
This section is identical in eect to Section 4A-204 which applies to unauthorized orders issued in the name of a customer of the receiving bank. The rationale is stated in Comment 2 to Section 4A-204.

4A-305. Liability for Late or Improper Execution or Failure to Execute Payment Order. (a) If a funds transfer is completed but execution of a payment order by the receiving bank in breach of Section 4A-302 results in delay in payment to the beneciary, the bank is obliged to pay interest to either the origina531

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tor or the beneciary of the funds transfer for the period of delay caused by the improper execution. Except as provided in subsection (c), additional damages are not recoverable. (b) If execution of a payment order by a receiving bank in breach of Section 4A-302 results in (i) noncompletion of the funds transfer, (ii) failure to use an intermediary bank designated by the originator, or (iii) issuance of a payment order that does not comply with the terms of the payment order of the originator, the bank is liable to the originator for its expenses in the funds transfer and for incidental expenses and interest losses, to the extent not covered by subsection (a), resulting from the improper execution. Except as provided in subsection (c), additional damages are not recoverable. (c) In addition to the amounts payable under subsections (a) and (b), damages, including consequential damages, are recoverable to the extent provided in an express written agreement of the receiving bank. (d) If a receiving bank fails to execute a payment order it was obliged by express agreement to execute, the receiving bank is liable to the sender for its expenses in the transaction and for incidental expenses and interest losses resulting from the failure to execute. Additional damages, including consequential damages, are recoverable to the extent provided in an express written agreement of the receiving bank, but are not otherwise recoverable. (e) Reasonable attorney's fees are recoverable if demand for compensation under subsection (a) or (b) is made and refused before an action is brought on the claim. If a claim is made for breach of an agreement under subsection (d) and the agreement does not provide for damages, reasonable attorney's fees are recoverable if demand for compensation under subsection (d) is made and refused before an action is brought on the claim. (f) Except as stated in this section, the liability of a receiving bank under subsections (a) and (b) may not be varied by agreement. Ocial Comment
1. Subsection (a) covers cases of delay in completion of a funds transfer resulting from an execution by a receiving bank in breach of Section 4A-302(a). The receiving bank is obliged to pay interest on the amount of the order for the period of the delay. The rate of interest is stated in Section 4A-506. With respect to wire transfers (other than ACH transactions) within the United States, the expectation is that the funds transfer will be completed the same day. In those cases, the originator can reasonably expect that the originator's account will be debited on the same day as the beneciary's account is credited. If the funds transfer is delayed, compensation can be paid either to the originator or to the beneciary. The normal practice is to compensate the beneciary's bank to allow that bank to compensate the beneciary by back-valuing the payment by the number of days of delay. Thus, the beneciary is in the same position that it would have been in if the funds transfer had been completed on the same day. Assume on Day 1, Originator's Bank issues its payment order to Intermediary Bank which is received on that day. Intermediary Bank does not execute that order until Day 2 when it issues an order to Beneciary's Bank which is accepted on that day. Intermediary Bank complies with subsection (a) by paying one day's interest to Beneciary's Bank for the account of Beneciary. 2. Subsection (b) applies to cases of breach of Section 4A-302 involving more than mere delay. In those cases the bank is liable for damages for improper execution but they are limited to compensation for interest losses and incidental expenses of the sender resulting from the breach, the expenses of the sender in the funds transfer and attorney's fees. This subsection reects the judgment that imposition of consequential damages on a bank for 532

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commission of an error is not justied. The leading common law case on the subject of consequential damages is Evra Corp. v. Swiss Bank Corp., 673 F.2d 951 (7th Cir.1982), in which Swiss Bank, an intermediary bank, failed to execute a payment order. Because the beneciary did not receive timely payment the originator lost a valuable ship charter. The lower court awarded the originator $2.1 million for lost prots even though the amount of the payment order was only $27,000. The Seventh Circuit reversed, in part on the basis of the common law rule of Hadley v. Baxendale that consequential damages may not be awarded unless the defendant is put on notice of the special circumstances giving rise to them. Swiss Bank may have known that the originator was paying the shipowner for the hire of a vessel but did not know that a favorable charter would be lost if the payment was delayed. Electronic payments are not so unusual as to automatically place a bank on notice of extraordinary consequences if such a transfer goes awry. Swiss Bank did not have enough information to infer that if it lost a $27,000 payment order it would face liability in excess of $2 million. 673 F.2d at 956. If Evra means that consequential damages can be imposed if the culpable bank has notice of particular circumstances giving rise to the damages, it does not provide an acceptable solution to the problem of bank liability for consequential damages. In the typical case transmission of the payment order is made electronically. Personnel of the receiving bank that process payment orders are not the appropriate people to evaluate the risk of liability for consequential damages in relation to the price charged for the wire transfer service. Even if notice is received by higher level management personnel who could make an appropriate decision whether the risk is justied by the price, liability based on notice would require evaluation of payment orders on an individual basis. This kind of evaluation is inconsistent with the high-speed, low-price, mechanical nature of the processing system that characterizes wire transfers. Moreover, in Evra the culpable bank was an intermediary bank with which the originator did not deal. Notice to the originator's bank would not bind the intermediary bank, and it seems impractical for the originator's bank to convey notice of this kind to intermediary banks in the funds transfer. The success of the wholesale wire transfer industry has largely been based on its ability to eect payment at low cost and great speed. Both of these essential aspects of the modern wire transfer system would be adversely aected by a rule that imposed on banks liability for consequential damages. A banking industry amicus brief in Evra stated: Whether banks can continue to make EFT services available on a widespread basis, by charging reasonable rates, depends on whether they can do so without incurring unlimited consequential risks. Certainly, no bank would handle for $3.25 a transaction entailing potential liability in the millions of dollars. As the court in Evra also noted, the originator of the funds transfer is in the best position to evaluate the risk that a funds transfer will not be made on time and to manage that risk by issuing a payment order in time to allow monitoring of the transaction. The originator, by asking the beneciary, can quickly determine if the funds transfer has been completed. If the originator has sent the payment order at a time that allows a reasonable margin for correcting error, no loss is likely to result if the transaction is monitored. The other published cases on this issue reach the Evra result. Central Coordinates, Inc. v. Morgan Guaranty Trust Co., 40 U.C.C.Rep.Serv. 1340 (N.Y.Sup.Ct.1985), and Gatoil (U.S.A.), Inc. v. Forest Hill State Bank, 1 U.C.C.Rep.Serv.2d 171 (D.Md.1986). Subsection (c) allows the measure of damages in subsection (b) to be increased by an express written agreement of the receiving bank. An originator's bank might be willing to assume additional responsibilities and incur additional liability in exchange for a higher fee. 3. Subsection (d) governs cases in which a receiving bank has obligated itself by express agreement to accept payment orders of a sender. In the absence of such an agreement there is no obligation by a receiving bank to accept a payment order. Section 4A-212. The measure of damages for breach of an agreement to accept a payment order is the same as that stated in subsection (b). As in the case of subsection (b), additional damages, including consequential damages, may be recovered to the extent stated in an express written agreement of the receiving bank. 4. Reasonable attorney's fees are recoverable only in cases in which damages are limited to statutory damages stated in subsections (a), (b) and (d). If additional damages are recoverable because provided for by an express written agreement, attorney's fees are not recoverable. The rationale is that there is no need for statutory attorney's fees in the latter case, because the parties have agreed to a measure of damages which may or may not 533

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provide for attorney's fees. 5. The eect of subsection (f) is to prevent reduction of a receiving bank's liability under Section 4A-305.

PART 4. PAYMENT
4A-401. Payment Date. Payment date of a payment order means the day on which the amount of the order is payable to the beneciary by the beneciary's bank. The payment date may be determined by instruction of the sender but cannot be earlier than the day the order is received by the beneciary's bank and, unless otherwise determined, is the day the order is received by the beneciary's bank. Ocial Comment
Payment date refers to the day the beneciary's bank is to pay the beneciary. The payment date may be expressed in various ways so long as it indicates the day the beneciary is to receive payment. For example, in ACH transfers the payment date is the equivalent of settlement date or eective date. Payment date applies to the payment order issued to the beneciary's bank, but a payment order issued to a receiving bank other than the beneciary's bank may also state a date for payment to the beneciary. In the latter case, the statement of a payment date is to instruct the receiving bank concerning time of execution of the sender's order. Section 4A-301(b).

4A-402. Obligation of Sender to Pay Receiving Bank. (a) This section is subject to Sections 4A-205 and 4A-207. (b) With respect to a payment order issued to the beneciary's bank, acceptance of the order by the bank obliges the sender to pay the bank the amount of the order, but payment is not due until the payment date of the order. (c) This subsection is subject to subsection (e) and to Section 4A-303. With respect to a payment order issued to a receiving bank other than the beneciary's bank, acceptance of the order by the receiving bank obliges the sender to pay the bank the amount of the sender's order. Payment by the sender is not due until the execution date of the sender's order. The obligation of that sender to pay its payment order is excused if the funds transfer is not completed by acceptance by the beneciary's bank of a payment order instructing payment to the beneciary of that sender's payment order. (d) If the sender of a payment order pays the order and was not obliged to pay all or part of the amount paid, the bank receiving payment is obliged to refund payment to the extent the sender was not obliged to pay. Except as provided in Sections 4A-204 and 4A-304, interest is payable on the refundable amount from the date of payment. (e) If a funds transfer is not completed as stated in subsection (c) and an intermediary bank is obliged to refund payment as stated in subsection (d) but is unable to do so because not permitted by applicable law or because the bank suspends payments, a sender in the funds transfer that executed a payment order in compliance with an instruction, as stated in Section 4A-302(a)(1), to route the funds transfer through that intermediary bank is entitled to receive or retain payment from the sender of the payment order that it accepted. The rst sender in the funds transfer that issued an
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instruction requiring routing through that intermediary bank is subrogated to the right of the bank that paid the intermediary bank to refund as stated in subsection (d). (f) The right of the sender of a payment order to be excused from the obligation to pay the order as stated in subsection (c) or to receive refund under subsection (d) may not be varied by agreement. Ocial Comment
1. Subsection (b) states that the sender of a payment order to the beneciary's bank must pay the order when the beneciary's bank accepts the order. At that point the beneciary's bank is obliged to pay the beneciary. Section 4A-404(a). The last clause of subsection (b) covers a case of premature acceptance by the beneciary's bank. In some funds transfers, notably automated clearing house transfers, a beneciary's bank may receive a payment order with a payment date after the day the order is received. The beneciary's bank might accept the order before the payment date by notifying the beneciary of receipt of the order. Although the acceptance obliges the beneciary's bank to pay the beneciary, payment is not due until the payment date. The last clause of subsection (b) is consistent with that result. The beneciary's bank is also not entitled to payment from the sender until the payment date. 2. Assume that Originator instructs Bank A to order immediate payment to the account of Beneciary in Bank B. Execution of Originator's payment ordered by Bank A is acceptance under Section 4A-209(a). Under the second sentence of Section 4A-402(c) the acceptance creates an obligation of Originator to pay Bank A the amount of the order. The last clause of that sentence deals with attempted funds transfers that are not completed. In that event the obligation of the sender to pay its payment order is excused. Originator makes payment to Beneciary when Bank B, the beneciary's bank, accepts a payment order for the benet of Beneciary. Section 4A-406(a). If that acceptance by Bank B does not occur, the funds transfer has miscarried because Originator has not paid Beneciary. Originator doesn't have to pay its payment order, and if it has already paid it is entitled to refund of the payment with interest. The rate of interest is stated in Section 4A-506. This money-back guarantee is an important protection of Originator. Originator is assured that it will not lose its money if something goes wrong in the transfer. For example, risk of loss resulting from payment to the wrong beneciary is borne by some bank, not by Originator. The most likely reason for noncompletion is a failure to execute or an erroneous execution of a payment order by Bank A or an intermediary bank. Bank A may have issued its payment order to the wrong bank or it may have identied the wrong beneciary in its order. The money-back guarantee is particularly important to Originator if noncompletion of the funds transfer is due to the fault of an intermediary bank rather than Bank A. In that case Bank A must refund payment to Originator, and Bank A has the burden of obtaining refund from the intermediary bank that it paid. Subsection (c) can result in loss if an intermediary bank suspends payments. Suppose Originator instructs Bank A to pay to Beneciary's account in Bank B and to use Bank C as an intermediary bank. Bank A executes Originator's order by issuing a payment order to Bank C. Bank A pays Bank C. Bank C fails to execute the order of Bank A and suspends payments. Under subsections (c) and (d), Originator is not obliged to pay Bank A and is entitled to refund from Bank A of any payment that it may have made. Bank A is entitled to a refund from Bank C, but Bank C is insolvent. Subsection (e) deals with this case. Bank A was required to issue its payment order to Bank C because Bank C was designated as an intermediary bank by Originator. Section 4A-302(a)(1). In this case Originator takes the risk of insolvency of Bank C. Under subsection (e), Bank A is entitled to payment from Originator and Originator is subrogated to the right of Bank A under subsection (d) to refund of payment from Bank C. 3. A payment order is not like a negotiable instrument on which the drawer or maker has liability. Acceptance of the order by the receiving bank creates an obligation of the sender to pay the receiving bank the amount of the order. That is the extent of the sender's liability to the receiving bank and no other person has any rights against the sender with respect to the sender's order. 535

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4A-403. Payment by Sender to Receiving Bank. (a) Payment of the sender's obligation under Section 4A-402 to pay the receiving bank occurs as follows: (1) If the sender is a bank, payment occurs when the receiving bank receives nal settlement of the obligation through a Federal Reserve Bank or through a funds-transfer system. (2) If the sender is a bank and the sender (i) credited an account of the receiving bank with the sender, or (ii) caused an account of the receiving bank in another bank to be credited, payment occurs when the credit is withdrawn or, if not withdrawn, at midnight of the day on which the credit is withdrawable and the receiving bank learns of that fact. (3) If the receiving bank debits an account of the sender with the receiving bank, payment occurs when the debit is made to the extent the debit is covered by a withdrawable credit balance in the account. (b) If the sender and receiving bank are members of a funds-transfer system that nets obligations multilaterally among participants, the receiving bank receives nal settlement when settlement is complete in accordance with the rules of the system. The obligation of the sender to pay the amount of a payment order transmitted through the funds-transfer system may be satised, to the extent permitted by the rules of the system, by setting o and applying against the sender's obligation the right of the sender to receive payment from the receiving bank of the amount of any other payment order transmitted to the sender by the receiving bank through the funds-transfer system. The aggregate balance of obligations owed by each sender to each receiving bank in the funds-transfer system may be satised, to the extent permitted by the rules of the system, by setting o and applying against that balance the aggregate balance of obligations owed to the sender by other members of the system. The aggregate balance is determined after the right of seto stated in the second sentence of this subsection has been exercised. (c) If two banks transmit payment orders to each other under an agreement that settlement of the obligations of each bank to the other under Section 4A-402 will be made at the end of the day or other period, the total amount owed with respect to all orders transmitted by one bank shall be set o against the total amount owed with respect to all orders transmitted by the other bank. To the extent of the seto, each bank has made payment to the other. (d) In a case not covered by subsection (a), the time when payment of the sender's obligation under Section 4A-402(b) or 4A-402(c) occurs is governed by applicable principles of law that determine when an obligation is satised. Ocial Comment
1. This section denes when a sender pays the obligation stated in Section 4A-402. If a group of two or more banks engage in funds transfers with each other, the participating banks will sometimes be senders and sometimes receiving banks. With respect to payment orders other than Fedwires, the amounts of the various payment orders may be credited and debited to accounts of one bank with another or to a clearing house account of each bank and amounts owed and amounts due are netted. Settlement is made through a Federal Reserve Bank by charges to the Federal Reserve accounts of the net debtor banks and credits to the Federal Reserve accounts of the net creditor banks. In the case of Fedwires 536

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the sender's obligation is settled by a debit to the Federal Reserve account of the sender and a credit to the Federal Reserve account of the receiving bank at the time the receiving bank receives the payment order. Both of these cases are covered by subsection (a)(1). When the Federal Reserve settlement becomes nal the obligation of the sender under Section 4A-402 is paid. 2. In some cases a bank does not settle an obligation owed to another bank through a Federal Reserve Bank. This is the case if one of the banks is a foreign bank without access to the Federal Reserve payment system. In this kind of case, payment is usually made by credits or debits to accounts of the two banks with each other or to accounts of the two banks in a third bank. Suppose Bank B has an account in Bank A. Bank A advises Bank B that its account in Bank A has been credited $1,000,000 and that the credit is immediately withdrawable. Bank A also instructs Bank B to pay $1,000,000 to the account of Beneciary in Bank B. This case is covered by subsection (a)(2). Bank B may want to immediately withdraw this credit. For example, it might do so by instructing Bank A to debit the account and pay some third party. Payment by Bank A to Bank B of Bank A's payment order occurs when the withdrawal is made. Suppose Bank B does not withdraw the credit. Since Bank B is the beneciary's bank, one of the eects of receipt of payment by Bank B is that acceptance of Bank A's payment order automatically occurs at the time of payment. Section 4A-209(b)(2). Acceptance means that Bank B is obliged to pay $1,000,000 to Beneciary. Section 4A-404(a). Subsection (a)(2) of Section 4A-403 states that payment does not occur until midnight if the credit is not withdrawn. This allows Bank B an opportunity to reject the order if it does not have time to withdraw the credit to its account and it is not willing to incur the liability to Beneciary before it has use of the funds represented by the credit. 3. Subsection (a)(3) applies to a case in which the sender (bank or nonbank) has a funded account in the receiving bank. If Sender has an account in Bank and issues a payment order to Bank, Bank can obtain payment from Sender by debiting the account of Sender, which pays its Section 4A-402 obligation to Bank when the debit is made. 4. Subsection (b) deals with multilateral settlements made through a funds transfer system and is based on the CHIPS settlement system. In a funds transfer system such as CHIPS, which allows the various banks that transmit payment orders over the system to settle obligations at the end of each day, settlement is not based on individual payment orders. Each bank using the system engages in funds transfers with many other banks using the system. Settlement for any participant is based on the net credit or debit position of that participant with all other banks using the system. Subsection (b) is designed to make clear that the obligations of any sender are paid when the net position of that sender is settled in accordance with the rules of the funds transfer system. This provision is intended to invalidate any argument, based on common-law principles, that multilateral netting is not valid because mutuality of obligation is not present. Subsection (b) dispenses with any mutuality of obligation requirements. Subsection (c) applies to cases in which two banks send payment orders to each other during the day and settle with each other at the end of the day or at the end of some other period. It is similar to subsection (b) in that it recognizes that a sender's obligation to pay a payment order is satised by a seto. The obligations of each bank as sender to the other as receiving bank are obligations of the bank itself and not as representative of customers. These two sections are important in the case of insolvency of a bank. They make clear that liability under Section 4A-402 is based on the net position of the insolvent bank after seto. 5. Subsection (d) relates to the uncommon case in which the sender doesn't have an account relationship with the receiving bank and doesn't settle through a Federal Reserve Bank. An example would be a customer that pays over the counter for a payment order that the customer issues to the receiving bank. Payment would normally be by cash, check or bank obligation. When payment occurs is determined by law outside Article 4A.

4A-404. Obligation of Beneciary's Bank to Pay and Give Notice to Beneciary. (a) Subject to Sections 4A-211(e), 4A-405(d), and 4A-405(e), if a beneciary's bank accepts a payment order, the bank is obliged to pay the amount of the order to the beneciary of the order. Payment is due on the payment date of the order, but if acceptance occurs on the payment date
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after the close of the funds-transfer business day of the bank, payment is due on the next funds-transfer business day. If the bank refuses to pay after demand by the beneciary and receipt of notice of particular circumstances that will give rise to consequential damages as a result of nonpayment, the beneciary may recover damages resulting from the refusal to pay to the extent the bank had notice of the damages, unless the bank proves that it did not pay because of a reasonable doubt concerning the right of the beneciary to payment. (b) If a payment order accepted by the beneciary's bank instructs payment to an account of the beneciary, the bank is obliged to notify the beneciary of receipt of the order before midnight of the next funds-transfer business day following the payment date. If the payment order does not instruct payment to an account of the beneciary, the bank is required to notify the beneciary only if notice is required by the order. Notice may be given by rst class mail or any other means reasonable in the circumstances. If the bank fails to give the required notice, the bank is obliged to pay interest to the beneciary on the amount of the payment order from the day notice should have been given until the day the beneciary learned of receipt of the payment order by the bank. No other damages are recoverable. Reasonable attorney's fees are also recoverable if demand for interest is made and refused before an action is brought on the claim. (c) The right of a beneciary to receive payment and damages as stated in subsection (a) may not be varied by agreement or a funds-transfer system rule. The right of a beneciary to be notied as stated in subsection (b) may be varied by agreement of the beneciary or by a funds-transfer system rule if the beneciary is notied of the rule before initiation of the funds transfer. Ocial Comment
1. The rst sentence of subsection (a) states the time when the obligation of the beneciary's bank arises. The second and third sentences state when the beneciary's bank must make funds available to the beneciary. They also state the measure of damages for failure, after demand, to comply. Since the Expedited Funds Availability Act, 12 U.S.C. 4001 et seq., also governs funds availability in a funds transfer, the second and third sentences of subsection (a) may be subject to preemption by that Act. 2. Subsection (a) provides that the beneciary of an accepted payment order may recover consequential damages if the beneciary's bank refuses to pay the order after demand by the beneciary if the bank at that time had notice of the particular circumstances giving rise to the damages. Such damages are recoverable only to the extent the bank had notice of the damages. The quoted phrase requires that the bank have notice of the general type or nature of the damages that will be suered as a result of the refusal to pay and their general magnitude. There is no requirement that the bank have notice of the exact or even the approximate amount of the damages, but if the amount of damages is extraordinary the bank is entitled to notice of that fact. For example, in Evra Corp. v. Swiss Bank Corp., 673 F.2d 951 (7th Cir.1982), failure to complete a funds transfer of only $27,000 required to retain rights to a very favorable ship charter resulted in a claim for more than $2,000,000 of consequential damages. Since it is not reasonably foreseeable that a failure to make a relatively small payment will result in damages of this magnitude, notice is not sucient if the beneciary's bank has notice only that the $27,000 is necessary to retain rights on a ship charter. The bank is entitled to notice that an exceptional amount of damages will result as well. For example, there would be adequate notice if the bank had been made aware that damages of $1,000,000 or more might result. 3. Under the last clause of subsection (a) the beneciary's bank is not liable for damages 538

Art. 4A

Funds Transfers

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if its refusal to pay was because of a reasonable doubt concerning the right of the beneciary to payment. Normally there will not be any question about the right of the beneciary to receive payment. Normally, the bank should be able to determine whether it has accepted the payment order and, if it has been accepted, the rst sentence of subsection (a) states that the bank is obliged to pay. There may be uncommon cases, however, in which there is doubt whether acceptance occurred. For example, if acceptance is based on receipt of payment by the beneciary's bank under Section 4A-403(a)(1) or (2), there may be cases in which the bank is not certain that payment has been received. There may also be cases in which there is doubt about whether the person demanding payment is the person identied in the payment order as beneciary of the order. The last clause of subsection (a) does not apply to cases in which a funds transfer is being used to pay an obligation and a dispute arises between the originator and the beneciary concerning whether the obligation is in fact owed. For example, the originator may try to prevent payment to the beneciary by the beneciary's bank by alleging that the beneciary is not entitled to payment because of fraud against the originator or a breach of contract relating to the obligation. The fraud or breach of contract claim of the originator may be grounds for recovery by the originator from the beneciary after the beneciary is paid, but it does not aect the obligation of the beneciary's bank to pay the beneciary. Unless the payment order has been cancelled pursuant to Section 4A-211(c), there is no excuse for refusing to pay the beneciary and, in a proper case, the refusal may result in consequential damages. Except in the case of a book transfer, in which the beneciary's bank is also the originator's bank, the originator of a funds transfer cannot cancel a payment order to the beneciary's bank, with or without the consent of that bank, because the originator is not the sender of that order. Thus, the beneciary's bank may safely ignore any instruction by the originator to withhold payment to the beneciary. 4. Subsection (b) states the duty of the beneciary's bank to notify the beneciary of receipt of the order. If acceptance occurs under Section 4A-209(b)(1) the beneciary is normally notied. Thus, subsection (b) applies primarily to cases in which acceptance occurs under Section 4A-209(b)(2) or (3). Notice under subsection (b) is not required if the person entitled to the notice agrees or a funds transfer system rule provides that notice is not required and the beneciary is given notice of the rule. In ACH transactions the normal practice is not to give notice to the beneciary unless notice is requested by the beneciary. This practice can be continued by adoption of a funds transfer system rule. Subsection (a) is not subject to variation by agreement or by a funds transfer system rule.

4A-405. Payment by Beneciary's Bank to Beneciary. (a) If the beneciary's bank credits an account of the beneciary of a payment order, payment of the bank's obligation under Section 4A-404(a) occurs when and to the extent (i) the beneciary is notied of the right to withdraw the credit, (ii) the bank lawfully applies the credit to a debt of the beneciary, or (iii) funds with respect to the order are otherwise made available to the beneciary by the bank. (b) If the beneciary's bank does not credit an account of the beneciary of a payment order, the time when payment of the bank's obligation under Section 4A-404(a) occurs is governed by principles of law that determine when an obligation is satised. (c) Except as stated in subsections (d) and (e), if the beneciary's bank pays the beneciary of a payment order under a condition to payment or agreement of the beneciary giving the bank the right to recover payment from the beneciary if the bank does not receive payment of the order, the condition to payment or agreement is not enforceable. (d) A funds-transfer system rule may provide that payments made to beneciaries of funds transfers made through the system are provisional until receipt of payment by the beneciary's bank of the payment order it accepted. A beneciary's bank that makes a payment that is provisional
539

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under the rule is entitled to refund from the beneciary if (i) the rule requires that both the beneciary and the originator be given notice of the provisional nature of the payment before the funds transfer is initiated, (ii) the beneciary, the beneciary's bank and the originator's bank agreed to be bound by the rule, and (iii) the beneciary's bank did not receive payment of the payment order that it accepted. If the beneciary is obliged to refund payment to the beneciary's bank, acceptance of the payment order by the beneciary's bank is nullied and no payment by the originator of the funds transfer to the beneciary occurs under Section 4A-406. (e) This subsection applies to a funds transfer that includes a payment order transmitted over a funds-transfer system that (i) nets obligations multilaterally among participants, and (ii) has in eect a loss-sharing agreement among participants for the purpose of providing funds necessary to complete settlement of the obligations of one or more participants that do not meet their settlement obligations. If the beneciary's bank in the funds transfer accepts a payment order and the system fails to complete settlement pursuant to its rules with respect to any payment order in the funds transfer, (i) the acceptance by the beneciary's bank is nullied and no person has any right or obligation based on the acceptance, (ii) the beneciary's bank is entitled to recover payment from the beneciary, (iii) no payment by the originator to the beneciary occurs under Section 4A-406, and (iv) subject to Section 4A-402(e), each sender in the funds transfer is excused from its obligation to pay its payment order under Section 4A-402(c) because the funds transfer has not been completed. Ocial Comment
1. This section denes when the beneciary's bank pays the beneciary and when the obligation of the beneciary's bank under Section 4A-404 to pay the beneciary is satised. In almost all cases the bank will credit an account of the beneciary when it receives a payment order. In the typical case the beneciary is paid when the beneciary is given notice of the right to withdraw the credit. Subsection (a)(i). In some cases payment might be made to the beneciary not by releasing funds to the beneciary, but by applying the credit to a debt of the beneciary. Subsection (a)(ii). In this case the beneciary gets the benet of the payment order because a debt of the beneciary has been satised. The two principal cases in which payment will occur in this manner are seto by the beneciary's bank and payment of the proceeds of the payment order to a garnishing creditor of the beneciary. These cases are discussed in Comment 2 to Section 4A-502. 2. If a beneciary's bank releases funds to the beneciary before it receives payment from the sender of the payment order, it assumes the risk that the sender may not pay the sender's order because of suspension of payments or other reason. Subsection (c). As stated in Comment 5 to Section 4A-209, the beneciary's bank can protect itself against this risk by delaying acceptance. But if the bank accepts the order it is obliged to pay the beneciary. If the beneciary's bank has given the beneciary notice of the right to withdraw a credit made to the beneciary's account, the beneciary has received payment from the bank. Once payment has been made to the beneciary with respect to an obligation incurred by the bank under Section 4A-404(a), the payment cannot be recovered by the beneciary's bank unless subsection (d) or (e) applies. Thus, a right to withdraw a credit cannot be revoked if the right to withdraw constituted payment of the bank's obligation. This principle applies even if funds were released as a loan (see Comment 5 to Section 4A-209), or were released subject to a condition that they would be repaid in the event the bank does not receive payment from the sender of the payment order, or the beneciary agreed to return the payment if the bank did not receive payment from the sender. 3. Subsection (c) is subject to an exception stated in subsection (d) which is intended to apply to automated clearing house transfers. ACH transfers are made in batches. A beneciary's bank will normally accept, at the same time and as part of a single batch, pay540

Art. 4A

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ment orders with respect to many dierent originator's banks. Comment 2 to Section 4A206. The custom in ACH transactions is to release funds to the beneciary early on the payment date even though settlement to the beneciary's bank does not occur until later in the day. The understanding is that payments to beneciaries are provisional until the beneciary's bank receives settlement. This practice is similar to what happens when a depositary bank releases funds with respect to a check forwarded for collection. If the check is dishonored the bank is entitled to recover the funds from the customer. ACH transfers are widely perceived as check substitutes. Section 4A-405(d) allows the funds transfer system to adopt a rule making payments to beneciaries provisional. If such a rule is adopted, a beneciary's bank that releases funds to the beneciary will be able to recover the payment if it doesn't receive payment of the payment order that it accepted. There are two requirements with respect to the funds transfer system rule. The beneciary, the beneciary's bank and the originator's bank must all agree to be bound by the rule and the rule must require that both the beneciary and the originator be given notice of the provisional nature of the payment before the funds transfer is initiated. There is no requirement that the notice be given with respect to a particular funds transfer. Once notice of the provisional nature of the payment has been given, the notice is eective for all subsequent payments to or from the person to whom the notice was given. Subsection (d) provides only that the funds transfer system rule must require notice to the beneciary and the originator. The beneciary's bank will know what the rule requires, but it has no way of knowing whether the originator's bank complied with the rule. Subsection (d) does not require proof that the originator received notice. If the originator's bank failed to give the required notice and the originator suered as a result, the appropriate remedy is an action by the originator against the originator's bank based on that failure. But the beneciary's bank will not be able to get the benet of subsection (d) unless the beneciary had notice of the provisional nature of the payment because subsection (d) requires an agreement by the beneciary to be bound by the rule. Implicit in an agreement to be bound by a rule that makes a payment provisional is a requirement that notice be given of what the rule provides. The notice can be part of the agreement or separately given. For example, notice can be given by providing a copy of the system's operating rules. With respect to ACH transfers made through a Federal Reserve Bank acting as an intermediary bank, the Federal Reserve Bank is obliged under Section 4A-402(b) to pay a beneciary's bank that accepts the payment order. Unlike Fedwire transfers, under current ACH practice a Federal Reserve Bank that processes a payment order does not obligate itself to pay if the originator's bank fails to pay the Federal Reserve Bank. It is assumed that the Federal Reserve will use its right of preemption which is recognized in Section 4A-107 to disclaim the Section 4A-402(b) obligation in ACH transactions if it decides to retain the provisional payment rule. 4. Subsection (e) is another exception to subsection (c). It refers to funds transfer systems having loss-sharing rules described in the subsection. CHIPS has proposed a rule that ts the description. Under the CHIPS loss-sharing rule the CHIPS banks will have agreed to contribute funds to allow the system to settle for payment orders sent over the system during the day in the event that one or more banks are unable to meet their settlement obligations. Subsection (e) applies only if CHIPS fails to settle despite the loss-sharing rule. Since funds under the loss-sharing rule will be instantly available to CHIPS and will be in an amount sucient to cover any failure that can be reasonably anticipated, it is extremely unlikely that CHIPS would ever fail to settle. Thus, subsection (e) addresses an event that should never occur. If that event were to occur, all payment orders made over the system would be cancelled under the CHIPS rule. Thus, no bank would receive settlement, whether or not a failed bank was involved in a particular funds transfer. Subsection (e) provides that each funds transfer in which there is a payment order with respect to which there is a settlement failure is unwound. Acceptance by the beneciary's bank in each funds transfer is nullied. The consequences of nullication are that the beneciary has no right to receive or retain payment by the beneciary's bank, no payment is made by the originator to the beneciary and each sender in the funds transfer is, subject to Section 4A-402(e), not obliged to pay its payment order and is entitled to refund under Section 4A-402(d) if it has already paid.

4A-406. Payment by Originator to Beneciary; Discharge of Underlying Obligation. (a) Subject to Sections 4A-211(e), 4A-405(d), and 4A-405(e), the origina541

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tor of a funds transfer pays the beneciary of the originator's payment order (i) at the time a payment order for the benet of the beneciary is accepted by the beneciary's bank in the funds transfer and (ii) in an amount equal to the amount of the order accepted by the beneciary's bank, but not more than the amount of the originator's order. (b) If payment under subsection (a) is made to satisfy an obligation, the obligation is discharged to the same extent discharge would result from payment to the beneciary of the same amount in money, unless (i) the payment under subsection (a) was made by a means prohibited by the contract of the beneciary with respect to the obligation, (ii) the beneciary, within a reasonable time after receiving notice of receipt of the order by the beneciary's bank, notied the originator of the beneciary's refusal of the payment, (iii) funds with respect to the order were not withdrawn by the beneciary or applied to a debt of the beneciary, and (iv) the beneciary would suer a loss that could reasonably have been avoided if payment had been made by a means complying with the contract. If payment by the originator does not result in discharge under this section, the originator is subrogated to the rights of the beneciary to receive payment from the beneciary's bank under Section 4A-404(a). (c) For the purpose of determining whether discharge of an obligation occurs under subsection (b), if the beneciary's bank accepts a payment order in an amount equal to the amount of the originator's payment order less charges of one or more receiving banks in the funds transfer, payment to the beneciary is deemed to be in the amount of the originator's order unless upon demand by the beneciary the originator does not pay the beneciary the amount of the deducted charges. (d) Rights of the originator or of the beneciary of a funds transfer under this section may be varied only by agreement of the originator and the beneciary. Ocial Comment
1. Subsection (a) states the fundamental rule of Article 4A that payment by the originator to the beneciary is accomplished by providing to the beneciary the obligation of the beneciary's bank to pay. Since this obligation arises when the beneciary's bank accepts a payment order, the originator pays the beneciary at the time of acceptance and in the amount of the payment order accepted. 2. In a large percentage of funds transfers, the transfer is made to pay an obligation of the originator. Subsection (a) states that the beneciary is paid by the originator when the beneciary's bank accepts a payment order for the benet of the beneciary. When that happens the eect under subsection (b) is to substitute the obligation of the beneciary's bank for the obligation of the originator. The eect is similar to that under Article 3 if a cashier's check payable to the beneciary had been taken by the beneciary. Normally, payment by funds transfer is sought by the beneciary because it puts money into the hands of the beneciary more quickly. As a practical matter the beneciary and the originator will nearly always agree to the funds transfer in advance. Under subsection (b) acceptance by the beneciary's bank will result in discharge of the obligation for which payment was made unless the beneciary had made a contract with respect to the obligation which did not permit payment by the means used. Thus, if there is no contract of the beneciary with respect to the means of payment of the obligation, acceptance by the beneciary's bank of a payment order to the account of the beneciary can result in discharge. 3. Suppose Beneciary's contract stated that payment of an obligation owed by Originator was to be made by a cashier's check of Bank A. Instead, Originator paid by a funds transfer to Beneciary's account in Bank B. Bank B accepted a payment order for the benet of Beneciary by immediately notifying Beneciary that the funds were available for 542

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withdrawal. Before Beneciary had a reasonable opportunity to withdraw the funds Bank B suspended payments. Under the unless clause of subsection (b) Beneciary is not required to accept the payment as discharging the obligation owed by Originator to Beneciary if Beneciary's contract means that Beneciary was not required to accept payment by wire transfer. Beneciary could refuse the funds transfer as payment of the obligation and could resort to rights under the underlying contract to enforce the obligation. The rationale is that Originator cannot impose the risk of Bank B's insolvency on Beneciary if Beneciary had specied another means of payment that did not entail that risk. If Beneciary is required to accept Originator's payment, Beneciary would suer a loss that would not have occurred if payment had been made by a cashier's check on Bank A, and Bank A has not suspended payments. In this case Originator will have to pay twice. It is obliged to pay the amount of its payment order to the bank that accepted it and has to pay the obligation it owes to Beneciary which has not been discharged. Under the last sentence of subsection (b) Originator is subrogated to Beneciary's right to receive payment from Bank B under Section 4A-404(a). 4. Suppose Beneciary's contract called for payment by a Fedwire transfer to Bank B, but the payment order accepted by Bank B was not a Fedwire transfer. Before the funds were withdrawn by Beneciary, Bank B suspended payments. The sender of the payment order to Bank B paid the amount of the order to Bank B. In this case the payment by Originator did not comply with Beneciary's contract, but the noncompliance did not result in a loss to Beneciary as required by subsection (b)(iv). A Fedwire transfer avoids the risk of insolvency of the sender of the payment order to Bank B, but it does not aect the risk that Bank B will suspend payments before withdrawal of the funds by Beneciary. Thus, the unless clause of subsection (b) is not applicable and the obligation owed to Beneciary is discharged. 5. Charges of receiving banks in a funds transfer normally are nominal in relationship to the amount being paid by the originator to the beneciary. Wire transfers are normally agreed to in advance and the parties may agree concerning how these charges are to be divided between the parties. Subsection (c) states a rule that applies in the absence of agreement. In some funds transfers charges of banks that execute payment orders are collected by deducting the charges from the amount of the payment order issued by the bank, i.e. the bank issues a payment order that is slightly less than the amount of the payment order that is being executed. The process is described in Comment 3 to Section 4A-302. The result in such a case is that the payment order accepted by the beneciary's bank will be slightly less than the amount of the originator's order. Subsection (c) recognizes the principle that a beneciary is entitled to full payment of a debt paid by wire transfer as a condition to discharge. On the other hand, subsection (c) prevents a beneciary from denying the originator the benet of the payment by asserting that discharge did not occur because deduction of bank charges resulted in less than full payment. The typical case is one in which the payment is made to exercise a valuable right such as an option which is unfavorable to the beneciary. Subsection (c) allows discharge notwithstanding the deduction unless the originator fails to reimburse the beneciary for the deducted charges after demand by the beneciary.

PART 5. MISCELLANEOUS PROVISIONS

4A-501. Variation by Agreement and Eect of Funds-Transfer System Rule. (a) Except as otherwise provided in this Article, the rights and obligations of a party to a funds transfer may be varied by agreement of the affected party. (b) Funds-transfer system rule means a rule of an association of banks (i) governing transmission of payment orders by means of a funds-transfer system of the association or rights and obligations with respect to those orders, or (ii) to the extent the rule governs rights and obligations between banks that are parties to a funds transfer in which a Federal Reserve Bank, acting as an intermediary bank, sends a payment order to the
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beneciary's bank. Except as otherwise provided in this Article, a fundstransfer system rule governing rights and obligations between participating banks using the system may be eective even if the rule conicts with this Article and indirectly aects another party to the funds transfer who does not consent to the rule. A funds-transfer system rule may also govern rights and obligations of parties other than participating banks using the system to the extent stated in Sections 4A-404(c), 4A-405(d), and 4A507(c). Ocial Comment
1. This section is designed to give some exibility to Article 4A. Funds transfer system rules govern rights and obligations between banks that use the system. They may cover a wide variety of matters such as form and content of payment orders, security procedures, cancellation rights and procedures, indemnity rights, compensation rules for delays in completion of a funds transfer, time and method of settlement, credit restrictions with respect to senders of payment orders and risk allocation with respect to suspension of payments by a participating bank. Funds transfer system rules can be very eective in supplementing the provisions of Article 4A and in lling gaps that may be present in Article 4A. To the extent they do not conict with Article 4A there is no problem with respect to their eectiveness. In that case they merely supplement Article 4A. Section 4A-501 goes further. It states that unless the contrary is stated, funds transfer system rules can override provisions of Article 4A. Thus, rights and obligations of a sender bank and a receiving bank with respect to each other can be dierent from that stated in Article 4A to the extent a funds transfer system rule applies. Since funds transfer system rules are dened as those governing the relationship between participating banks, a rule can have a direct eect only on participating banks. But a rule that aects the conduct of a participating bank may indirectly aect the rights of nonparticipants such as the originator or beneciary of a funds transfer, and such a rule can be eective even though it may aect nonparticipants without their consent. For example, a rule might prevent execution of a payment order or might allow cancellation of a payment order with the result that a funds transfer is not completed or is delayed. But a rule purporting to dene rights and obligations of nonparticipants in the system would not be eective to alter Article 4A rights because the rule is not within the denition of funds transfer system rule. Rights and obligations arising under Article 4A may also be varied by agreement of the aected parties, except to the extent Article 4A otherwise provides. Rights and obligations arising under Article 4A can also be changed by Federal Reserve regulations and operating circulars of Federal Reserve Banks. Section 4A-107. 2. Subsection (b)(ii) refers to ACH transfers. Whether an ACH transfer is made through an automated clearing house of a Federal Reserve Bank or through an automated clearing house of another association of banks, the rights and obligations of the originator's bank and the beneciary's bank are governed by uniform rules adopted by various associations of banks in various parts of the nation. With respect to transfers in which a Federal Reserve Bank acts as intermediary bank these rules may be incorporated, in whole or in part, in operating circulars of the Federal Reserve Bank. Even if not so incorporated these rules can still be binding on the association banks. If a transfer is made through a Federal Reserve Bank, the rules are eective under subsection (b)(ii). If the transfer is not made through a Federal Reserve Bank, the association rules are eective under subsection (b)(i).

4A-502. Creditor Process Served on Receiving Bank; Seto by Beneciary's Bank. (a) As used in this section, creditor process means levy, attachment, garnishment, notice of lien, sequestration, or similar process issued by or on behalf of a creditor or other claimant with respect to an account. (b) This subsection applies to creditor process with respect to an authorized account of the sender of a payment order if the creditor process is served on the receiving bank. For the purpose of determining rights with respect to the creditor process, if the receiving bank accepts the payment
544

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order the balance in the authorized account is deemed to be reduced by the amount of the payment order to the extent the bank did not otherwise receive payment of the order, unless the creditor process is served at a time and in a manner aording the bank a reasonable opportunity to act on it before the bank accepts the payment order. (c) If a beneciary's bank has received a payment order for payment to the beneciary's account in the bank, the following rules apply: (1) The bank may credit the beneciary's account. The amount credited may be set o against an obligation owed by the beneciary to the bank or may be applied to satisfy creditor process served on the bank with respect to the account. (2) The bank may credit the beneciary's account and allow withdrawal of the amount credited unless creditor process with respect to the account is served at a time and in a manner aording the bank a reasonable opportunity to act to prevent withdrawal. (3) If creditor process with respect to the beneciary's account has been served and the bank has had a reasonable opportunity to act on it, the bank may not reject the payment order except for a reason unrelated to the service of process. (d) Creditor process with respect to a payment by the originator to the beneciary pursuant to a funds transfer may be served only on the beneciary's bank with respect to the debt owed by that bank to the beneciary. Any other bank served with the creditor process is not obliged to act with respect to the process. Ocial Comment
1. When a receiving bank accepts a payment order, the bank normally receives payment from the sender by debiting an authorized account of the sender. In accepting the sender's order the bank may be relying on a credit balance in the account. If creditor process is served on the bank with respect to the account before the bank accepts the order but the bank employee responsible for the acceptance was not aware of the creditor process at the time the acceptance occurred, it is unjust to the bank to allow the creditor process to take the credit balance on which the bank may have relied. Subsection (b) allows the bank to obtain payment from the sender's account in this case. Under that provision, the balance in the sender's account to which the creditor process applies is deemed to be reduced by the amount of the payment order unless there was sucient time for notice of the service of creditor process to be received by personnel of the bank responsible for the acceptance. 2. Subsection (c) deals with payment orders issued to the beneciary's bank. The bank may credit the beneciary's account when the order is received, but under Section 4A-404(a) the bank incurs no obligation to pay the beneciary until the order is accepted pursuant to Section 4A-209(b). Thus, before acceptance, the credit to the beneciary's account is provisional. But under Section 4A-209(b) acceptance occurs if the beneciary's bank pays the beneciary pursuant to Section 4A-405(a). Under that provision, payment occurs if the credit to the beneciary's account is applied to a debt of the beneciary. Subsection (c)(1) allows the bank to credit the beneciary's account with respect to a payment order and to accept the order by setting o the credit against an obligation owed to the bank or applying the credit to creditor process with respect to the account. Suppose a beneciary's bank receives a payment order for the benet of a customer. Before the bank accepts the order, the bank learns that creditor process has been served on the bank with respect to the customer's account. Normally there is no reason for a beneciary's bank to reject a payment order, but if the beneciary's account is garnished, the bank may be faced with a dicult choice. If it rejects the order, the garnishing creditor's potential recovery of funds of the beneciary is frustrated. It may be faced with a claim by the creditor that the rejection was a wrong to the creditor. If the bank accepts the order, 545

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the eect is to allow the creditor to seize funds of its customer, the beneciary. Subsection (c)(3) gives the bank no choice in this case. It provides that it may not favor its customer over the creditor by rejecting the order. The beneciary's bank may rightfully reject only if there is an independent basis for rejection. 3. Subsection (c)(2) is similar to subsection (b). Normally the beneciary's bank will release funds to the beneciary shortly after acceptance or it will accept by releasing funds. Since the bank is bound by a garnishment order served before funds are released to the beneciary, the bank might suer a loss if funds were released without knowledge that a garnishment order had been served. Subsection (c)(2) protects the bank if it did not have adequate notice of the garnishment when the funds were released. 4. A creditor may want to reach funds involved in a funds transfer. The creditor may try to do so by serving process on the originator's bank, an intermediary bank or the beneciary's bank. The purpose of subsection (d) is to guide the creditor and the court as to the proper method of reaching the funds involved in a funds transfer. A creditor of the originator can levy on the account of the originator in the originator's bank before the funds transfer is initiated, but that levy is subject to the limitations stated in subsection (b). The creditor of the originator cannot reach any other funds because no property of the originator is being transferred. A creditor of the beneciary cannot levy on property of the originator and until the funds transfer is completed by acceptance by the beneciary's bank of a payment order for the benet of the beneciary, the beneciary has no property interest in the funds transfer which the beneciary's creditor can reach. A creditor of the beneciary that wants to reach the funds to be received by the beneciary must serve creditor process on the beneciary's bank to reach the obligation of the beneciary's bank to pay the beneciary which arises upon acceptance by the beneciary's bank under Section 4A-404(a). 5. Creditor process is dened in subsection (a) to cover a variety of devices by which a creditor of the holder of a bank account or a claimant to a bank account can seize the account. Procedure and nomenclature varies widely from state to state. The term used in Section 4A-502 is a generic term.

4A-503. Injunction or Restraining Order With Respect to Funds Transfer. For proper cause and in compliance with applicable law, a court may restrain (i) a person from issuing a payment order to initiate a funds transfer, (ii) an originator's bank from executing the payment order of the originator, or (iii) the beneciary's bank from releasing funds to the beneciary or the beneciary from withdrawing the funds. A court may not otherwise restrain a person from issuing a payment order, paying or receiving payment of a payment order, or otherwise acting with respect to a funds transfer. Ocial Comment
This section is related to Section 4A-502(d) and to Comment 4 to Section 4A-502. It is designed to prevent interruption of a funds transfer after it has been set in motion. The initiation of a funds transfer can be prevented by enjoining the originator or the originator's bank from issuing a payment order. After the funds transfer is completed by acceptance of a payment order by the beneciary's bank, that bank can be enjoined from releasing funds to the beneciary or the beneciary can be enjoined from withdrawing the funds. No other injunction is permitted. In particular, intermediary banks are protected, and injunctions against the originator and the originator's bank are limited to issuance of a payment order. Except for the beneciary's bank, nobody can be enjoined from paying a payment order, and no receiving bank can be enjoined from receiving payment from the sender of the order that it accepted.

4A-504. Order in Which Items and Payment Orders May Be Charged to Account; Order of Withdrawals From Account. (a) If a receiving bank has received more than one payment order of the sender or one or more payment orders and other items that are payable
546

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4A-506

from the sender's account, the bank may charge the sender's account with respect to the various orders and items in any sequence. (b) In determining whether a credit to an account has been withdrawn by the holder of the account or applied to a debt of the holder of the account, credits rst made to the account are rst withdrawn or applied. Ocial Comment
1. Subsection (a) concerns priority among various obligations that are to be paid from the same account. A customer may have written checks on its account with the receiving bank and may have issued one or more payment orders payable from the same account. If the account balance is not sucient to cover all of the checks and payment orders, some checks may be dishonored and some payment orders may not be accepted. Although there is no concept of wrongful dishonor of a payment order in Article 4A in the absence of an agreement to honor by the receiving bank, some rights and obligations may depend on the amount in the customer's account. Section 4A-209(b)(3) and Section 4A-210(b). Whether dishonor of a check is wrongful also may depend upon the balance in the customer's account. Under subsection (a), the bank is not required to consider the competing items and payment orders in any particular order. Rather it may charge the customer's account for the various items and orders in any order. Suppose there is $12,000 in the customer's account. If a check for $5,000 is presented for payment and the bank receives a $10,000 payment order from the customer, the bank could dishonor the check and accept the payment order. Dishonor of the check is not wrongful because the account balance was less than the amount of the check after the bank charged the account $10,000 on account of the payment order. Or, the bank could pay the check and not execute the payment order because the amount of the order is not covered by the balance in the account. 2. Subsection (b) follows Section 4-208(b) in using the rst-in-rst-out rule for determining the order in which credits to an account are withdrawn.

4A-505. Preclusion of Objection to Debit of Customer's Account. If a receiving bank has received payment from its customer with respect to a payment order issued in the name of the customer as sender and accepted by the bank, and the customer received notication reasonably identifying the order, the customer is precluded from asserting that the bank is not entitled to retain the payment unless the customer noties the bank of the customer's objection to the payment within one year after the notication was received by the customer. Ocial Comment
This section is in the nature of a statute of repose for objecting to debits made to the customer's account. A receiving bank that executes payment orders of a customer may have received payment from the customer by debiting the customer's account with respect to a payment order that the customer was not required to pay. For example, the payment order may not have been authorized or veried pursuant to Section 4A-202 or the funds transfer may not have been completed. In either case the receiving bank is obliged to refund the payment to the customer and this obligation to refund payment cannot be varied by agreement. Section 4A-204 and Section 4A-402. Refund may also be required if the receiving bank is not entitled to payment from the customer because the bank erroneously executed a payment order. Section 4A-303. A similar analysis applies to that case. Section 4A-402(d) and (f) require refund and the obligation to refund may not be varied by agreement. Under 4A-505, however, the obligation to refund may not be asserted by the customer if the customer has not objected to the debiting of the account within one year after the customer received notication of the debit.

4A-506. Rate of Interest. (a) If, under this Article, a receiving bank is obliged to pay interest with respect to a payment order issued to the bank, the amount payable may be determined (i) by agreement of the sender and receiving bank, or (ii) by a
547

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funds-transfer system rule if the payment order is transmitted through a funds-transfer system. (b) If the amount of interest is not determined by an agreement or rule as stated in subsection (a), the amount is calculated by multiplying the applicable Federal Funds rate by the amount on which interest is payable, and then multiplying the product by the number of days for which interest is payable. The applicable Federal Funds rate is the average of the Federal Funds rates published by the Federal Reserve Bank of New York for each of the days for which interest is payable divided by 360. The Federal Funds rate for any day on which a published rate is not available is the same as the published rate for the next preceding day for which there is a published rate. If a receiving bank that accepted a payment order is required to refund payment to the sender of the order because the funds transfer was not completed, but the failure to complete was not due to any fault by the bank, the interest payable is reduced by a percentage equal to the reserve requirement on deposits of the receiving bank. Ocial Comment
1. A receiving bank is required to pay interest on the amount of a payment order received by the bank in a number of situations. Sometimes the interest is payable to the sender and in other cases it is payable to either the originator or the beneciary of the funds transfer. The relevant provisions are Section 4A-204(a), Section 4A-209(b)(3), Section 4A-210(b), Section 4A-305(a), Section 4A-402(d) and Section 4A-404(b). The rate of interest may be governed by a funds transfer system rule or by agreement as stated in subsection (a). If subsection (a) doesn't apply, the rate is determined under subsection (b). Subsection (b) is illustrated by the following example. A bank is obliged to pay interest on $1,000,000 for three days, July 3, July 4, and July 5. The published Fed Funds rate is .082 for July 3 and .081 for July 5. There is no published rate for July 4 because that day is not a banking day. The rate for July 3 applies to July 4. The applicable Fed Funds rate is .08167 (the average of .082, .082, and .081) divided by 360 which equals .0002268. The amount of interest payable is $1,000,000 .0002268 3 = $680.40. 2. In some cases, interest is payable in spite of the fact that there is no fault by the receiving bank. The last sentence of subsection (b) applies to those cases. For example, a funds transfer might not be completed because the beneciary's bank rejected the payment order issued to it by the originator's bank or an intermediary bank. Section 4A-402(c) provides that the originator is not obliged to pay its payment order and Section 4A-402(d) provides that the originator's bank must refund any payment received plus interest. The requirement to pay interest in this case is not based on fault by the originator's bank. Rather, it is based on restitution. Since the originator's bank had the use of the originator's money, it is required to pay the originator for the value of that use. The value of that use is not determined by multiplying the interest rate by the refundable amount because the originator's bank is required to deposit with the Federal Reserve a percentage of the bank's deposits as a reserve requirement. Since that deposit does not bear interest, the bank had use of the refundable amount reduced by a percentage equal to the reserve requirement. If the reserve requirement is 12%, the amount of interest payable by the bank under the formula stated in subsection (b) is reduced by 12%.

4A-507. Choice of Law. (a) The following rules apply unless the aected parties otherwise agree or subsection (c) applies: (1) The rights and obligations between the sender of a payment order and the receiving bank are governed by the law of the jurisdiction in which the receiving bank is located. (2) The rights and obligations between the beneciary's bank and the beneciary are governed by the law of the jurisdiction in which the beneciary's bank is located.
548

Art. 4A

Funds Transfers

4A-507

(3) The issue of when payment is made pursuant to a funds transfer by the originator to the beneciary is governed by the law of the jurisdiction in which the beneciary's bank is located. (b) If the parties described in each paragraph of subsection (a) have made an agreement selecting the law of a particular jurisdiction to govern rights and obligations between each other, the law of that jurisdiction governs those rights and obligations, whether or not the payment order or the funds transfer bears a reasonable relation to that jurisdiction. (c) A funds-transfer system rule may select the law of a particular jurisdiction to govern (i) rights and obligations between participating banks with respect to payment orders transmitted or processed through the system, or (ii) the rights and obligations of some or all parties to a funds transfer any part of which is carried out by means of the system. A choice of law made pursuant to clause (i) is binding on participating banks. A choice of law made pursuant to clause (ii) is binding on the originator, other sender, or a receiving bank having notice that the funds-transfer system might be used in the funds transfer and of the choice of law by the system when the originator, other sender, or receiving bank issued or accepted a payment order. The beneciary of a funds transfer is bound by the choice of law if, when the funds transfer is initiated, the beneciary has notice that the funds-transfer system might be used in the funds transfer and of the choice of law by the system. The law of a jurisdiction selected pursuant to this subsection may govern, whether or not that law bears a reasonable relation to the matter in issue. (d) In the event of inconsistency between an agreement under subsection (b) and a choice-of-law rule under subsection (c), the agreement under subsection (b) prevails. (e) If a funds transfer is made by use of more than one funds-transfer system and there is inconsistency between choice-of-law rules of the systems, the matter in issue is governed by the law of the selected jurisdiction that has the most signicant relationship to the matter in issue. Ocial Comment
1. Funds transfers are typically interstate or international in character. If part of a funds transfer is governed by Article 4A and another part is governed by other law, the rights and obligations of parties to the funds transfer may be unclear because there is no clear consensus in various jurisdictions concerning the juridical nature of the transaction. Unless all of a funds transfer is governed by a single law it may be very dicult to predict the result if something goes wrong in the transfer. Section 4A-507 deals with this problem. Subsection (b) allows parties to a funds transfer to make a choice-of-law agreement. Subsection (c) allows a funds transfer system to select the law of a particular jurisdiction to govern funds transfers carried out by means of the system. Subsection (a) states residual rules if no choice of law has occurred under subsection (b) or subsection (c). 2. Subsection (a) deals with three sets of relationships. Rights and obligations between the sender of a payment order and the receiving bank are governed by the law of the jurisdiction in which the receiving bank is located. If the receiving bank is the beneciary's bank the rights and obligations of the beneciary are also governed by the law of the jurisdiction in which the receiving bank is located. Suppose Originator, located in Canada, sends a payment order to Originator's Bank located in a state in which Article 4A has been enacted. The order is for payment to an account of Beneciary in a bank in England. Under subsection (a)(1), the rights and obligations of Originator and Originator's Bank toward each other are governed by Article 4A if an action is brought in a court in the Article 4A state. If an action is brought in a Canadian court, the conict of laws issue will be 549

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Art. 4A

determined by Canadian law which might or might not apply the law of the state in which Originator's Bank is located. If that law is applied, the execution of Originator's order will be governed by Article 4A, but with respect to the payment order of Originator's Bank to the English bank, Article 4A may or may not be applied with respect to the rights and obligations between the two banks. The result may depend upon whether action is brought in a court in the state in which Originator's Bank is located or in an English court. Article 4A is binding only on a court in a state that enacts it. It can have extraterritorial eect only to the extent courts of another jurisdiction are willing to apply it. Subsection (c) also bears on the issues discussed in this Comment. Under Section 4A-406 payment by the originator to the beneciary of the funds transfer occurs when the beneciary's bank accepts a payment order for the benet of the beneciary. A jurisdiction in which Article 4A is not in eect may follow a dierent rule or it may not have a clear rule. Under Section 4A-507(a)(3) the issue is governed by the law of the jurisdiction in which the beneciary's bank is located. Since the payment to the beneciary is made through the beneciary's bank it is reasonable that the issue of when payment occurs be governed by the law of the jurisdiction in which the bank is located. Since it is dicult in many cases to determine where a beneciary is located, the location of the beneciary's bank provides a more certain rule. 3. Subsection (b) deals with choice-of-law agreements and it gives maximum freedom of choice. Since the law of funds transfers is not highly developed in the case law there may be a strong incentive to choose the law of a jurisdiction in which Article 4A is in eect because it provides a greater degree of certainty with respect to the rights of various parties. With respect to commercial transactions, it is often said that [u]niformity and predictability based upon commercial convenience are the prime considerations in making the choice of governing law . . .. R. Lear, American Conicts Law, 185 (1977). Subsection (b) is derived in part from recently enacted choice-of-law rules in the States of New York and California. N.Y.Gen. Obligations Law 5-1401 (McKinney's 1989 Supp.) and California Civil Code 1646.5. This broad endorsement of freedom of contract is an enhancement of the approach taken by Restatement (Second) of Conict of Laws 187(b) (1971). The Restatement recognizes the basic right of freedom of contract, but the freedom granted the parties may be more limited than the freedom granted here. Under the formulation of the Restatement, if there is no substantial relationship to the jurisdiction whose law is selected and there is no other reasonable basis for the parties' choice, then the selection of the parties need not be honored by a court. Further, if the choice is violative of a fundamental policy of a state which has a materially greater interest than the chosen state, the selection could be disregarded by a court. Those limitations are not found in subsection (b). 4. Subsection (c) may be the most important provision in regard to creating uniformity of law in funds transfers. Most rights stated in Article 4A regard parties who are in privity of contract such as originator and beneciary, sender and receiving bank, and beneciary's bank and beneciary. Since they are in privity they can make a choice of law by agreement. But that is not always the case. For example, an intermediary bank that improperly executes a payment order is not in privity with either the originator or the beneciary. The ability of a funds transfer system to make a choice of law by rule is a convenient way of dispensing with individual agreements and to cover cases in which agreements are not feasible. It is probable that funds transfer systems will adopt a governing law to increase the certainty of commercial transactions that are eected over such systems. A system rule might adopt the law of an Article 4A state to govern transfers on the system in order to provide a consistent, unitary, law governing all transfers made on the system. To the extent such system rules develop, individual choice-of-law agreements become unnecessary. Subsection (c) has broad application. A system choice of law applies not only to rights and obligations between banks that use the system, but may also apply to other parties to the funds transfer so long as some part of the transfer was carried out over the system. The originator and any other sender or receiving bank in the funds transfer is bound if at the time it issues or accepts a payment order it had notice that the funds transfer involved use of the system and that the system chose the law of a particular jurisdiction. Under Section 4A-107, the Federal Reserve by regulation could make a similar choice of law to govern funds transfers carried out by use of Federal Reserve Banks. Subsection (d) is a limitation on subsection (c). If parties have made a choice-of-law agreement that conicts with a choice of law made under subsection (c), the agreement prevails. 550

Art. 4A

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4A-507

5. Subsection (e) addresses the case in which a funds transfer involves more than one funds transfer system and the systems adopt conicting choice-of-law rules. The rule that has the most signicant relationship to the matter at issue prevails. For example, each system should be able to make a choice of law governing payment orders transmitted over that system with regard to a choice of law made by another system. TECHNICAL AMENDMENT TO ARTICLE 1 A state enacting Article 4A should amend Section 1-105(2) by adding the following: Governing law in the Article on Funds Transfers. Section 4A-507.

551

ARTICLE 5. LETTERS OF CREDIT*

5-101. 5-102. 5-103. 5-104. 5-105. 5-106. 5-107. 5-108. 5-109. 5-110. 5-111. 5-112. 5-113. 5-114. 5-115. 5-116. 5-117. 5-118. National Conference of Commissioners on Uniform State Laws Table of Disposition of Sections in Former Article 5 Short Title. Denitions. Scope. Formal Requirements. Consideration. Issuance, Amendment, Cancellation, and Duration. Conrmer, Nominated Person, and Adviser. Issuer's Rights and Obligations. Fraud and Forgery. Warranties. Remedies. Transfer of Letter of Credit. Transfer by Operation of Law. Assignment of Proceeds. Statute of Limitations. Choice of Law and Forum. Subrogation of Issuer, Applicant, and Nominated Person. Security Interest of Issuer or Nominated Person.

National Conference of Commissioners on Uniform State Laws

REPORTER James J. White, Ann Arbor, Michigan DRAFTING COMMITTEE CHAIRMAN Carlyle C. Ring, Jr., Vienna, Virginia MEMBERS Marion W. Beneld, Jr., Winston-Salem, North Carolina John P. Burton, Santa Fe, New Mexico, National Conference Representative and The American Law Institute Representative Bruce A. Coggeshall, Portland, Maine William C. Hillman, Boston, Massachusetts Edwin E. Huddleson, III, Washington, District of Columbia, The American Law Institute Representative Jeremiah Marsh, Chicago, Illinois Richard L. Morningstar, Washington, District of Columbia *Article 5 was revised in 1995. Prerevision Article 5 may be found in Appendix 552 N.

Art. 5

Letters of Credit

Edwin E. Smith, Boston, Massachusetts Sandra S. Stern, Scarsdale, New York Richard C. Hite, Wichita, Kansas, President (Member Ex Ocio) Neal Ossen, Hartford, Connecticut, Chairman, Division C (Member Ex Ocio) REVIEW COMMITTEE CHAIRMAN William M. Burke, Los Angeles, California MEMBERS Boris Auerbach, Wyoming, Ohio Robert J. Desiderio, Albuquerque, New Mexico PREFATORY NOTE Reason for Revision When the original Article 5 was drafted 40 years ago, it was written for paper transactions and before many innovations in letters of credit. Now electronic and other media are used extensively. Since the 50's, standby letters of credit have developed and now nearly $500 billion standby letters of credit are issued annually worldwide, of which $250 billion are issued in the United States. The use of deferred payment letters of credit has also greatly increased. The customs and practices for letters of credit have evolved and are reected in the Uniform Customs and Practice (UCP), usually incorporated into letters of credit, particularly international letters of credit, which have seen four revisions since the 1950's; the current version became eective in 1994 (UCP 500). Lastly, in a number of areas, court decisions have resulted in conicting rules. Prior to the appointment of a drafting committee, the ABA UCC Committee appointed a Task Force composed of knowledgeable practitioners and academics. The ABA Task Force studied the case law, evolving technologies and the changes in customs and practices. The Task Force identied a large number of issues which they discussed at some length, and made recommendations for revisions to Article 5. The Task Force stated in a foreword:
As a result of these increases and changes in usage, practice, players, and pressure, it comes as no surprise that there has been a sizable increase in litigation. Indeed, the approximately 62 cases reported in the United States in 1987 constituted double the cumulative reported cases up to 1965 . . .. Moreover, almost forty years of hard use have revealed weaknesses, gaps and errors in the original statute which compromise its relevance. U.C.C. Article 5 was one of the few areas of the Uniform Commercial Code which did not benet from prior codication and it should come as no surprise that it may require some revision . . .. Measured in terms of these areas which are vital to any system of commercial law, the current combination of statute and case law is found wanting in major respects both as to predictability and certainty. What is at issue here are not matters of sophistry but important issues of substance which have not been resolved by the current case law/code method and which admit of little likelihood of such resolution. (45 Bus. Lawyer 1521, at 1532, 15356)1

The Drafting Committee began its deliberations with the Task Force Report in hand. The nal work of the Drafting Committee varies from many of the suggestions of the Task Force. Need for Uniformity Letters of Credit are a major instrument in international trade, as well as domestic transactions. To facilitate its usefulness and competitiveness, it is essential that U.S. law be in harmony with international rules and practices, as well as exible enough to accomThe Task Force members were: Professor James E. Byrne (George Mason University School of Law) Chair; Professor Boris Kozolchyk (University of Arizona College of Law); Michael Evan Avidon (Moses & Singer); James G. Barnes (Baker & McKenzie); Arthur G. Lloyd (Citibank N.A.); Janis
1

S. Penton (Rosen, Wachtell & Gilbert); Richard F. Purcell (Connell, Rice & Sugar Co.); Alan L. Bloodgood (Morgan Guaranty Trust Co.); Charles del Busto (Manufacturers Hanover Trust Co.); Vincent Maulella (Manufacturers Hanover Trust Co.). 553

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modate changes in technology and practices that have, and are, evolving. Not only should the rules be consistent within the United States, but they need to be substantively and procedurally consistent with international practices. Thus, the goals of the drafting eort were: E conforming the Article 5 rules to current customs and practices; E accommodating new forms of Letters of Credit, changes in customs and practices, and evolving technology, particularly the use of electronic media; E maintaining Letters of Credit as an inexpensive and ecient instrument facilitating trade; and E resolving conicts among reported decisions. Process of Achieving Uniformity The essence of uniform law revision is to obtain a sucient consensus and balance among the interests of the various participants so that universal and uniform enactment by the various States may be achieved. In part this is accomplished by extensive consultation on and broad circulation of the drafts from 1990, when the project began, until approval of the nal draft by the American law Institute (ALI) and the National Conference of Commissioners on Uniform State Laws (NCCUSL). Hundreds of groups were invited to participate in the drafting process. Twenty Advisors were appointed, representing a cross-section of interested parties. In addition 20 Observers regularly attended drafting meetings and over 100 were on the mailing list to receive all drafts of the revision. The Drafting Committee meetings were open and all those who attended were aorded full opportunity to express their views and participate in the dialogue. The Advisors and Observers were a balanced group with ten representatives of users (Beneciaries and Applicants); ve representatives of governmental agencies; ve representatives of the U.S. Council on International Banking (USCIB); seven from major banks in letter of credit transactions; eight from regional banks; and seven law professors who teach and write on Letters of Credit. Nine Drafting Committee meetings were held that began Friday morning and ended Sunday noon. In addition, the draft was twice debated in full by NCCUSL, once by the ALI Council, once considered by the ALI Consultative Group and once by an ad hoc Committee of the Council; and reviewed and discussed by the ABA Subcommittee on Letters of Credit semi-annually and by several state and city bar association committees. The drafts were regularly reviewed and discussed in The Business Lawyer, Letter of Credit Update, and in other publications. The consensus, balance and quality achieved in this lengthy deliberative process is a product of not only its Reporter and the Drafting Committee, but also the faithful and energetic participation of the following Advisors and active participants: Advisors

Professor Gerald T. McLaughlin, Loyola Law School, ABA, Section of Business Law James G. Barnes, Baker & McKenzie/U.S. Council on International Banking, Inc. Harold S. Burman, U.S. Department of State James E. Byrne, George Mason University, Institute of International Banking Law and Practice Inc. Professor John Dolan, original ABA Advisor Henry N. Dyhouse, U.S. Central Credit Union David P. Goch, Treasury Management Association Thomas J. Greco, American Bankers Association Henry Hareld, Shearman & Sterling Oliver I. Ireland, Board of Governors of Federal Reserve Board
554

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Letters of Credit

James W. Kopp, Shell Oil Company/Treasury Management Association Professor Boris Kozolchyk, University of Arizona/National Law Center for Inter-American Free Trade, U.S. Council on International Banking, Inc. Vincent M. Maulella, Manufacturers Hanover Trust Co./U.S.Council on International Banking, Inc. Robert M. Rosenblith, National Westminster Bank Bradley K. Sabel, Federal Reserve Bank of New York Joseph H. Sommer, Federal Reserve Bank of New York Jamileh Soufan, American General Corporation/Treasury Management Association Dan Taylor, U.S. Council on International Banking, Inc. William H. Thornton, Security Pacic National Bank/California Bankers Association Paul S. Turner, Occidental Petroleum Corporation/Treasury Management Association Stanley M. Walker, Exxon Company U.S.A./Treasury Management Association
Active Participants

Michael E. Avidon, Moses & Singer/N.Y. State Bar Association, Banking Law Committee, Subcommittee on Letters of Credit Walter B. Baker, ABN AMRO Bank, N.V. Thomas C. Baxter, Jr., Federal Reserve Bank of New York Professor Amelia H. Boss, Pennsylvania Bar Association, Section of Corporation, Banking & Business Law, Commercial Law Committee Maria A. Chanco, Bank of America, N.T. & S.A. Frank P. Curran, Treasury Management Association Carol R. Dennis, Oce of Federal Procurement Policy, OFMB Albert J. Givray, Oklahoma Bar Association, Section of Banking & Commercial Law Sidney S. Goldstein, New York State Bar Association Professor Egon Guttman, The American University George A. Hisert, State Bar of California, Section of Business Law, Committee on UCC, Subcommittee on Letters of Credit Larry J. Jones, Mobil Oil Credit Corporation Carter H. Klein, Jenner & Block Arthur G. Lloyd, ABA, Section of Business Law, Committee on UCC, Subcommittee on Letters of Credit, Working Group on UCC Article 5 Revision Rebecca S. McCulloch, ABN AMRO Bank, N.V. Dennis L. Noah, First National Bank of Maryland/U.S. Council on International Banking, Inc. James Purvis, The Bank of California
555

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James E. Roselle, First National Bank of Chicago R. David Whitaker, ABA, Section of Business Law, Committee on UCC, Subcommittee on ECP, Working Group on EDC Brooke Wunnicke, ABA, Section of Business Law, Committee on UCC, Subcommittee on Letters of Credit
Balance of Benets Uniform laws can be enacted only if there is a consensus that the benets achieved advance the public interest in a manner that can be embraced by all users of the law. It appears that as drafted, Revised Article 5 will enjoy substantial support by the participating interests in letter of credit transactions. Benets of Revised Article 5 in General Independence Principle. Revised Article 5 clearly and forcefully states the independence of the letter of credit obligations from the underlying transactions that was unexpressed in, but was a fundamental predicate for, the original Article 5 (Sections 5-103(d) and 5-108(f)). Certainty of payment, independent of other claims, setos or other causes of action, is a core element of the commercial utility of letters of credit. Clarications. The revision authorizes the use of electronic technology (Sections 5-102(a) (14) and 5-104); expressly permits deferred payment letters of credit (Section 5-102(a)(8)) and two party letters of credit (Section 5-102(a)(10)); provides rules for unstated expiry dates (Section 5-106(c)), perpetual letters of credit (Section 5-106(d)), and non-documentary conditions (Section 5-108(g)); claries and establishes rules for successors by operation of law (Sections 5-102(a)(15) and 5-113); conforms to existing practice for assignment of proceeds (Section 5-114); and claries the rules where decisions have been in conict (Section 5-106, Comment 1; Section 5-108, Comments 1, 3, 4, 7, and 9; Section 5-109, Comments 1 and 3; Section 5-113, Comment 1; and Section 5-117, Comment 1). Harmonizes with International Practice The UCP is used in most international letters of credit and in many domestic letters of credit. These international practices are well known and employed by the major issuers and users of letters of credit. Revisions have been made to Article 5 to coordinate the Article 5 rules with current international practice (e.g., deferred payment obligations, reasonable time to examine documents, preclusion, non-documentary conditions, return of documents, and irrevocable unless stated to be revocable). Benets of Revised Article 5 to Issuers Consequential Damages. Section 5-111 precludes consequential and punitive damages. It, however, provides strong incentives for Issuers to honor, including provisions for attorneys fees and expenses of litigation, interest, and specic performance. If consequential and punitive damages were allowed, the cost of letters of credit could rise substantially. Statute of Limitation. Section 5-115 establishes a one year statute of limitation from the expiration date or from accrual of the cause of action, whichever occurs later. Because it is usually obvious to all when there has been a breach, a short limitation period is fair to potential plaintis. Choice of Law. Section 5-116 permits the issuer (or nominated party or adviser) to choose the law of the jurisdiction that will govern even if that law bears no relation to the transaction. Absent agreement, Section 5-116 states choice of law rules. Assignment of Proceeds. Section 5-114 conforms more fully to existing practice and provides an orderly procedure for recording and accommodating assignments by consent of the issuer (or nominated party). Subrogation. Section 5-117 claries the subrogation rights of an Issuer who has honored a letter of credit. These rights of subrogation also extend to an applicant who reimburses and a nominated party who pays or gives value. Recognition of UCP. Section 5-116(c) expressly recognizes that if the UCP is incorporated by reference into the letter of credit, the agreement varies the provisions of Article 5 with which it may conict except for the non-variable provisions of Article 5. 556

Art. 5

Letters of Credit
Benets of Revised Article 5 to Applicants

Warranties. Section 5-110 species the warranties made by a beneciary. It gives the applicant on a letter of credit which has been honored a direct cause of action if a drawing is fraudulent or forged or if a drawing violates any agreement augmented by a letter of credit. Strict Compliance. Absent agreement to the contrary, the issuer must dishonor a presentation that does not strictly comply under standard practice with the terms and conditions of the letter of credit (Section 5-108). Subrogation. New Section 5-117 claries the parties' rights of subrogation if the letter of credit is honored. Limitations on General Disclaimers and Waivers. Section 5-103(c) limits the eect of general disclaimers and waivers in a letter of credit, or reimbursement or other agreement. Benets of Revised Article 5 to Beneciaries Irrevocable. A letter of credit is irrevocable unless the letter of credit expressly provides it is revocable (Section 5-106(a)). Preclusion. Section 5-108(c) now provides that the Issuer is precluded from asserting any discrepancy not stated in its notice timely given, except for fraud, forgery or expiration. Timely Examination. Section 5-108(b) requires examination and notice of any discrepancies within a reasonable time not to exceed the 7th business day after presentation of the documents. Transfers by Operation of Law. New Section 5-113 allows a successor to a beneciary by operation of law to make presentation and receive payment or acceptance. Damages. The damages provided are expanded and claried. They include attorneys fees and expenses of litigation and payment of the full amount of the wrongfully dishonored or repudiated demand, with interest, without an obligation of the beneciary to mitigate damages (Section 5-111). Revisions for Article 9 and Transition Provisions The draft includes suggested revisions to conform Article 9 to the Article 5 changes. Article 9 itself is under revision and the interface with Revised Article 5 will be more fully examined by the Article 9 drafting committee, as well, in light of changes to Article 9. The Article 9 revisions will probably not be completed until 19989. Revised Article 8 (1994) also makes changes to Article 9 so care should be taken to coordinate the changes of both Revised Articles 5 and 8 within each State. The draft also includes transition provisions and some cross reference changes in other Articles of the UCC. Lastly, there follows a table showing the changes from the original Article 5 made by the revisions to Article 5.

Table of Disposition of Sections in Former Article 5

The reference to a section in revised Article 5 is to the section that refers to the issue addressed by the section in former Article 5. If there is no comparable section in Revised Article 5 to a section in former Article 5, that fact is indicated by the word Omitted and a reason is stated. Former Article 5 Section 5-101 . . . . . . . . . . . . . . . . . . . . . . . . . 5-102(1) . . . . . . . . . . . . . . . . . . . . . . 5-102(2) . . . . . . . . . . . . . . . . . . . . . . 5-103(3) . . . . . . . . . . . . . . . . . . . . . . 5-103(1)(a) . . . . . . . . . . . . . . . . . . . Revised Article 5 Section 5-101 5-103(a) Omitted (inherent in 5-103(a) and denitions) (rst sentence omitted) 5-103(b) 5-102(a)(10); 5-106(a); 5-102(a)(8) 557

Uniform Commercial Code

Former Article 5 Section 5-103(1)(b) . . . . . . . . . . . . . . . . . . .

Art. 5

5-103(1)(c) . . . . . . . . . . . . . . . . . . . . 5-103(1)(d) . . . . . . . . . . . . . . . . . . . 5-103(1)(e) . . . . . . . . . . . . . . . . . . . . 5-103(1)(f) . . . . . . . . . . . . . . . . . . . . 5-103(1)(g) . . . . . . . . . . . . . . . . . . . 5-103(2) . . . . . . . . . . . . . . . . . . . . . . 5-103(3) . . . . . . . . . . . . . . . . . . . . . . 5-103(4) . . . . . . . . . . . . . . . . . . . . . . 5-104 . . . . . . . . . . . . . . . . . . . . . . . . . 5-105 . . . . . . . . . . . . . . . . . . . . . . . . . 5-106(1) . . . . . . . . . . . . . . . . . . . . . . 5-106(2) . . . . . . . . . . . . . . . . . . . . . . 5-106(3) . . . . . . . . . . . . . . . . . . . . . . 5-106(4) . . . . . . . . . . . . . . . . . . . . . . 5-107(1) . . . . . . . . . . . . . . . . . . . . . . 5-107(2) . . . . . . . . . . . . . . . . . . . . . . 5-107(3) . . . . . . . . . . . . . . . . . . . . . . 5-107(4) . . . . . . . . . . . . . . . . . . . . . . 5-108 . . . . . . . . . . . . . . . . . . . . . . . . . 5-109(1) . . . . . . . . . . . . . . . . . . . . . . 5-109(2) . . . . . . . . . . . . . . . . . . . . . . 5-109(3) . . . . . . . . . . . . . . . . . . . . . . 5-110(1) . . . . . . . . . . . . . . . . . . . . . . 5-110(2) . . . . . . . . . . . . . . . . . . . . . . 5-111(1) . . . . . . . . . . . . . . . . . . . . . . 5-111(2) . . . . . . . . . . . . . . . . . . . . . . 5-112(1) . . . . . . . . . . . . . . . . . . . . . . 5-112(2) . . . . . . . . . . . . . . . . . . . . . . 5-112(3) . . . . . . . . . . . . . . . . . . . . . . 5-113 . . . . . . . . . . . . . . . . . . . . . . . . . 5-114(1) . . . . . . . . . . . . . . . . . . . . . . 5-114(2)(a) . . . . . . . . . . . . . . . . . . . 5-114(2)(b) . . . . . . . . . . . . . . . . . . . 5-114(3) . . . . . . . . . . . . . . . . . . . . . . 5-114(4), (5) . . . . . . . . . . . . . . . . . . 5-115(1) . . . . . . . . . . . . . . . . . . . . . . 5-115(2) . . . . . . . . . . . . . . . . . . . . . . 5-116(1) . . . . . . . . . . . . . . . . . . . . . . 5-116(2) . . . . . . . . . . . . . . . . . . . . . . 5-116(3) . . . . . . . . . . . . . . . . . . . . . . 5-117 . . . . . . . . . . . . . . . . . . . . . . . . .

Revised Article 5 Section 5-102(a)(6) (Document), and 5-102(a)(14) (Record); Documentary draft or demand not used 5-102(a)(9) 5-102(a)(3) 5-102(a)(1) 5-102(a)(4) (Applicant rather than Customer) 5-102(a)(2) Omitted as not applicable 5-102(b) 5-102(c) 5-104 and 5-102(6) and (14) 5-105 5-106(a) 5-106(b) 5-106(b) 5-106(b) 5-107(c) 5-107(a) 5-107(c) Omitted as inadvisable default rule Omitted (as outdated) 5-108 5-108 Omitted (all issuers required to observe standard practices) Omitted (covered in denitions and comments) Omitted (covered in denitions and comments) 5-110(a) 5-110(b) 5-108(b) and (c) 5-108(h) 5-102(a)(12) Omitted (covered by other contract law) 5-108(a) 5-109(a)(1) 5-109(a)(2) 5-108(i) Omitted; were optional 5-111 5-111 5-112 5-114 5-114 Omitted (covered by other law)

Table of New Provisions (Provisions which were not included in former Article 5 and subjects not addressed in for558

Art. 5
mer Article 5.) Subject

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5-101

Successor to a beneciary . . . . . . . . . . . . . . . . . . . . Non-variable terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . Independence principle . . . . . . . . . . . . . . . . . . . . . . . . Unstated expiry date . . . . . . . . . . . . . . . . . . . . . . . . . . Perpetual letter of credit . . . . . . . . . . . . . . . . . . . . . . . Preclusion of unstated deciencies . . . . . . . . . . . . . Standard practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Independence of obligation . . . . . . . . . . . . . . . . . . . . . Non-documentary conditions . . . . . . . . . . . . . . . . . . . Standards for issuing injunction . . . . . . . . . . . . . . . Transfer by operation of law . . . . . . . . . . . . . . . . . . . Statute of Limitation . . . . . . . . . . . . . . . . . . . . . . . . . . Choice of law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Subrogation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Revised Article 5 Section 5-102(15) 5-103(c) 5-103(d) 5-106(c) 5-106(d) 5-108(c) 5-108(e) 5-108(f) 5-108(g) 5-109(b) 5-113 5-115 5-116 5-117

5-101. Short Title. This article may be cited as Uniform Commercial CodeLetters of Credit. Ocial Comment
The Ocial Comment to the original Section 5-101 was a remarkably brief inaugural address. Noting that letters of credit had not been the subject of statutory enactment and that the law concerning them had been developed in the cases, the Comment stated that Article 5 was intended within its limited scope to set an independent theoretical frame for the further development of letters of credit. That statement addressed accurately conditions as they existed when the statement was made, nearly half a century ago. Since Article 5 was originally drafted, the use of letters of credit has expanded and developed, and the case law concerning these developments is, in some respects, discordant. Revision of Article 5 therefore has required reappraisal both of the statutory goals and of the extent to which particular statutory provisions further or adversely aect achievement of those goals. The statutory goal of Article 5 was originally stated to be: (1) to set a substantive theoretical frame that describes the function and legal nature of letters of credit; and (2) to preserve procedural exibility in order to accommodate further development of the ecient use of letters of credit. A letter of credit is an idiosyncratic form of undertaking that supports performance of an obligation incurred in a separate nancial, mercantile, or other transaction or arrangement. The objectives of the original and revised Article 5 are best achieved (1) by dening the peculiar characteristics of a letter of credit that distinguish it and the legal consequences of its use from other forms of assurance such as secondary guarantees, performance bonds, and insurance policies, and from ordinary contracts, duciary engagements, and escrow arrangements; and (2) by preserving exibility through variation by agreement in order to respond to and accommodate developments in custom and usage that are not inconsistent with the essential denitions and substantive mandates of the statute. No statute can, however, prescribe the manner in which such substantive rights and duties are to be enforced or imposed without risking stultication of wholesome developments in the letter of credit mechanism. Letter of credit law should remain responsive to commercial reality and in particular to the customs and expectations of the international banking and mercantile community. Courts should read the terms of this article in a manner consistent with these customs and expectations. The subject matter in Article 5, letters of credit, may also be governed by an international 559

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convention that is now being drafted by UNCITRAL, the draft Convention on Independent Guarantees and Standby Letters of Credit. The Uniform Customs and Practice is an international body of trade practice that is commonly adopted by international and domestic letters of credit and as such is the law of the transaction by agreement of the parties. Article 5 is consistent with and was inuenced by the rules in the existing version of the UCP. In addition to the UCP and the international convention, other bodies of law apply to letters of credit. For example, the federal bankruptcy law applies to letters of credit with respect to applicants and beneciaries that are in bankruptcy; regulations of the Federal Reserve Board and the Comptroller of the Currency lay out requirements for banks that issue letters of credit and describe how letters of credit are to be treated for calculating asset risk and for the purpose of loan limitations. In addition there is an array of anti-boycott and other similar laws that may aect the issuance and performance of letters of credit. All of these laws are beyond the scope of Article 5, but in certain circumstances they will override Article 5.

5-102. Denitions. (a) In this article: (1) Adviser means a person who, at the request of the issuer, a conrmer, or another adviser, noties or requests another adviser to notify the beneciary that a letter of credit has been issued, conrmed, or amended. (2) Applicant means a person at whose request or for whose account a letter of credit is issued. The term includes a person who requests an issuer to issue a letter of credit on behalf of another if the person making the request undertakes an obligation to reimburse the issuer. (3) Beneciary means a person who under the terms of a letter of credit is entitled to have its complying presentation honored. The term includes a person to whom drawing rights have been transferred under a transferable letter of credit. (4) Conrmer means a nominated person who undertakes, at the request or with the consent of the issuer, to honor a presentation under a letter of credit issued by another. (5) Dishonor of a letter of credit means failure timely to honor or to take an interim action, such as acceptance of a draft, that may be required by the letter of credit. (6) Document means a draft or other demand, document of title, investment security, certicate, invoice, or other record, statement, or representation of fact, law, right, or opinion (i) which is presented in a written or other medium permitted by the letter of credit or, unless prohibited by the letter of credit, by the standard practice referred to in Section 5-108(e) and (ii) which is capable of being examined for compliance with the terms and conditions of the letter of credit. A document may not be oral. (7) Good faith means honesty in fact in the conduct or transaction concerned. (8) Honor of a letter of credit means performance of the issuer's undertaking in the letter of credit to pay or deliver an item of value. Unless the letter of credit otherwise provides, honor occurs (i) upon payment, (ii) if the letter of credit provides for acceptance, upon acceptance of a draft and, at maturity, its payment, or
560

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(iii) if the letter of credit provides for incurring a deferred obligation, upon incurring the obligation and, at maturity, its performance. (9) Issuer means a bank or other person that issues a letter of credit, but does not include an individual who makes an engagement for personal, family, or household purposes. (10) Letter of credit means a denite undertaking that satises the requirements of Section 5-104 by an issuer to a beneciary at the request or for the account of an applicant or, in the case of a nancial institution, to itself or for its own account, to honor a documentary presentation by payment or delivery of an item of value. (11) Nominated person means a person whom the issuer (i) designates or authorizes to pay, accept, negotiate, or otherwise give value under a letter of credit and (ii) undertakes by agreement or custom and practice to reimburse. (12) Presentation means delivery of a document to an issuer or nominated person for honor or giving of value under a letter of credit. (13) Presenter means a person making a presentation as or on behalf of a beneciary or nominated person. (14) Record means information that is inscribed on a tangible medium, or that is stored in an electronic or other medium and is retrievable in perceivable form. (15) Successor of a beneciary means a person who succeeds to substantially all of the rights of a beneciary by operation of law, including a corporation with or into which the beneciary has been merged or consolidated, an administrator, executor, personal representative, trustee in bankruptcy, debtor in possession, liquidator, and receiver. (b) Denitions in other Articles applying to this article and the sections in which they appear are: Accept or Acceptance Section 3-409 Value Sections 3-303, 4-211 (c) Article 1 contains certain additional general denitions and principles of construction and interpretation applicable throughout this article. Ocial Comment
1. Since no one can be a conrmer unless that person is a nominated person as dened in Section 5-102(a)(11), those who agree to conrm without the designation or authorization of the issuer are not conrmers under Article 5. Nonetheless, the undertakings to the beneciary of such persons may be enforceable by the beneciary as letters of credit issued by the conrmer for its own account or as guarantees or contracts outside of Article 5. 2. The denition of document contemplates and facilitates the growing recognition of electronic and other nonpaper media as documents, however, for the time being, data in those media constitute documents only in certain circumstances. For example, a facsimile received by an issuer would be a document only if the letter of credit explicitly permitted it, if the standard practice authorized it and the letter did not prohibit it, or the agreement of the issuer and beneciary permitted it. The fact that data transmitted in a nonpaper (unwritten) medium can be recorded on paper by a recipient's computer printer, facsimile machine, or the like does not under current practice render the data so transmitted a document. A facsimile or S.W.I.F.T. message received directly by the issuer is in an electronic medium when it crosses the boundary of the issuer's place of business. One wishing to make a presentation by facsimile (an electronic medium) will have to procure the explicit agreement of the issuer (assuming that the standard practice does not authorize it). Article 5 contemplates that electronic documents may be presented under a letter of credit 561

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and the provisions of this Article should be read to apply to electronic documents as well as tangible documents. An electronic document of title is delivered through the voluntary transfer of control. Article 1, Section 1-201 (denition of delivery). See Article 7, Section 7-106 on control of an electronic document. Where electronic transmissions are authorized neither by the letter of credit nor by the practice, the beneciary may transmit the data electronically to its agent who may be able to put it in written form and make a conforming presentation. Cf. Article 7, Section 7-105 on reissuing an electronic document in a tangible medium. 3. Good faith continues in revised Article 5 to be dened as honesty in fact. Observance of reasonable standards of fair dealing has not been added to the denition. The narrower denition of honesty in fact reinforces the independence principle in the treatment of fraud, strict compliance, preclusion, and other tests aecting the performance of obligations that are unique to letters of credit. This narrower denitionwhich does not include fair dealingis appropriate to the decision to honor or dishonor a presentation of documents specied in a letter of credit. The narrower denition is also appropriate for other parts of revised Article 5 where greater certainty of obligations is necessary and is consistent with the goals of speed and low cost. It is important that U.S. letters of credit have continuing vitality and competitiveness in international transactions. For example, it would be inconsistent with the independence principle if any of the following occurred: (i) the beneciary's failure to adhere to the standard of fair dealing in the underlying transaction or otherwise in presenting documents were to provide applicants and issuers with an unfairness defense to dishonor even when the documents complied with the terms of the letter of credit; (ii) the issuer's obligation to honor in strict compliance in accordance with standard practice were changed to reasonable compliance by use of the fair dealing standard, or (iii) the preclusion against the issuer (Section 5-108(d)) were modied under the fair dealing standard to enable the issuer later to raise additional deciencies in the presentation. The rights and obligations arising from presentation, honor, dishonor and reimbursement, are independent and strict, and thus honesty in fact is an appropriate standard. The contract between the applicant and beneciary is not governed by Article 5, but by applicable contract law, such as Article 2 or the general law of contracts. Good faith in that contract is dened by other law, such as Section 2-103(1)(b) or Restatement of Contracts 2d, 205, which incorporate the principle of fair dealing in most cases, or a State's common law or other statutory provisions that may apply to that contract. The contract between the applicant and the issuer (sometimes called the reimbursement agreement) is governed in part by this article (e.g., Sections 5-108(i), 5-111(b), and 5-103(c)) and partly by other law (e.g., the general law of contracts). The denition of good faith in Section 5-102(a)(7) applies only to the extent that the reimbursement contract is governed by provisions in this article; for other purposes good faith is dened by other law. 4. Payment and acceptance are familiar modes of honor. A third mode of honor, incurring an unconditional obligation, has legal eects similar to an acceptance of a time draft but does not technically constitute an acceptance. The practice of making letters of credit available by deferred payment undertaking as now provided in UCP 500 has grown up in other countries and spread to the United States. The denition of honor will accommodate that practice. 5. The exclusion of consumers from the denition of issuer is to keep creditors from using a letter of credit in consumer transactions in which the consumer might be made the issuer and the creditor would be the beneciary. If that transaction were recognized under Article 5, the eect would be to leave the consumer without defenses against the creditor. That outcome would violate the policy behind the Federal Trade Commission Rule in 16 CFR Part 433. In a consumer transaction, an individual cannot be an issuer where that person would otherwise be either the principal debtor or a guarantor. 6. The label on a document is not conclusive; certain documents labelled guarantees in accordance with European (and occasionally, American) practice are letters of credit. On the other hand, even documents that are labelled letter of credit may not constitute letters of credit under the denition in Section 5-102(a). When a document labelled a letter of credit requires the issuer to pay not upon the presentation of documents, but upon the determination of an extrinsic fact such as applicant's failure to perform a construction contract, and where that condition appears on its face to be fundamental and would, if 562

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ignored, leave no obligation to the issuer under the document labelled letter of credit, the issuer's undertaking is not a letter of credit. It is probably some form of suretyship or other contractual arrangement and may be enforceable as such. See Sections 5-102(a)(10) and 5-103(d). Therefore, undertakings whose fundamental term requires an issuer to look beyond documents and beyond conventional reference to the clock, calendar, and practices concerning the form of various documents are not governed by Article 5. Although Section 5-108(g) recognizes that certain nondocumentary conditions can be included in a letter of credit without denying the undertaking the status of letter of credit, that section does not apply to cases where the nondocumentary condition is fundamental to the issuer's obligation. The rules in Sections 5-102(a)(10), 5-103(d), and 5-108(g) approve the conclusion in Wichita Eagle & Beacon Publishing Co. v. Pacic Nat. Bank, 493 F.2d 1285 (9th Cir. 1974). The adjective denite is taken from the UCP. It approves cases that deny letter of credit status to documents that are unduly vague or incomplete. See, e.g., Transparent Products Corp. v. Paysaver Credit Union, 864 F.2d 60 (7th Cir.1988). Note, however, that no particular phrase or label is necessary to establish a letter of credit. It is sucient if the undertaking of the issuer shows that it is intended to be a letter of credit. In most cases the parties' intention will be indicated by a label on the undertaking itself indicating that it is a letter of credit, but no such language is necessary. A nancial institution may be both the issuer and the applicant or the issuer and the beneciary. Such letters are sometimes issued by a bank in support of the bank's own lease obligations or on behalf of one of its divisions as an applicant or to one of its divisions as beneciary, such as an overseas branch. Because wide use of letters of credit in which the issuer and the applicant or the issuer and the beneciary are the same would endanger the unique status of letters of credit, only nancial institutions are authorized to issue them. In almost all cases the ultimate performance of the issuer under a letter of credit is the payment of money. In rare cases the issuer's obligation is to deliver stock certicates or the like. The denition of letter of credit in Section 5-102(a)(10) contemplates those cases. 7. Under the UCP any bank is a nominated bank where the letter of credit is freely negotiable. A letter of credit might also nominate by the following: We hereby engage with the drawer, indorsers, and bona de holders of drafts drawn under and in compliance with the terms of this credit that the same will be duly honored on due presentation or available with any bank by negotiation. A restricted negotiation credit might be available with x bank by negotiation or the like. Several legal consequences may attach to the status of nominated person. First, when the issuer nominates a person, it is authorizing that person to pay or give value and is authorizing the beneciary to make presentation to that person. Unless the letter of credit provides otherwise, the beneciary need not present the documents to the issuer before the letter of credit expires; it need only present those documents to the nominated person. Secondly, a nominated person that gives value in good faith has a right to payment from the issuer despite fraud. Section 5-109(a)(1). 8. A record must be in or capable of being converted to a perceivable form. For example, an electronic message recorded in a computer memory that could be printed from that memory could constitute a record. Similarly, a tape recording of an oral conversation could be a record. 9. Absent a specic agreement to the contrary, documents of a beneciary delivered to an issuer or nominated person are considered to be presented under the letter of credit to which they refer, and any payment or value given for them is considered to be made under that letter of credit. As the court held in Alaska Textile Co. v. Chase Manhattan Bank, N.A., 982 F.2d 813, 820 (2d Cir.1992), it takes a signicant showing to make the presentation of a beneciary's documents for collection only or otherwise outside letter of credit law and practice. 10. Although a successor of a beneciary is one who succeeds by operation of law, some of the successions contemplated by Section 5-102(a)(15) will have resulted from voluntary action of the beneciary such as merger of a corporation. Any merger makes the successor corporation the successor of a beneciary even though the transfer occurs partly by operation of law and partly by the voluntary action of the parties. The denition excludes certain transfers, where no part of the transfer is by operation of lawsuch as the sale of assets by one company to another. 563

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11. Draft in Article 5 does not have the same meaning it has in Article 3. For example, a document may be a draft under Article 5 even though it would not be a negotiable instrument, and therefore would not qualify as a draft under Section 3-104(e).

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

5-103. Scope. (a) This article applies to letters of credit and to certain rights and obligations arising out of transactions involving letters of credit. (b) The statement of a rule in this article does not by itself require, imply, or negate application of the same or a dierent rule to a situation not provided for, or to a person not specied, in this article. (c) With the exception of this subsection, subsections (a) and (d), Sections 5-102(a)(9) and (10), 5-106(d), and 5-114(d), and except to the extent prohibited in Sections 1-302 and 5-117(d), the eect of this article may be varied by agreement or by a provision stated or incorporated by reference in an undertaking. A term in an agreement or undertaking generally excusing liability or generally limiting remedies for failure to perform obligations is not sucient to vary obligations prescribed by this article. (d) Rights and obligations of an issuer to a beneciary or a nominated person under a letter of credit are independent of the existence, performance, or nonperformance of a contract or arrangement out of which the letter of credit arises or which underlies it, including contracts or arrangements between the issuer and the applicant and between the applicant and the beneciary. As amended in 2001.
See Appendix I contained within revised Article 1 for material relating to changes made in text in 2001.

Ocial Comment
1. Sections 5-102(a)(10) and 5-103 are the principal limits on the scope of Article 5. Many undertakings in commerce and contract are similar, but not identical to the letter of credit. Principal among those are secondary, accessory, or suretyship guarantees. Although the word guarantee is sometimes used to describe an independent obligation like that of the issuer of a letter of credit (most often in the case of European bank undertakings but occasionally in the case of undertakings of American banks), in the United States the word guarantee is more typically used to describe a suretyship transaction in which the guarantor is only secondarily liable and has the right to assert the underlying debtor's defenses. This article does not apply to secondary or accessory guarantees and it is important to recognize the distinction between letters of credit and those guarantees. It is often a defense to a secondary or accessory guarantor's liability that the underlying debt has been discharged or that the debtor has other defenses to the underlying liability. In letter of credit law, on the other hand, the independence principle recognized throughout Article 5 states that the issuer's liability is independent of the underlying obligation. That the beneciary may have breached the underlying contract and thus have given a good defense on that contract to the applicant against the beneciary is no defense for the issuer's refusal to honor. Only staunch recognition of this principle by the issuers and the courts will give letters of credit the continuing vitality that arises from the certainty and speed of payment under letters of credit. To that end, it is important that the law not carry into letter of credit transactions rules that properly apply only to secondary guarantees or to other forms of engagement. 2. Like all of the provisions of the Uniform Commercial Code, Article 5 is supplemented by Section 1-103 and, through it, by many rules of statutory and common law. Because this 564

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article is quite short and has no rules on many issues that will aect liability with respect to a letter of credit transaction, law beyond Article 5 will often determine rights and liabilities in letter of credit transactions. Even within letter of credit law, the article is far from comprehensive; it deals only with certain rights of the parties. Particularly with respect to the standards of performance that are set out in Section 5-108, it is appropriate for the parties and the courts to turn to customs and practice such as the Uniform Customs and Practice for Documentary Credits, currently published by the International Chamber of Commerce as I.C.C. Pub. No. 500 (hereafter UCP). Many letters of credit specically adopt the UCP as applicable to the particular transaction. Where the UCP are adopted but conict with Article 5 and except where variation is prohibited, the UCP terms are permissible contractual modications under Sections 1-302 and 5-103(c). See Section 5-116(c). Normally Article 5 should not be considered to conict with practice except when a rule explicitly stated in the UCP or other practice is dierent from a rule explicitly stated in Article 5. Except by choosing the law of a jurisdiction that has not adopted the Uniform Commercial Code, it is not possible entirely to escape the Uniform Commercial Code. Since incorporation of the UCP avoids only conicting Article 5 rules, parties who do not wish to be governed by the nonconicting provisions of Article 5 must normally either adopt the law of a jurisdiction other than a State of the United States or state explicitly the rule that is to govern. When rules of custom and practice are incorporated by reference, they are considered to be explicit terms of the agreement or undertaking. Neither the obligation of an issuer under Section 5-108 nor that of an adviser under Section 5-107 is an obligation of the kind that is invariable under Section 1-102(3). Section 5-103(c) and Comment 1 to Section 5-108 make it clear that the applicant and the issuer may agree to almost any provision establishing the obligations of the issuer to the applicant. The last sentence of subsection (c) limits the power of the issuer to achieve that result by a nonnegotiated disclaimer or limitation of remedy. What the issuer could achieve by an explicit agreement with its applicant or by a term that explicitly denes its duty, it cannot accomplish by a general disclaimer. The restriction on disclaimers in the last sentence of subsection (c) is based more on procedural than on substantive unfairness. Where, for example, the reimbursement agreement provides explicitly that the issuer need not examine any documents, the applicant understands the risk it has undertaken. A term in a reimbursement agreement which states generally that an issuer will not be liable unless it has acted in bad faith or committed gross negligence is ineective under Section 5-103(c). On the other hand, less general terms such as terms that permit issuer reliance on an oral or electronic message believed in good faith to have been received from the applicant or terms that entitle an issuer to reimbursement when it honors a substantially though not strictly complying presentation, are eective. In each case the question is whether the disclaimer or limitation is suciently clear and explicit in reallocating a liability or risk that is allocated dierently under a variable Article 5 provision. Of course, no term in a letter of credit, whether incorporated by reference to practice rules or stated specically, can free an issuer from a conicting contractual obligation to its applicant. If, for example, an issuer promised its applicant that it would pay only against an inspection certicate of a particular company but failed to require such a certicate in its letter of credit or made the requirement only a nondocumentary condition that had to be disregarded, the issuer might be obliged to pay the beneciary even though its payment might violate its contract with its applicant. 3. Parties should generally avoid modifying the denitions in Section 5-102. The eect of such an agreement is almost inevitably unclear. To say that something is a guarantee in the typical domestic transaction is to say that the parties intend that particular legal rules apply to it. By acknowledging that something is a guarantee, but asserting that it is to be treated as a letter of credit, the parties leave a court uncertain about where the rules on guarantees stop and those concerning letters of credit begin. 4. Section 5-102(2) and (3) of Article 5 are omitted as unneeded; the omission does not change the law.

As amended in 2001.
See Appendix I contained within revised Article 1 for material relating to changes made in Ocial Comment in 2001.
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 5-104

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5-104. Formal Requirements. A letter of credit, conrmation, advice, transfer, amendment, or cancellation may be issued in any form that is a record and is authenticated (i) by a signature or (ii) in accordance with the agreement of the parties or the standard practice referred to in Section 5-108(e). Ocial Comment
1. Neither Section 5-104 nor the denition of letter of credit in Section 5-102(a)(10) requires inclusion of all the terms that are normally contained in a letter of credit in order for an undertaking to be recognized as a letter of credit under Article 5. For example, a letter of credit will typically specify the amount available, the expiration date, the place where presentation should be made, and the documents that must be presented to entitle a person to honor. Undertakings that have the formalities required by Section 5-104 and meet the conditions specied in Section 5-102(a)(10) will be recognized as letters of credit even though they omit one or more of the items usually contained in a letter of credit. 2. The authentication specied in this section is authentication only of the identity of the issuer, conrmer, or adviser. An authentication agreement may be by system rule, by standard practice, or by direct agreement between the parties. The reference to practice is intended to incorporate future developments in the UCP and other practice rules as well as those that may arise spontaneously in commercial practice. 3. Many banking transactions, including the issuance of many letters of credit, are now conducted mostly by electronic means. For example, S.W.I.F.T. is currently used to transmit letters of credit from issuing to advising banks. The letter of credit text so transmitted may be printed at the advising bank, stamped original and provided to the beneciary in that form. The printed document may then be used as a way of controlling and recording payments and of recording and authorizing assignments of proceeds or transfers of rights under the letter of credit. Nothing in this section should be construed to conict with that practice. To be a record sucient to serve as a letter of credit or other undertaking under this section, data must have a durability consistent with that function. Because consideration is not required for a binding letter of credit or similar undertaking (Section 5-105) yet those undertakings are to be strictly construed (Section 5-108), parties to a letter of credit transaction are especially dependent on the continued availability of the terms and conditions of the letter of credit or other undertaking. By declining to specify any particular medium in which the letter of credit must be established or communicated, Section 5-104 leaves room for future developments.

5-105. Consideration. Consideration is not required to issue, amend, transfer, or cancel a letter of credit, advice, or conrmation. Ocial Comment
It is not to be expected that any issuer will issue its letter of credit without some form of remuneration. But it is not expected that the beneciary will know what the issuer's remuneration was or whether in fact there was any identiable remuneration in a given case. And it might be dicult for the beneciary to prove the issuer's remuneration. This section dispenses with this proof and is consistent with the position of Lord Manseld in Pillans v. Van Mierop, 97 Eng.Rep. 1035 (K.B. 1765) in making consideration irrelevant.

5-106. Issuance, Amendment, Cancellation, and Duration. (a) A letter of credit is issued and becomes enforceable according to its terms against the issuer when the issuer sends or otherwise transmits it to the person requested to advise or to the beneciary. A letter of credit is revocable only if it so provides. (b) After a letter of credit is issued, rights and obligations of a beneciary, applicant, conrmer, and issuer are not aected by an amendment
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or cancellation to which that person has not consented except to the extent the letter of credit provides that it is revocable or that the issuer may amend or cancel the letter of credit without that consent. (c) If there is no stated expiration date or other provision that determines its duration, a letter of credit expires one year after its stated date of issuance or, if none is stated, after the date on which it is issued. (d) A letter of credit that states that it is perpetual expires ve years after its stated date of issuance, or if none is stated, after the date on which it is issued. Ocial Comment
1. This section adopts the position taken by several courts, namely that letters of credit that are silent as to revocability are irrevocable. See, e.g., Weyerhaeuser Co. v. First Nat. Bank, 27 UCC Rep.Serv. 777 (S.D. Iowa 1979); West Va. Hous. Dev. Fund v. Sroka, 415 F.Supp. 1107 (W.D.Pa.1976). This is the position of the current UCP (500). Given the usual commercial understanding and purpose of letters of credit, revocable letters of credit oer unhappy possibilities for misleading the parties who deal with them. 2. A person can consent to an amendment by implication. For example, a beneciary that tenders documents for honor that conform to an amended letter of credit but not to the original letter of credit has probably consented to the amendment. By the same token an applicant that has procured the issuance of a transferable letter of credit has consented to its transfer and to performance under the letter of credit by a person to whom the beneciary's rights are duly transferred. If some, but not all of the persons involved in a letter of credit transaction consent to performance that does not strictly conform to the original letter of credit, those persons assume the risk that other nonconsenting persons may insist on strict compliance with the original letter of credit. Under subsection (b) those not consenting are not bound. For example, an issuer might agree to amend its letter of credit or honor documents presented after the expiration date in the belief that the applicant has consented or will consent to the amendment or will waive presentation after the original expiration date. If that belief is mistaken, the issuer is bound to the beneciary by the terms of the letter of credit as amended or waived, even though it may be unable to recover from the applicant. In general, the rights of a recognized transferee beneciary cannot be altered without the transferee's consent, but the same is not true of the rights of assignees of proceeds from the beneciary. When the beneciary makes a complete transfer of its interest that is eective under the terms for transfer established by the issuer, adviser, or other party controlling transfers, the beneciary no longer has an interest in the letter of credit, and the transferee steps into the shoes of the beneciary as the one with rights under the letter of credit. Section 5-102(a)(3). When there is a partial transfer, both the original beneciary and the transferee beneciary have an interest in performance of the letter of credit and each expects that its rights will not be altered by amendment unless it consents. The assignee of proceeds under a letter of credit from the beneciary enjoys no such expectation. Notwithstanding an assignee's notice to the issuer of the assignment of proceeds, the assignee is not a person protected by subsection (b). An assignee of proceeds should understand that its rights can be changed or completely extinguished by amendment or cancellation of the letter of credit. An assignee's claim is precarious, for it depends entirely upon the continued existence of the letter of credit and upon the beneciary's preparation and presentation of documents that would entitle the beneciary to honor under Section 5-108. 3. The issuer's right to cancel a revocable letter of credit does not free it from a duty to reimburse a nominated person who has honored, accepted, or undertaken a deferred obligation prior to receiving notice of the amendment or cancellation. Compare UCP Article 8. 4. Although all letters of credit should specify the date on which the issuer's engagement expires, the failure to specify an expiration date does not invalidate the letter of credit, or diminish or relieve the obligation of any party with respect to the letter of credit. A letter of credit that may be revoked or terminated at the discretion of the issuer by notice to the beneciary is not perpetual. 567

 5-107

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5-107. Conrmer, Nominated Person, and Adviser. (a) A conrmer is directly obligated on a letter of credit and has the rights and obligations of an issuer to the extent of its conrmation. The conrmer also has rights against and obligations to the issuer as if the issuer were an applicant and the conrmer had issued the letter of credit at the request and for the account of the issuer. (b) A nominated person who is not a conrmer is not obligated to honor or otherwise give value for a presentation. (c) A person requested to advise may decline to act as an adviser. An adviser that is not a conrmer is not obligated to honor or give value for a presentation. An adviser undertakes to the issuer and to the beneciary accurately to advise the terms of the letter of credit, conrmation, amendment, or advice received by that person and undertakes to the beneciary to check the apparent authenticity of the request to advise. Even if the advice is inaccurate, the letter of credit, conrmation, or amendment is enforceable as issued. (d) A person who noties a transferee beneciary of the terms of a letter of credit, conrmation, amendment, or advice has the rights and obligations of an adviser under subsection (c). The terms in the notice to the transferee beneciary may dier from the terms in any notice to the transferor beneciary to the extent permitted by the letter of credit, conrmation, amendment, or advice received by the person who so noties. Ocial Comment
1. A conrmer has the rights and obligations identied in Section 5-108. Accordingly, unless the context otherwise requires, the terms conrmer and conrmation should be read into this article wherever the terms issuer and letter of credit appear. A conrmer that has paid in accordance with the terms and conditions of the letter of credit is entitled to reimbursement by the issuer even if the beneciary committed fraud (see Section 5-109(a)(1)(ii)) and, in that sense, has greater rights against the issuer than the beneciary has. To be entitled to reimbursement from the issuer under the typical conrmed letter of credit, the conrmer must submit conforming documents, but the conrmer's presentation to the issuer need not be made before the expiration date of the letter of credit. A letter of credit conrmation has been analogized to a guarantee of issuer performance, to a parallel letter of credit issued by the conrmer for the account of the issuer or the letter of credit applicant or both, and to a back-to-back letter of credit in which the conrmer is a kind of beneciary of the original issuer's letter of credit. Like letter of credit undertakings, conrmations are both unique and exible, so that no one of these analogies is perfect, but unless otherwise indicated in the letter of credit or conrmation, a conrmer should be viewed by the letter of credit issuer and the beneciary as an issuer of a parallel letter of credit for the account of the original letter of credit issuer. Absent a direct agreement between the applicant and a conrmer, normally the obligations of a conrmer are to the issuer not the applicant, but the applicant might have a right to injunction against a conrmer under Section 5-109 or warranty claim under Section 5-110, and either might have claims against the other under Section 5-117. 2. No one has a duty to advise until that person agrees to be an adviser or undertakes to act in accordance with the instructions of the issuer. Except where there is a prior agreement to serve or where the silence of the adviser would be an acceptance of an oer to contract, a person's failure to respond to a request to advise a letter of credit does not in and of itself create any liability, nor does it establish a relationship of issuer and adviser between the two. Since there is no duty to advise a letter of credit in the absence of a prior agreement, there can be no duty to advise it timely or at any particular time. When the adviser manifests its agreement to advise by actually doing so (as is normally the case), the adviser cannot have violated any duty to advise in a timely way. This analysis is consistent 568

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with the result of Sound of Market Street v. Continental Bank International, 819 F.2d 384 (3d Cir.1987) which held that there is no such duty. This section takes no position on the reasoning of that case, but does not overrule the result. By advising or agreeing to advise a letter of credit, the adviser assumes a duty to the issuer and to the beneciary accurately to report what it has received from the issuer, but, beyond determining the apparent authenticity of the letter, an adviser has no duty to investigate the accuracy of the message it has received from the issuer. Checking the apparent authenticity of the request to advise means only that the prospective adviser must attempt to authenticate the message (e.g., by testing the telex that comes from the purported issuer), and if it is unable to authenticate the message must report that fact to the issuer and, if it chooses to advise the message, to the beneciary. By proper agreement, an adviser may disclaim its obligation under this section. 3. An issuer may issue a letter of credit which the adviser may advise with dierent terms. The issuer may then believe that it has undertaken a certain engagement, yet the text in the hands of the beneciary will contain dierent terms, and the beneciary would not be entitled to honor if the documents it submitted did not comply with the terms of the letter of credit as originally issued. On the other hand, if the adviser also conrmed the letter of credit, then as a conrmer it will be independently liable on the letter of credit as advised and conrmed. If in that situation the beneciary's ultimate presentation entitled it to honor under the terms of the conrmation but not under those in the original letter of credit, the conrmer would have to honor but might not be entitled to reimbursement from the issuer. 4. When the issuer nominates another person to pay, negotiate, or otherwise to take up the documents and give value, there can be confusion about the legal status of the nominated person. In rare cases the person might actually be an agent of the issuer and its act might be the act of the issuer itself. In most cases the nominated person is not an agent of the issuer and has no authority to act on the issuer's behalf. Its nomination allows the beneciary to present to it and earns it certain rights to payment under Section 5-109 that others do not enjoy. For example, when an issuer issues a freely negotiable credit, it contemplates that banks or others might take up documents under that credit and advance value against them, and it is agreeing to pay those persons but only if the presentation to the issuer made by the nominated person complies with the credit. Usually there will be no agreement to pay, negotiate, or to serve in any other capacity by the nominated person, therefore the nominated person will have the right to decline to take the documents. It may return them or agree merely to act as a forwarding agent for the documents but without giving value against them or taking any responsibility for their conformity to the letter of credit.

5-108. Issuer's Rights and Obligations. (a) Except as otherwise provided in Section 5-109, an issuer shall honor a presentation that, as determined by the standard practice referred to in subsection (e), appears on its face strictly to comply with the terms and conditions of the letter of credit. Except as otherwise provided in Section 5-113 and unless otherwise agreed with the applicant, an issuer shall dishonor a presentation that does not appear so to comply. (b) An issuer has a reasonable time after presentation, but not beyond the end of the seventh business day of the issuer after the day of its receipt of documents: (1) to honor, (2) if the letter of credit provides for honor to be completed more than seven business days after presentation, to accept a draft or incur a deferred obligation, or (3) to give notice to the presenter of discrepancies in the presentation. (c) Except as otherwise provided in subsection (d), an issuer is precluded from asserting as a basis for dishonor any discrepancy if timely notice is
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not given, or any discrepancy not stated in the notice if timely notice is given. (d) Failure to give the notice specied in subsection (b) or to mention fraud, forgery, or expiration in the notice does not preclude the issuer from asserting as a basis for dishonor fraud or forgery as described in Section 5-109(a) or expiration of the letter of credit before presentation. (e) An issuer shall observe standard practice of nancial institutions that regularly issue letters of credit. Determination of the issuer's observance of the standard practice is a matter of interpretation for the court. The court shall oer the parties a reasonable opportunity to present evidence of the standard practice. (f) An issuer is not responsible for: (1) the performance or nonperformance of the underlying contract, arrangement, or transaction, (2) an act or omission of others, or (3) observance or knowledge of the usage of a particular trade other than the standard practice referred to in subsection (e). (g) If an undertaking constituting a letter of credit under Section 5-102(a) (10) contains nondocumentary conditions, an issuer shall disregard the nondocumentary conditions and treat them as if they were not stated. (h) An issuer that has dishonored a presentation shall return the documents or hold them at the disposal of, and send advice to that eect to, the presenter. (i) An issuer that has honored a presentation as permitted or required by this article: (1) is entitled to be reimbursed by the applicant in immediately available funds not later than the date of its payment of funds; (2) takes the documents free of claims of the beneciary or presenter; (3) is precluded from asserting a right of recourse on a draft under Sections 3-414 and 3-415; (4) except as otherwise provided in Sections 5-110 and 5-117, is precluded from restitution of money paid or other value given by mistake to the extent the mistake concerns discrepancies in the documents or tender which are apparent on the face of the presentation; and (5) is discharged to the extent of its performance under the letter of credit unless the issuer honored a presentation in which a required signature of a beneciary was forged. Ocial Comment
1. This section combines some of the duties previously included in Sections 5-114 and 5-109. Because a conrmer has the rights and duties of an issuer, this section applies equally to a conrmer and an issuer. See Section 5-107(a). The standard of strict compliance governs the issuer's obligation to the beneciary and to the applicant. By requiring that a presentation appear strictly to comply, the section requires not only that the documents themselves appear on their face strictly to comply, but also that the other terms of the letter of credit such as those dealing with the time and place of presentation are strictly complied with. Typically, a letter of credit will provide that presentation is timely if made to the issuer, conrmer, or any other nominated person prior to expiration of the letter of credit. Accordingly, a nominated person that has honored a demand or otherwise given value before expiration will have a right to reimbursement 570

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from the issuer even though presentation to the issuer is made after the expiration of the letter of credit. Conversely, where the beneciary negotiates documents to one who is not a nominated person, the beneciary or that person acting on behalf of the beneciary must make presentation to a nominated person, conrmer, or issuer prior to the expiration date. This section does not impose a bifurcated standard under which an issuer's right to reimbursement might be broader than a beneciary's right to honor. However, the explicit deference to standard practice in Section 5-108(a) and (e) and elsewhere expands issuers' rights of reimbursement where that practice so provides. Also, issuers can and often do contract with their applicants for expanded rights of reimbursement. Where that is done, the beneciary will have to meet a more stringent standard of compliance as to the issuer than the issuer will have to meet as to the applicant. Similarly, a nominated person may have reimbursement and other rights against the issuer based on this article, the UCP, bank-to-bank reimbursement rules, or other agreement or undertaking of the issuer. These rights may allow the nominated person to recover from the issuer even when the nominated person would have no right to obtain honor under the letter of credit. The section adopts strict compliance, rather than the standard that commentators have called substantial compliance, the standard arguably applied in Banco Espaol de Credito v. State Street Bank and Trust Company, 385 F.2d 230 (1st Cir.1967) and Flagship Cruises Ltd. v. New England Merchants Nat. Bank, 569 F.2d 699 (1st Cir.1978). Strict compliance does not mean slavish conformity to the terms of the letter of credit. For example, standard practice (what issuers do) may recognize certain presentations as complying that an unschooled layman would regard as discrepant. By adopting standard practice as a way of measuring strict compliance, this article indorses the conclusion of the court in New Braunfels Nat. Bank v. Odiorne, 780 S.W.2d 313 (Tex.Ct.App. 1989) (beneciary could collect when draft requested payment on Letter of Credit No. 86-122-5 and letter of credit specied Letter of Credit No. 86-122-S holding strict compliance does not demand oppressive perfectionism). The section also indorses the result in Tosco Corp. v. Federal Deposit Insurance Corp., 723 F.2d 1242 (6th Cir.1983). The letter of credit in that case called for drafts Drawn under Bank of Clarksville Letter of Credit Number 105. The draft presented stated drawn under Bank of Clarksville, Clarksville, Tennessee letter of Credit No. 105. The court correctly found that despite the change of upper case L to a lower case l and the use of the word No. instead of Number, and despite the addition of the words Clarksville, Tennessee, the presentation conformed. Similarly a document addressed by a foreign person to General Motors as Jeneral Motors would strictly conform in the absence of other defects. Identifying and determining compliance with standard practice are matters of interpretation for the court, not for the jury. As with similar rules in Sections 4A-202(c) and 2-302, it is hoped that there will be more consistency in the outcomes and speedier resolution of disputes if the responsibility for determining the nature and scope of standard practice is granted to the court, not to a jury. Granting the court authority to make these decisions will also encourage the salutary practice of courts' granting summary judgment in circumstances where there are no signicant factual disputes. The statute encourages outcomes such as American Coleman Co. v. Intrawest Bank, 887 F.2d 1382 (10th Cir.1989), where summary judgment was granted. In some circumstances standards may be established between the issuer and the applicant by agreement or by custom that would free the issuer from liability that it might otherwise have. For example, an applicant might agree that the issuer would have no duty whatsoever to examine documents on certain presentations (e.g., those below a certain dollar amount). Where the transaction depended upon the issuer's payment in a very short time period (e.g., on the same day or within a few hours of presentation), the issuer and the applicant might agree to reduce the issuer's responsibility for failure to discover discrepancies. By the same token, an agreement between the applicant and the issuer might permit the issuer to examine documents exclusively by electronic or electro-optical means. Neither those agreements nor others like them explicitly made by issuers and applicants violate the terms of Section 5-108(a) or (b) or Section 5-103(c). 2. Section 5-108(a) balances the need of the issuer for time to examine the documents against the possibility that the examiner (at the urging of the applicant or for fear that it will not be reimbursed) will take excessive time to search for defects. What is a reasonable time is not extended to accommodate an issuer's procuring a waiver from the applicant. See Article 14c of the UCP. 571

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Under both the UCC and the UCP the issuer has a reasonable time to honor or give notice. The outside limit of that time is measured in business days under the UCC and in banking days under the UCP, a dierence that will rarely be signicant. Neither business nor banking days are dened in Article 5, but a court may nd useful analogies in Regulation CC, 12 CFR 229.2, in state law outside of the Uniform Commercial Code, and in Article 4. Examiners must note that the seven-day period is not a safe harbor. The time within which the issuer must give notice is the lesser of a reasonable time or seven business days. Where there are few documents (as, for example, with the mine run standby letter of credit), the reasonable time would be less than seven days. If more than a reasonable time is consumed in examination, no timely notice is possible. What is a reasonable time is to be determined by examining the behavior of those in the business of examining documents, mostly banks. Absent prior agreement of the issuer, one could not expect a bank issuer to examine documents while the beneciary waited in the lobby if the normal practice was to give the documents to a person who had the opportunity to examine those together with many others in an orderly process. That the applicant has not yet paid the issuer or that the applicant's account with the issuer is insucient to cover the amount of the draft is not a basis for extension of the time period. This section does not preclude the issuer from contacting the applicant during its examination; however, the decision to honor rests with the issuer, and it has no duty to seek a waiver from the applicant or to notify the applicant of receipt of the documents. If the issuer dishonors a conforming presentation, the beneciary will be entitled to the remedies under Section 5-111, irrespective of the applicant's views. Even though the person to whom presentation is made cannot conduct a reasonable examination of documents within the time after presentation and before the expiration date, presentation establishes the parties' rights. The beneciary's right to honor or the issuer's right to dishonor arises upon presentation at the place provided in the letter of credit even though it might take the person to whom presentation has been made several days to determine whether honor or dishonor is the proper course. The issuer's time for honor or giving notice of dishonor may be extended or shortened by a term in the letter of credit. The time for the issuer's performance may be otherwise modied or waived in accordance with Section 5-106. The issuer's time to inspect runs from the time of its receipt of documents. Documents are considered to be received only when they are received at the place specied for presentation by the issuer or other party to whom presentation is made. Receipt of documents when documents of title are presented must be read in light of the denition of delivery in Article 1, Section 1-201 and the denition of presentment in Section 5-102(a)(12). Failure of the issuer to act within the time permitted by subsection (b) constitutes dishonor. Because of the preclusion in subsection (c) and the liability that the issuer may incur under Section 5-111 for wrongful dishonor, the eect of such a silent dishonor may ultimately be the same as though the issuer had honored, i.e., it may owe damages in the amount drawn but unpaid under the letter of credit. 3. The requirement that the issuer send notice of the discrepancies or be precluded from asserting discrepancies is new to Article 5. It is taken from the similar provision in the UCP and is intended to promote certainty and nality. The section thus substitutes a strict preclusion principle for the doctrines of waiver and estoppel that might otherwise apply under Section 1-103. It rejects the reasoning in Flagship Cruises Ltd. v. New England Merchants' Nat. Bank, 569 F.2d 699 (1st Cir.1978) and Wing On Bank Ltd. v. American Nat. Bank & Trust Co., 457 F.2d 328 (5th Cir.1972) where the issuer was held to be estopped only if the beneciary relied on the issuer's failure to give notice. Assume, for example, that the beneciary presented documents to the issuer shortly before the letter of credit expired, in circumstances in which the beneciary could not have cured any discrepancy before expiration. Under the reasoning of Flagship and Wing On, the beneciary's inability to cure, even if it had received notice, would absolve the issuer of its failure to give notice. The virtue of the preclusion obligation adopted in this section is that it forecloses litigation about reliance and detriment. Even though issuers typically give notice of the discrepancy of tardy presentation when presentation is made after the expiration of a credit, they are not required to give that no572

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tice and the section permits them to raise late presentation as a defect despite their failure to give that notice. 4. To act within a reasonable time, the issuer must normally give notice without delay after the examining party makes its decision. If the examiner decides to dishonor on the rst day, it would be obliged to notify the beneciary shortly thereafter, perhaps on the same business day. This rule accepts the reasoning in cases such as Datapoint Corp. v. M & I Bank, 665 F.Supp. 722 (W.D.Wis.1987) and Esso Petroleum Canada, Div. of Imperial Oil, Ltd. v. Security Pacic Bank, 710 F.Supp. 275 (D.Or.1989). The section deprives the examining party of the right simply to sit on a presentation that is made within seven days of expiration. The section requires the examiner to examine the documents and make a decision and, having made a decision to dishonor, to communicate promptly with the presenter. Nevertheless, a beneciary who presents documents shortly before the expiration of a letter of credit runs the risk that it will never have the opportunity to cure any discrepancies. 5. Conrmers, other nominated persons, and collecting banks acting for beneciaries can be presenters and, when so, are entitled to the notice provided in subsection (b). Even nominated persons who have honored or given value against an earlier presentation of the beneciary and are themselves seeking reimbursement or honor need notice of discrepancies in the hope that they may be able to procure complying documents. The issuer has the obligations imposed by this section whether the issuer's performance is characterized as reimbursement of a nominated person or as honor. 6. In many cases a letter of credit authorizes presentation by the beneciary to someone other than the issuer. Sometimes that person is identied as a payor or paying bank, or as an acceptor or accepting bank, in other cases as a negotiating bank, and in other cases there will be no specic designation. The section does not impose any duties on a person other than the issuer or conrmer, however a nominated person or other person may have liability under this article or at common law if it fails to perform an express or implied agreement with the beneciary. 7. The issuer's obligation to honor runs not only to the beneciary but also to the applicant. It is possible that an applicant who has made a favorable contract with the beneciary will be injured by the issuer's wrongful dishonor. Except to the extent that the contract between the issuer and the applicant limits that liability, the issuer will have liability to the applicant for wrongful dishonor under Section 5-111 as a matter of contract law. A good faith extension of the time in Section 5-108(b) by agreement between the issuer and beneciary binds the applicant even if the applicant is not consulted or does not consent to the extension. The issuer's obligation to dishonor when there is no apparent compliance with the letter of credit runs only to the applicant. No other party to the transaction can complain if the applicant waives compliance with terms or conditions of the letter of credit or agrees to a less stringent standard for compliance than that supplied by this article. Except as otherwise agreed with the applicant, an issuer may dishonor a noncomplying presentation despite an applicant's waiver. Waiver of discrepancies by an issuer or an applicant in one or more presentations does not waive similar discrepancies in a future presentation. Neither the issuer nor the beneciary can reasonably rely upon honor over past waivers as a basis for concluding that a future defective presentation will justify honor. The reasoning of Courtaulds of North America Inc. v. North Carolina Nat. Bank, 528 F.2d 802 (4th Cir.1975) is accepted and that expressed in Schweibish v. Pontchartrain State Bank, 389 So.2d 731 (La.App.1980) and Titanium Metals Corp. v. Space Metals, Inc., 529 P.2d 431 (Utah 1974) is rejected. 8. The standard practice referred to in subsection (e) includes (i) international practice set forth in or referenced by the Uniform Customs and Practice, (ii) other practice rules published by associations of nancial institutions, and (iii) local and regional practice. It is possible that standard practice will vary from one place to another. Where there are conicting practices, the parties should indicate which practice governs their rights. A practice may be overridden by agreement or course of dealing. See Section 1-205(4). 9. The responsibility of the issuer under a letter of credit is to examine documents and to make a prompt decision to honor or dishonor based upon that examination. Nondocumentary conditions have no place in this regime and are better accommodated under contract or suretyship law and practice. In requiring that nondocumentary conditions in letters of 573

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credit be ignored as surplusage, Article 5 remains aligned with the UCP (see UCP 500 Article 13c), approves cases like Pringle-Associated Mortgage Corp. v. Southern National Bank, 571 F.2d 871, 874 (5th Cir.1978), and rejects the reasoning in cases such as Sherwood & Roberts, Inc. v. First Security Bank, 682 P.2d 149 (Mont. 1984). Subsection (g) recognizes that letters of credit sometimes contain nondocumentary terms or conditions. Conditions such as a term prohibiting shipment on vessels more than 15 years old, are to be disregarded and treated as surplusage. Similarly, a requirement that there be an award by a duly appointed arbitrator would not require the issuer to determine whether the arbitrator had been duly appointed. Likewise a term in a standby letter of credit that provided for diering forms of certication depending upon the particular type of default does not oblige the issuer independently to determine which kind of default has occurred. These conditions must be disregarded by the issuer. Where the nondocumentary conditions are central and fundamental to the issuer's obligation (as for example a condition that would require the issuer to determine in fact whether the beneciary had performed the underlying contract or whether the applicant had defaulted) their inclusion may remove the undertaking from the scope of Article 5 entirely. See Section 5-102(a)(10) and Comment 6 to Section 5-102. Subsection (g) would not permit the beneciary or the issuer to disregard terms in the letter of credit such as place, time, and mode of presentation. The rule in subsection (g) is intended to prevent an issuer from deciding or even investigating extrinsic facts, but not from consulting the clock, the calendar, the relevant law and practice, or its own general knowledge of documentation or transactions of the type underlying a particular letter of credit. Even though nondocumentary conditions must be disregarded in determining compliance of a presentation (and thus in determining the issuer's duty to the beneciary), an issuer that has promised its applicant that it will honor only on the occurrence of those nondocumentary conditions may have liability to its applicant for disregarding the conditions. 10. Subsection (f) condones an issuer's ignorance of any usage of a particular trade; that trade is the trade of the applicant, beneciary, or others who may be involved in the underlying transaction. The issuer is expected to know usage that is commonly encountered in the course of document examination. For example, an issuer should know the common usage with respect to documents in the maritime shipping trade but would not be expected to understand synonyms used in a particular trade for product descriptions appearing in a letter of credit or an invoice. 11. Where the issuer's performance is the delivery of an item of value other than money, the applicant's reimbursement obligation would be to make the item of value available to the issuer. 12. An issuer is entitled to reimbursement from the applicant after honor of a forged or fraudulent drawing if honor was permitted under Section 5-109(a). 13. The last clause of Section 5-108(i)(5) deals with a special case in which the fraud is not committed by the beneciary, but is committed by a stranger to the transaction who forges the beneciary's signature. If the issuer pays against documents on which a required signature of the beneciary is forged, it remains liable to the true beneciary. This principle is applicable to both electronic and tangible documents.

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

5-109. Fraud and Forgery. (a) If a presentation is made that appears on its face strictly to comply with the terms and conditions of the letter of credit, but a required document is forged or materially fraudulent, or honor of the presentation would facilitate a material fraud by the beneciary on the issuer or applicant: (1) the issuer shall honor the presentation, if honor is demanded by (i) a nominated person who has given value in good faith and without notice of forgery or material fraud, (ii) a conrmer who has honored its
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conrmation in good faith, (iii) a holder in due course of a draft drawn under the letter of credit which was taken after acceptance by the issuer or nominated person, or (iv) an assignee of the issuer's or nominated person's deferred obligation that was taken for value and without notice of forgery or material fraud after the obligation was incurred by the issuer or nominated person; and (2) the issuer, acting in good faith, may honor or dishonor the presentation in any other case. (b) If an applicant claims that a required document is forged or materially fraudulent or that honor of the presentation would facilitate a material fraud by the beneciary on the issuer or applicant, a court of competent jurisdiction may temporarily or permanently enjoin the issuer from honoring a presentation or grant similar relief against the issuer or other persons only if the court nds that: (1) the relief is not prohibited under the law applicable to an accepted draft or deferred obligation incurred by the issuer; (2) a beneciary, issuer, or nominated person who may be adversely aected is adequately protected against loss that it may suer because the relief is granted; (3) all of the conditions to entitle a person to the relief under the law of this State have been met; and (4) on the basis of the information submitted to the court, the applicant is more likely than not to succeed under its claim of forgery or material fraud and the person demanding honor does not qualify for protection under subsection (a)(1). Ocial Comment
1. This recodication makes clear that fraud must be found either in the documents or must have been committed by the beneciary on the issuer or applicant. See Cromwell v. Commerce & Energy Bank, 464 So.2d 721 (La.1985). Secondly, it makes clear that fraud must be material. Necessarily courts must decide the breadth and width of materiality. The use of the word requires that the fraudulent aspect of a document be material to a purchaser of that document or that the fraudulent act be signicant to the participants in the underlying transaction. Assume, for example, that the beneciary has a contract to deliver 1,000 barrels of salad oil. Knowing that it has delivered only 998, the beneciary nevertheless submits an invoice showing 1,000 barrels. If two barrels in a 1,000 barrel shipment would be an insubstantial and immaterial breach of the underlying contract, the beneciary's act, though possibly fraudulent, is not materially so and would not justify an injunction. Conversely, the knowing submission of those invoices upon delivery of only ve barrels would be materially fraudulent. The courts must examine the underlying transaction when there is an allegation of material fraud, for only by examining that transaction can one determine whether a document is fraudulent or the beneciary has committed fraud and, if so, whether the fraud was material. Material fraud by the beneciary occurs only when the beneciary has no colorable right to expect honor and where there is no basis in fact to support such a right to honor. The section indorses articulations such as those stated in Intraworld Indus. v. Girard Trust Bank, 336 A.2d 316 (Pa.1975), Roman Ceramics Corp. v. People's Nat. Bank, 714 F.2d 1207 (3d Cir.1983), and similar decisions and embraces certain decisions under Section 5-114 that relied upon the phrase fraud in the transaction. Some of these decisions have been summarized as follows in Ground Air Transfer v. Westate's Airlines, 899 F.2d 1269, 127273 (1st Cir.1990):

We have said throughout that courts may not normally issue an injunction because of an important exception to the general no injunction rule. The exception, as we also explained in Itek, 730 F.2d at 2425, concerns
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fraud so serious as to make it obviously pointless and unjust to permit the beneciary to obtain the money. Where the circumstances plainly show that the underlying contract forbids the beneciary to call a letter of credit, Itek, 730 F.2d at 24; where they show that the contract deprives the beneciary of even a colorable right to do so, id., at 25; where the contract and circumstances reveal that the beneciary's demand for payment has absolutely no basis in fact, id.; see Dynamics Corp. of America, 356 F.Supp. at 999; where the beneciary's conduct has so vitiated the entire transaction that the legitimate purposes of the independence of the issuer's obligation would no longer be served, Itek, 730 F.2d at 25 (quoting Roman Ceramics Corp. v. Peoples National Bank, 714 F.2d 1207, 1212 n.12, 1215 (3d Cir.1983) (quoting Intraworld Indus., 336 A.2d at 32425)); then a court may enjoin payment.
2. Subsection (a)(2) makes clear that the issuer may honor in the face of the applicant's claim of fraud. The subsection also makes clear what was not stated in former Section 5-114, that the issuer may dishonor and defend that dishonor by showing fraud or forgery of the kind stated in subsection (a). Because issuers may be liable for wrongful dishonor if they are unable to prove forgery or material fraud, presumably most issuers will choose to honor despite applicant's claims of fraud or forgery unless the applicant procures an injunction. Merely because the issuer has a right to dishonor and to defend that dishonor by showing forgery or material fraud does not mean it has a duty to the applicant to dishonor. The applicant's normal recourse is to procure an injunction, if the applicant is unable to procure an injunction, it will have a claim against the issuer only in the rare case in which it can show that the issuer did not honor in good faith. 3. Whether a beneciary can commit fraud by presenting a draft under a clean letter of credit (one calling only for a draft and no other documents) has been much debated. Under the current formulation it would be possible but dicult for there to be fraud in such a presentation. If the applicant were able to show that the beneciary were committing material fraud on the applicant in the underlying transaction, then payment would facilitate a material fraud by the beneciary on the applicant and honor could be enjoined. The courts should be skeptical of claims of fraud by one who has signed a suicide or clean credit and thus granted a beneciary the right to draw by mere presentation of a draft. 4. The standard for injunctive relief is high, and the burden remains on the applicant to show, by evidence and not by mere allegation, that such relief is warranted. Some courts have enjoined payments on letters of credit on insucient showing by the applicant. For example, in Grin Cos. v. First Nat. Bank, 374 N.W.2d 768 (Minn.App.1985), the court enjoined payment under a standby letter of credit, basing its decision on plainti's allegation, rather than competent evidence, of fraud. There are at least two ways to prohibit injunctions against honor under this section after acceptance of a draft by the issuer. First is to dene honor (see Section 5-102(a)(8)) in the particular letter of credit to occur upon acceptance and without regard to later payment of the acceptance. Second is explicitly to agree that the applicant has no right to an injunction after acceptancewhether or not the acceptance constitutes honor. 5. Although the statute deals principally with injunctions against honor, it also cautions against granting similar relief and the same principles apply when the applicant or issuer attempts to achieve the same legal outcome by injunction against presentation (see Ground Air Transfer Inc. v. Westates Airlines, Inc., 899 F.2d 1269 (1st Cir.1990)), interpleader, declaratory judgment, or attachment. These attempts should face the same obstacles that face eorts to enjoin the issuer from paying. Expanded use of any of these devices could threaten the independence principle just as much as injunctions against honor. For that reason courts should have the same hostility to them and place the same restrictions on their use as would be applied to injunctions against honor. Courts should not allow the sacred cow of equity to trample the tender vines of letter of credit law. 6. Section 5-109(a)(1) also protects specied third parties against the risk of fraud. By issuing a letter of credit that nominates a person to negotiate or pay, the issuer (ultimately the applicant) induces that nominated person to give value and thereby assumes the risk that a draft drawn under the letter of credit will be transferred to one with a status like that of a holder in due course who deserves to be protected against a fraud defense. 7. The loss to be protected againstby bond or otherwise under subsection (b)(2) includes incidental damages. Among those are legal fees that might be incurred by the ben576

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eciary or issuer in defending against an injunction action.

5-110. Warranties. (a) If its presentation is honored, the beneciary warrants: (1) to the issuer, any other person to whom presentation is made, and the applicant that there is no fraud or forgery of the kind described in Section 5-109(a); and (2) to the applicant that the drawing does not violate any agreement between the applicant and beneciary or any other agreement intended by them to be augmented by the letter of credit. (b) The warranties in subsection (a) are in addition to warranties arising under Article 3, 4, 7, and 8 because of the presentation or transfer of documents covered by any of those articles. Ocial Comment
1. Since the warranties in subsection (a) are not given unless a letter of credit has been honored, no breach of warranty under this subsection can be a defense to dishonor by the issuer. Any defense must be based on Section 5-108 or 5-109 and not on this section. Also, breach of the warranties by the beneciary in subsection (a) cannot excuse the applicant's duty to reimburse. 2. The warranty in Section 5-110(a)(2) assumes that payment under the letter of credit is nal. It does not run to the issuer, only to the applicant. In most cases the applicant will have a direct cause of action for breach of the underlying contract. This warranty has primary application in standby letters of credit or other circumstances where the applicant is not a party to an underlying contract with the beneciary. It is not a warranty that the statements made on the presentation of the documents presented are truthful nor is it a warranty that the documents strictly comply under Section 5-108(a). It is a warranty that the beneciary has performed all the acts expressly and implicitly necessary under any underlying agreement to entitle the beneciary to honor. If, for example, an underlying sales contract authorized the beneciary to draw only upon due performance and the beneciary drew even though it had breached the underlying contract by delivering defective goods, honor of its draw would break the warranty. By the same token, if the underlying contract authorized the beneciary to draw only upon actual default or upon its or a third party's determination of default by the applicant and if the beneciary drew in violation of its authorization, then upon honor of its draw the warranty would be breached. In many cases, therefore, the documents presented to the issuer will contain inaccurate statements (concerning the goods delivered or concerning default or other matters), but the breach of warranty arises not because the statements are untrue but because the beneciary's drawing violated its express or implied obligations in the underlying transaction. 3. The damages for breach of warranty are not specied in Section 5-111. Courts may nd damage analogies in Section 2-714 in Article 2 and in warranty decisions under Articles 3 and 4. Unlike wrongful dishonor caseswhere the damages usually equal the amount of the drawthe damages for breach of warranty will often be much less than the amount of the draw, sometimes zero. Assume a seller entitled to draw only on proper performance of its sales contract. Assume it breaches the sales contract in a way that gives the buyer a right to damages but no right to reject. The applicant's damages for breach of the warranty in subsection (a)(2) are limited to the damages it could recover for breach of the contract of sale. Alternatively assume an underlying agreement that authorizes a beneciary to draw only the amount in default. Assume a default of $200,000 and a draw of $500,000. The damages for breach of warranty would be no more than $300,000.

5-111. Remedies. (a) If an issuer wrongfully dishonors or repudiates its obligation to pay money under a letter of credit before presentation, the beneciary, successor, or nominated person presenting on its own behalf may recover from
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the issuer the amount that is the subject of the dishonor or repudiation. If the issuer's obligation under the letter of credit is not for the payment of money, the claimant may obtain specic performance or, at the claimant's election, recover an amount equal to the value of performance from the issuer. In either case, the claimant may also recover incidental but not consequential damages. The claimant is not obligated to take action to avoid damages that might be due from the issuer under this subsection. If, although not obligated to do so, the claimant avoids damages, the claimant's recovery from the issuer must be reduced by the amount of damages avoided. The issuer has the burden of proving the amount of damages avoided. In the case of repudiation the claimant need not present any document. (b) If an issuer wrongfully dishonors a draft or demand presented under a letter of credit or honors a draft or demand in breach of its obligation to the applicant, the applicant may recover damages resulting from the breach, including incidental but not consequential damages, less any amount saved as a result of the breach. (c) If an adviser or nominated person other than a conrmer breaches an obligation under this article or an issuer breaches an obligation not covered in subsection (a) or (b), a person to whom the obligation is owed may recover damages resulting from the breach, including incidental but not consequential damages, less any amount saved as a result of the breach. To the extent of the conrmation, a conrmer has the liability of an issuer specied in this subsection and subsections (a) and (b). (d) An issuer, nominated person, or adviser who is found liable under subsection (a), (b), or (c) shall pay interest on the amount owed thereunder from the date of wrongful dishonor or other appropriate date. (e) Reasonable attorney's fees and other expenses of litigation must be awarded to the prevailing party in an action in which a remedy is sought under this article. (f) Damages that would otherwise be payable by a party for breach of an obligation under this article may be liquidated by agreement or undertaking, but only in an amount or by a formula that is reasonable in light of the harm anticipated. Ocial Comment
1. The right to specic performance is new. The express limitation on the duty of the beneciary to mitigate damages adopts the position of certain courts and commentators. Because the letter of credit depends upon speed and certainty of payment, it is important that the issuer not be given an incentive to dishonor. The issuer might have an incentive to dishonor if it could rely on the burden of mitigation falling on the beneciary, (to sell goods and sue only for the dierence between the price of the goods sold and the amount due under the letter of credit). Under the scheme contemplated by Section 5-111(a), the beneciary would present the documents to the issuer. If the issuer wrongfully dishonored, the beneciary would have no further duty to the issuer with respect to the goods covered by documents that the issuer dishonored and returned. The issuer thus takes the risk that the beneciary will let the goods rot or be destroyed. Of course the beneciary may have a duty of mitigation to the applicant arising from the underlying agreement, but the issuer would not have the right to assert that duty by way of defense or seto. See Section 5-117(d). If the beneciary sells the goods covered by dishonored documents or if the beneciary sells a draft after acceptance but before dishonor by the issuer, the net amount so gained should be subtracted from the amount of the beneciary's damagesat least where the damage claim against the issuer equals or exceeds the damage suered by the beneciary. If, on the 578

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other hand, the beneciary suers damages in an underlying transaction in an amount that exceeds the amount of the wrongfully dishonored demand (e.g., where the letter of credit does not cover 100 percent of the underlying obligation), the damages avoided should not necessarily be deducted from the beneciary's claim against the issuer. In such a case, the damages would be the lesser of (i) the amount recoverable in the absence of mitigation (that is, the amount that is subject to the dishonor or repudiation plus any incidental damages) and (ii) the damages remaining after deduction for the amount of damages actually avoided. A beneciary need not present documents as a condition of suit for anticipatory repudiation, but if a beneciary could never have obtained documents necessary for a presentation conforming to the letter of credit, the beneciary cannot recover for anticipatory repudiation of the letter of credit. Doelger v. Battery Park Bank, 201 A.D. 515, 194 N.Y.S. 582 (1922) and Decor by Nikkei Int'l, Inc. v. Federal Republic of Nigeria, 497 F.Supp. 893 (S.D.N.Y.1980), a'd, 647 F.2d 300 (2d Cir.1981), cert. denied, 454 U.S. 1148 (1982). The last sentence of subsection (c) does not expand the liability of a conrmer to persons to whom the conrmer would not otherwise be liable under Section 5-107. Almost all letters of credit, including those that call for an acceptance, are obligations to pay money as that term is used in Section 5-111(a). 2. What damages result from improper honor is for the courts to decide. Even though an issuer pays a beneciary in violation of Section 5-108(a) or of its contract with the applicant, it may have no liability to an applicant. If the underlying contract has been fully performed, the applicant may not have been damaged by the issuer's breach. Such a case would occur when A contracts for goods at $100 per ton, but, upon delivery, the market value of conforming goods has decreased to $25 per ton. If the issuer pays over discrepancies, there should be no recovery by A for the price dierential if the issuer's breach did not alter the applicant's obligation under the underlying contract, i.e., to pay $100 per ton for goods now worth $25 per ton. On the other hand, if the applicant intends to resell the goods and must itself satisfy the strict compliance requirements under a second letter of credit in connection with its sale, the applicant may be damaged by the issuer's payment despite discrepancies because the applicant itself may then be unable to procure honor on the letter of credit where it is the beneciary, and may be unable to mitigate its damages by enforcing its rights against others in the underlying transaction. Note that an issuer found liable to its applicant may have recourse under Section 5-117 by subrogation to the applicant's claim against the beneciary or other persons. One who inaccurately advises a letter of credit breaches its obligation to the beneciary, but may cause no damage. If the beneciary knows the terms of the letter of credit and understands the advice to be inaccurate, the beneciary will have suered no damage as a result of the adviser's breach. 3. Since the conrmer has the rights and duties of an issuer, in general it has an issuer's liability, see subsection (c). The conrmer is usually a conrming bank. A conrming bank often also plays the role of an adviser. If it breaks its obligation to the beneciary, the conrming bank may have liability as an issuer or, depending upon the obligation that was broken, as an adviser. For example, a wrongful dishonor would give it liability as an issuer under Section 5-111(a). On the other hand a conrming bank that broke its obligation to advise the credit but did not commit wrongful dishonor would be treated under Section 5-111(c). 4. Consequential damages for breach of obligations under this article are excluded in the belief that these damages can best be avoided by the beneciary or the applicant and out of the fear that imposing consequential damages on issuers would raise the cost of the letter of credit to a level that might render it uneconomic. A fortiori punitive and exemplary damages are excluded, however, this section does not bar recovery of consequential or even punitive damages for breach of statutory or common law duties arising outside of this article. 5. The section does not specify a rate of interest. It leaves the setting of the rate to the court. It would be appropriate for a court to use the rate that would normally apply in that court in other situations where interest is imposed by law. 6. The court must award attorney's fees to the prevailing party, whether that party is an applicant, a beneciary, an issuer, a nominated person, or adviser. Since the issuer may be entitled to recover its legal fees and costs from the applicant under the reimbursement agreement, allowing the issuer to recover those fees from a losing beneciary may also 579

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protect the applicant against undeserved losses. The party entitled to attorneys' fees has been described as the prevailing party. Sometimes it will be unclear which party prevailed, for example, where there are multiple issues and one party wins on some and the other party wins on others. Determining which is the prevailing party is in the discretion of the court. Subsection (e) authorizes attorney's fees in all actions where a remedy is sought under this article. It applies even when the remedy might be an injunction under Section 5-109 or when the claimed remedy is otherwise outside of Section 5-111. Neither an issuer nor a conrmer should be treated as a losing party when an injunction is granted to the applicant over the objection of the issuer or conrmer; accordingly neither should be liable for fees and expenses in that case. Expenses of litigation is intended to be broader than costs. For example, expense of litigation would include travel expenses of witnesses, fees for expert witnesses, and expenses associated with taking depositions. 7. For the purposes of Section 5-111(f) harm anticipated must be anticipated at the time when the agreement that includes the liquidated damage clause is executed or at the time when the undertaking that includes the clause is issued. See Section 2A-504.

5-112. Transfer of Letter of Credit. (a) Except as otherwise provided in Section 5-113, unless a letter of credit provides that it is transferable, the right of a beneciary to draw or otherwise demand performance under a letter of credit may not be transferred. (b) Even if a letter of credit provides that it is transferable, the issuer may refuse to recognize or carry out a transfer if: (1) the transfer would violate applicable law; or (2) the transferor or transferee has failed to comply with any requirement stated in the letter of credit or any other requirement relating to transfer imposed by the issuer which is within the standard practice referred to in Section 5-108(e) or is otherwise reasonable under the circumstances. Ocial Comment
1. In order to protect the applicant's reliance on the designated beneciary, letter of credit law traditionally has forbidden the beneciary to convey to third parties its right to draw or demand payment under the letter of credit. Subsection (a) codies that rule. The term transfer refers to the beneciary's conveyance of that right. Absent incorporation of the UCP (which make elaborate provision for partial transfer of a commercial letter of credit) or similar trade practice and absent other express indication in the letter of credit that the term is used to mean something else, a term in the letter of credit indicating that the beneciary has the right to transfer should be taken to mean that the beneciary may convey to a third party its right to draw or demand payment. Even in that case, the issuer or other person controlling the transfer may make the beneciary's right to transfer subject to conditions, such as timely notication, payment of a fee, delivery of the letter of credit to the issuer or other person controlling the transfer, or execution of appropriate forms to document the transfer. A nominated person who is not a conrmer has no obligation to recognize a transfer. The power to establish requirements does not include the right absolutely to refuse to recognize transfers under a transferable letter of credit. An issuer who wishes to retain the right to deny all transfers should not issue transferable letters of credit or should incorporate the UCP. By stating its requirements in the letter of credit an issuer may impose any requirement without regard to its conformity to practice or reasonableness. Transfer requirements of issuers and nominated persons must be made known to potential transferors and transferees to enable those parties to comply with the requirements. A common method of making such requirements known is to use a form that indicates the information that must be provided and the instructions that must be given to enable the issuer or nominated person to comply with a request to transfer. 2. The issuance of a transferable letter of credit with the concurrence of the applicant is 580

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ipso facto an agreement by the issuer and applicant to permit a beneciary to transfer its drawing right and permit a nominated person to recognize and carry out that transfer without further notice to them. In international commerce, transferable letters of credit are often issued under circumstances in which a nominated person or adviser is expected to facilitate the transfer from the original beneciary to a transferee and to deal with that transferee. In those circumstances it is the responsibility of the nominated person or adviser to establish procedures satisfactory to protect itself against double presentation or dispute about the right to draw under the letter of credit. Commonly such a person will control the transfer by requiring that the original letter of credit be given to it or by causing a paper copy marked as an original to be issued where the original letter of credit was electronic. By keeping possession of the original letter of credit the nominated person or adviser can minimize or entirely exclude the possibility that the original beneciary could properly procure payment from another bank. If the letter of credit requires presentation of the original letter of credit itself, no other payment could be procured. In addition to imposing whatever requirements it considers appropriate to protect itself against double payment the person that is facilitating the transfer has a right to charge an appropriate fee for its activity. Transfer of a letter of credit should be distinguished from assignment of proceeds. The former is analogous to a novation or a substitution of beneciaries. It contemplates not merely payment to but also performance by the transferee. For example, under the typical terms of transfer for a commercial letter of credit, a transferee could comply with a letter of credit transferred to it by signing and presenting its own draft and invoice. An assignee of proceeds, on the other hand, is wholly dependent on the presentation of a draft and invoice signed by the beneciary. By agreeing to the issuance of a transferable letter of credit, which is not qualied or limited, the applicant may lose control over the identity of the person whose performance will earn payment under the letter of credit.

5-113. Transfer by Operation of Law. (a) A successor of a beneciary may consent to amendments, sign and present documents, and receive payment or other items of value in the name of the beneciary without disclosing its status as a successor. (b) A successor of a beneciary may consent to amendments, sign and present documents, and receive payment or other items of value in its own name as the disclosed successor of the beneciary. Except as otherwise provided in subsection (e), an issuer shall recognize a disclosed successor of a beneciary as beneciary in full substitution for its predecessor upon compliance with the requirements for recognition by the issuer of a transfer of drawing rights by operation of law under the standard practice referred to in Section 5-108(e) or, in the absence of such a practice, compliance with other reasonable procedures sucient to protect the issuer. (c) An issuer is not obliged to determine whether a purported successor is a successor of a beneciary or whether the signature of a purported successor is genuine or authorized. (d) Honor of a purported successor's apparently complying presentation under subsection (a) or (b) has the consequences specied in Section 5-108(i) even if the purported successor is not the successor of a beneciary. Documents signed in the name of the beneciary or of a disclosed successor by a person who is neither the beneciary nor the successor of the beneciary are forged documents for the purposes of Section 5-109. (e) An issuer whose rights of reimbursement are not covered by subsection (d) or substantially similar law and any conrmer or nominated person may decline to recognize a presentation under subsection (b). (f) A beneciary whose name is changed after the issuance of a letter of
581

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credit has the same rights and obligations as a successor of a beneciary under this section. Ocial Comment
This section arms the result in Pastor v. Nat. Republic Bank of Chicago, 76 Ill.2d 139, 390 N.E.2d 894 (Ill.1979) and Federal Deposit Insurance Co. v. Bank of Boulder, 911 F.2d 1466 (10th Cir.1990). Both electronic and tangible documents may be signed. An issuer's requirements for recognition of a successor's status might include presentation of a certicate of merger, a court order appointing a bankruptcy trustee or receiver, a certicate of appointment as bankruptcy trustee, or the like. The issuer is entitled to rely upon such documents which on their face demonstrate that presentation is made by a successor of a beneciary. It is not obliged to make an independent investigation to determine the fact of succession.

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

5-114. Assignment of Proceeds. (a) In this section, proceeds of a letter of credit means the cash, check, accepted draft, or other item of value paid or delivered upon honor or giving of value by the issuer or any nominated person under the letter of credit. The term does not include a beneciary's drawing rights or documents presented by the beneciary. (b) A beneciary may assign its right to part or all of the proceeds of a letter of credit. The beneciary may do so before presentation as a present assignment of its right to receive proceeds contingent upon its compliance with the terms and conditions of the letter of credit. (c) An issuer or nominated person need not recognize an assignment of proceeds of a letter of credit until it consents to the assignment. (d) An issuer or nominated person has no obligation to give or withhold its consent to an assignment of proceeds of a letter of credit, but consent may not be unreasonably withheld if the assignee possesses and exhibits the letter of credit and presentation of the letter of credit is a condition to honor. (e) Rights of a transferee beneciary or nominated person are independent of the beneciary's assignment of the proceeds of a letter of credit and are superior to the assignee's right to the proceeds. (f) Neither the rights recognized by this section between an assignee and an issuer, transferee beneciary, or nominated person nor the issuer's or nominated person's payment of proceeds to an assignee or a third person aect the rights between the assignee and any person other than the issuer, transferee beneciary, or nominated person. The mode of creating and perfecting a security interest in or granting an assignment of a beneciary's rights to proceeds is governed by Article 9 or other law. Against persons other than the issuer, transferee beneciary, or nominated person, the rights and obligations arising upon the creation of a security interest or other assignment of a beneciary's right to proceeds and its perfection are governed by Article 9 or other law. Ocial Comment
1. Subsection (b) expressly validates the beneciary's present assignment of letter of credit proceeds if made after the credit is established but before the proceeds are realized. 582

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This section adopts the prevailing usageassignment of proceedsto an assignee. That terminology carries with it no implication, however, that an assignee acquires no interest until the proceeds are paid by the issuer. For example, an assignment of the right to proceeds of a letter of credit for purposes of security that meets the requirements of Section 9-203(b) would constitute the present creation of a security interest in a letter-ofcredit right. This security interest can be perfected by control (Section 9-107). Although subsection (a) explains the meaning of proceeds of a letter of credit, it should be emphasized that those proceeds also may be Article 9 proceeds of other collateral. For example, if a seller of inventory receives a letter of credit to support the account that arises upon the sale, payments made under the letter of credit are Article 9 proceeds of the inventory, account, and any document of title covering the inventory. Thus, the secured party who had a perfected security interest in that inventory, account, or document has a perfected security interest in the proceeds collected under the letter of credit, so long as they are identiable cash proceeds (Section 9-315(a), (d)). This perfection is continuous, regardless of whether the secured party perfected a security interest in the right to letter of credit proceeds. 2. An assignee's rights to enforce an assignment of proceeds against an issuer and the priority of the assignee's rights against a nominated person or transferee beneciary are governed by Article 5. Those rights and that priority are stated in subsections (c), (d), and (e). Note also that Section 4-210 gives rst priority to a collecting bank that has given value for a documentary draft. 3. By requiring that an issuer or nominated person consent to the assignment of proceeds of a letter of credit, subsections (c) and (d) follow more closely recognized national and international letter of credit practices than did prior law. In most circumstances, it has always been advisable for the assignee to obtain the consent of the issuer in order better to safeguard its right to the proceeds. When notice of an assignment has been received, issuers normally have required signatures on a consent form. This practice is reected in the revision. By unconditionally consenting to such an assignment, the issuer or nominated person becomes bound, subject to the rights of the superior parties specied in subsection (e), to pay to the assignee the assigned letter of credit proceeds that the issuer or nominated person would otherwise pay to the beneciary or another assignee. Where the letter of credit must be presented as a condition to honor and the assignee holds and exhibits the letter of credit to the issuer or nominated person, the risk to the issuer or nominated person of having to pay twice is minimized. In such a situation, subsection (d) provides that the issuer or nominated person may not unreasonably withhold its consent to the assignment.

5-115. Statute of Limitations. An action to enforce a right or obligation arising under this article must be commenced within one year after the expiration date of the relevant letter of credit or one year after the [claim for relief] [cause of action] accrues, whichever occurs later. A [claim for relief] [cause of action] accrues when the breach occurs, regardless of the aggrieved party's lack of knowledge of the breach. Ocial Comment
1. This section is based upon Sections 4-111 and 2-725(2). 2. This section applies to all claims for which there are remedies under Section 5-111 and to other claims made under this article, such as claims for breach of warranty under Section 5-110. Because it covers all claims under Section 5-111, the statute of limitations applies not only to wrongful dishonor claims against the issuer but also to claims between the issuer and the applicant arising from the reimbursement agreement. These might be for reimbursement (issuer v. applicant) or for breach of the reimbursement contract by wrongful honor (applicant v. issuer). 3. The statute of limitations, like the rest of the statute, applies only to a letter of credit issued on or after the eective date and only to transactions, events, obligations, or duties arising out of or associated with such a letter. If a letter of credit was issued before the effective date and an obligation on that letter of credit was breached after the eective date, 583

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the complaining party could bring its suit within the time that would have been permitted prior to the adoption of Section 5-115 and would not be limited by the terms of Section 5-115.

5-116. Choice of Law and Forum. (a) The liability of an issuer, nominated person, or adviser for action or omission is governed by the law of the jurisdiction chosen by an agreement in the form of a record signed or otherwise authenticated by the aected parties in the manner provided in Section 5-104 or by a provision in the person's letter of credit, conrmation, or other undertaking. The jurisdiction whose law is chosen need not bear any relation to the transaction. (b) Unless subsection (a) applies, the liability of an issuer, nominated person, or adviser for action or omission is governed by the law of the jurisdiction in which the person is located. The person is considered to be located at the address indicated in the person's undertaking. If more than one address is indicated, the person is considered to be located at the address from which the person's undertaking was issued. For the purpose of jurisdiction, choice of law, and recognition of interbranch letters of credit, but not enforcement of a judgment, all branches of a bank are considered separate juridical entities and a bank is considered to be located at the place where its relevant branch is considered to be located under this subsection. (c) Except as otherwise provided in this subsection, the liability of an issuer, nominated person, or adviser is governed by any rules of custom or practice, such as the Uniform Customs and Practice for Documentary Credits, to which the letter of credit, conrmation, or other undertaking is expressly made subject. If (i) this article would govern the liability of an issuer, nominated person, or adviser under subsection (a) or (b), (ii) the relevant undertaking incorporates rules of custom or practice, and (iii) there is conict between this article and those rules as applied to that undertaking, those rules govern except to the extent of any conict with the nonvariable provisions specied in Section 5-103(c). (d) If there is conict between this article and Article 3, 4, 4A, or 9, this article governs. (e) The forum for settling disputes arising out of an undertaking within this article may be chosen in the manner and with the binding eect that governing law may be chosen in accordance with subsection (a). Ocial Comment
1. Although it would be possible for the parties to agree otherwise, the law normally chosen by agreement under subsection (a) and that provided in the absence of agreement under subsection (b) is the substantive law of a particular jurisdiction not including the choice of law principles of that jurisdiction. Thus, two parties, an issuer and an applicant, both located in Oklahoma might choose the law of New York. Unless they agree otherwise, the section anticipates that they wish the substantive law of New York to apply to their transaction and they do not intend that a New York choice of law principle might direct a court to Oklahoma law. By the same token, the liability of an issuer located in New York is governed by New York substantive lawin the absence of agreementeven in circumstances in which choice of law principles found in the common law of New York might direct one to the law of another State. Subsection (b) states the relevant choice of law principles and it should not be subordinated to some other choice of law rule. Within the States of the United States renvoi will not be a problem once every jurisdiction has enacted Section 5-116 because every jurisdiction will then have the same choice of law rule and in a 584

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particular case all choice of law rules will point to the same substantive law. Subsection (b) does not state a choice of law rule for the liability of an applicant. However, subsection (b) does state a choice of law rule for the liability of an issuer, nominated person, or adviser, and since some of the issues in suits by applicants against those persons involve the liability of an issuer, nominated person, or adviser, subsection (b) states the choice of law rule for those issues. Because an issuer may have liability to a conrmer both as an issuer (Section 5-108(a), Comment 5 to Section 5-108) and as an applicant (Section 5-107(a), Comment 1 to Section 5-107, Section 5-108(i)), subsection (b) may state the choice of law rule for some but not all of the issuer's liability in a suit by a conrmer. 2. Because the conrmer or other nominated person may choose dierent law from that chosen by the issuer or may be located in a dierent jurisdiction and fail to choose law, it is possible that a conrmer or nominated person may be obligated to pay (under their law) but will not be entitled to payment from the issuer (under its law). Similarly, the rights of an unreimbursed issuer, conrmer, or nominated person against a beneciary under Section 5-109, 5-110, or 5-117, will not necessarily be governed by the same law that applies to the issuer's or conrmer's obligation upon presentation. Because the UCP and other practice are incorporated in most international letters of credit, disputes arising from dierent legal obligations to honor have not been frequent. Since Section 5-108 incorporates standard practice, these problems should be further minimizedat least to the extent that the same practice is and continues to be widely followed. 3. This section does not permit what is now authorized by the nonuniform Section 5-102(4) in New York. Under the current law in New York a letter of credit that incorporates the UCP is not governed in any respect by Article 5. Under revised Section 5-116 letters of credit that incorporate the UCP or similar practice will still be subject to Article 5 in certain respects. First, incorporation of the UCP or other practice does not override the nonvariable terms of Article 5. Second, where there is no conict between Article 5 and the relevant provision of the UCP or other practice, both apply. Third, practice provisions incorporated in a letter of credit will not be eective if they fail to comply with Section 5-103(c). Assume, for example, that a practice provision purported to free a party from any liability unless it were grossly negligent or that the practice generally limited the remedies that one party might have against another. Depending upon the circumstances, that disclaimer or limitation of liability might be ineective because of Section 5-103(c). Even though Article 5 is generally consistent with UCP 500, it is not necessarily consistent with other rules or with versions of the UCP that may be adopted after Article 5's revision, or with other practices that may develop. Rules of practice incorporated in the letter of credit or other undertaking are those in eect when the letter of credit or other undertaking is issued. Except in the unusual cases discussed in the immediately preceding paragraph, practice adopted in a letter of credit will override the rules of Article 5 and the parties to letter of credit transactions must be familiar with practice (such as future versions of the UCP) that is explicitly adopted in letters of credit. 4. In several ways Article 5 conicts with and overrides similar matters governed by Articles 3 and 4. For example, draft is more broadly dened in letter of credit practice than under Section 3-104. The time allowed for honor and the required notication of reasons for dishonor are dierent in letter of credit practice than in the handling of documentary and other drafts under Articles 3 and 4. 5. Subsection (e) must be read in conjunction with existing law governing subject matter jurisdiction. If the local law restricts a court to certain subject matter jurisdiction not including letter of credit disputes, subsection (e) does not authorize parties to choose that forum. For example, the parties' agreement under Section 5-116(e) would not confer jurisdiction on a probate court to decide a letter of credit case. If the parties choose a forum under subsection (e) and ifbecause of other lawthat forum will not take jurisdiction, the parties' agreement or undertaking should then be construed (for the purpose of forum selection) as though it did not contain a clause choosing a particular forum. That result is necessary to avoid sentencing the parties to eternal purgatory where neither the chosen State nor the State which would have jurisdiction but for the clause will take jurisdictionthe former in disregard of the clause and the latter in honor of the clause.

5-117. Subrogation of Issuer, Applicant, and Nominated Person. (a) An issuer that honors a beneciary's presentation is subrogated to
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the rights of the beneciary to the same extent as if the issuer were a secondary obligor of the underlying obligation owed to the beneciary and of the applicant to the same extent as if the issuer were the secondary obligor of the underlying obligation owed to the applicant. (b) An applicant that reimburses an issuer is subrogated to the rights of the issuer against any beneciary, presenter, or nominated person to the same extent as if the applicant were the secondary obligor of the obligations owed to the issuer and has the rights of subrogation of the issuer to the rights of the beneciary stated in subsection (a). (c) A nominated person who pays or gives value against a draft or demand presented under a letter of credit is subrogated to the rights of: (1) the issuer against the applicant to the same extent as if the nominated person were a secondary obligor of the obligation owed to the issuer by the applicant; (2) the beneciary to the same extent as if the nominated person were a secondary obligor of the underlying obligation owed to the beneciary; and (3) the applicant to same extent as if the nominated person were a secondary obligor of the underlying obligation owed to the applicant. (d) Notwithstanding any agreement or term to the contrary, the rights of subrogation stated in subsections (a) and (b) do not arise until the issuer honors the letter of credit or otherwise pays and the rights in subsection (c) do not arise until the nominated person pays or otherwise gives value. Until then, the issuer, nominated person, and the applicant do not derive under this section present or prospective rights forming the basis of a claim, defense, or excuse. Ocial Comment
1. By itself this section does not grant any right of subrogation. It grants only the right that would exist if the person seeking subrogation were a secondary obligor. (The term secondary obligor refers to a surety, guarantor, or other person against whom or whose property an obligee has recourse with respect to the obligation of a third party. See Restatement of the Law Third, Suretyship and Guaranty 1 (1996).) If the secondary obligor would not have a right to subrogation in the circumstances in which one is claimed under this section, none is granted by this section. In eect, the section does no more than to remove an impediment that some courts have found to subrogation because they conclude that the issuer's or other claimant's rights are independent of the underlying obligation. If, for example, a secondary obligor would not have a subrogation right because its payment did not fully satisfy the underlying obligation, none would be available under this section. The section indorses the position of Judge Becker in Tudor Development Group, Inc. v. United States Fidelity and Guaranty, 968 F.2d 357 (3rd Cir.1991). 2. To preserve the independence of the letter of credit obligation and to insure that subrogation not be used as an oensive weapon by an issuer or others, the admonition in subsection (d) must be carefully observed. Only one who has completed its performance in a letter of credit transaction can have a right to subrogation. For example, an issuer may not dishonor and then defend its dishonor or assert a seto on the ground that it is subrogated to another person's rights. Nor may the issuer complain after honor that its subrogation rights have been impaired by any good faith dealings between the beneciary and the applicant or any other person. Assume, for example, that the beneciary under a standby letter of credit is a mortgagee. If the mortgagee were obliged to issue a release of the mortgage upon payment of the underlying debt (by the issuer under the letter of credit), that release might impair the issuer's rights of subrogation, but the beneciary would have no liability to the issuer for having granted that release. 586

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5-118. Security Interest of Issuer or Nominated Person. (a) An issuer or nominated person has a security interest in a document presented under a letter of credit to the extent that the issuer or nominated person honors or gives value for the presentation. (b) So long as and to the extent that an issuer or nominated person has not been reimbursed or has not otherwise recovered the value given with respect to a security interest in a document under subsection (a), the security interest continues and is subject to Article 9, but: (1) a security agreement is not necessary to make the security interest enforceable under Section 9-203(b)(3); (2) if the document is presented in a medium other than a written or other tangible medium, the security interest is perfected; and (3) if the document is presented in a written or other tangible medium and is not a certicated security, chattel paper, a document of title, an instrument, or a letter of credit, the security interest is perfected and has priority over a conicting security interest in the document so long as the debtor does not have possession of the document. As added in 1999.
See Appendix I contained within revised Article 9 for material relating to adoption of section in 1999.

Ocial Comment
1. This section gives the issuer of a letter of credit or a nominated person thereunder an automatic perfected security interest in a document (as that term is dened in Section 5-102(a)(6)). The security interest arises only if the document is presented to the issuer or nominated person under the letter of credit and only to the extent of the value that is given. This security interest is analogous to that awarded to a collecting bank under Section 4-210. Subsection (b) contains special rules governing the security interest arising under this section. In all other respects, a security interest arising under this section is subject to Article 9. See Section 9-109. Thus, for example, a security interest arising under this section may give rise to a security interest in proceeds under Section 9-315. 2. Subsection (b)(1) makes a security agreement unnecessary to the creation of a security interest under this section. Under subsection (b)(2), a security interest arising under this section is perfected if the document is presented in a medium other than a written or tangible medium. Documents that are written and that are not an otherwise-dened type of collateral under Article 9 (e.g., an invoice or inspection certicate) may be goods, in which an issuer or nominated person could perfect its security interest by possession. Because the denition of document in Section 5-102(a)(6) includes records (e.g., electronic records) that may not be goods, subsection (b)(2) provides for automatic perfection (i.e., without ling or possession). Under subsection (b)(3), if the document (i) is in a written or tangible medium, (ii) is not a certicated security, chattel paper, a document of title, an instrument, or a letter of credit, and (iii) is not in the debtor's possession, the security interest is perfected and has priority over a conicting security interest. If the document is a type of tangible collateral that subsection (b)(3) excludes from its perfection and priority rules, the issuer or nominated person must comply with the normal method of perfection (e.g., possession of an instrument) and is subject to the applicable Article 9 priority rules. Documents to which subsection (b)(3) applies may be important to an issuer or nominated person. For example, a conrmer who pays the beneciary must be assured that its rights to all documents are not impaired. It will nd it necessary to present all of the required documents to the issuer in order to be reimbursed. Moreover, when a nominated person sends documents to an issuer in connection with the nominated person's reimbursement, that activity is not a collection, enforcement, or disposition of collateral under Article 9. One purpose of this section is to protect an issuer or nominated person from claims of a beneciary's creditors. It is a fallback provision inasmuch as issuers and nominated persons 587

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frequently may obtain and perfect security interests under the usual Article 9 rules, and, in many cases, the documents will be owned by the issuer, nominated person, or applicant.

As added in 1999.
See Appendix I contained within revised Article 9 for material relating to adoption of Ocial Comment in 1999.

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TRANSITION PROVISIONS
[ ]. Eective Date. This [Act] shall become eective on , 199 . [ ]. Repeal. This [Act] [repeals] [amends] [insert citation to existing Article 5]. [ ]. Applicability. This [Act] applies to a letter of credit that is issued on or after the eective date of this [Act]. This [Act] does not apply to a transaction, event, obligation, or duty arising out of or associated with a letter of credit that was issued before the eective date of this [Act]. [ ]. Savings Clause. A transaction arising out of or associated with a letter of credit that was issued before the eective date of this [Act] and the rights, obligations, and interests owing from that transaction are governed by any statute or other law amended or repealed by this [Act] as if repeal or amendment had not occurred and may be terminated, completed, consummated, or enforced under that statute or other law. CONFORMING AMENDMENTS TO ARTICLES 1, 2, AND 9 See Appendix M, infra.

589

REPEALER OF ARTICLE 6 BULK TRANSFERS AND [REVISED] ARTICLE 6 BULK SALES (STATES TO SELECT ONE ALTERNATIVE)*
ALTERNATIVE A
[ 1. Repeal. 2. Amendment. 3. Amendment. 4. Savings Clause.

ALTERNATIVE B
[ 6-101. Short Title. 6-102. Denitions and Index of Denitions. 6-103. Applicability of Article. 6-104. Obligations of Buyer. 6-105. Notice to Claimants. 6-106. Schedule of Distribution. 6-107. Liability for Noncompliance. 6-108. Bulk Sales by Auction; Bulk Sales Conducted by Liquidator. 6-109. What Constitutes Filing; Duties of Filing Ocer; Information From Filing Ocer. 6-110. Limitation of Actions.

*Article 6 was repealed in 1989, and a revised version was approved in 1989 as an alternative to repeal. For text and Ocial

Comments of Article 6 as they existed prior to repeal/revision in 1989, see Appendix E.

590

NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS

CO-REPORTERS Steven L. Harris, Champaign, Illinois William D. Hawkland, Baton Rouge, Louisiana DRAFTING COMMITTEE CHAIRMAN Gerald L. Bepko, Indianapolis, Indiana MEMBERS William C. Hillman, Providence, Rhode Island Frederick H. Miller, Norman, Oklahoma Raymond P. Pepe, Harrisburg, Pennsylvania Donald J. Rapson, Livingston, New Jersey, The American Law Institute Representative Curtis R. Reitz, Philadelphia, Pennsylvania Millard H. Ruud, Austin, Texas, Drafting Liaison Hiroshi Sakai, Honolulu, Hawaii Michael P. Sullivan, Minneapolis, Minnesota, President (Member Ex Ocio) Neal Ossen, Hartford, Connecticut, Chairman, Division C (Member Ex Ocio) REVIEW COMMITTEE CHAIRMAN John A. Chanin, Honolulu, Hawaii MEMBERS Stephen E. Cicilline, Providence, Rhode Island Morris W. Macey, Atlanta, Georgia Robert G. Pugh, Shreveport, Louisiana ABA ADVISOR, SECTION OF CORPORATION, BANKING, AND BUSINESS LAW Howard Ruda, New York, New York ADDITIONAL ADVISORS Don L. Baker, Commercial Law League of America William Z. Fox, National Auctioneers Association Thomas J. Greco, American Bankers Association Frank R. Kennedy, National Bankruptcy Conference James E. Snider, National Association of Credit Management Douglas H. Williams, National Commercial Finance Association PREFATORY NOTE Background. Bulk sale legislation originally was enacted in response to a fraud perceived to be common around the turn of the century: a merchant would acquire his stock in trade on credit, then sell his entire inventory (in bulk) and abscond with the proceeds, leaving creditors unpaid. The creditors had a right to sue the merchant on the unpaid debts, but that right often was of little practical value. Even if the merchant-debtor was found, in personam jurisdiction over him might not have been readily available. Those creditors who succeeded in obtaining a judgment often were unable to satisfy it because the defrauding seller had spent or hidden the sale proceeds. Nor did the creditors ordinarily have recourse to the merchandise sold. The transfer of the inventory to an innocent buyer eectively immunized the goods from the reach of the seller's creditors. The creditors of a bulk seller thus might be left without a means to satisfy their claims. 591

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To a limited extent, the law of fraudulent conveyances ameliorated the creditors' plight. When the buyer in bulk was in league with the seller or paid less than full value for the inventory, fraudulent conveyance law enabled the defrauded creditors to avoid the sale and apply the transferred inventory toward the satisfaction of their claims against the seller. But fraudulent conveyance law provided no remedy against persons who bought in good faith, without reason to know of the seller's intention to pocket the proceeds and disappear, and for adequate value. In those cases, the only remedy for the seller's creditors was to attempt to recover from the absconding seller. State legislatures responded to this perceived bulk sale risk with a variety of legislative enactments. Common to these statutes was the imposition of a duty on the buyer in bulk to notify the seller's creditors of the impending sale. The buyer's failure to comply with these and any other statutory duties generally aorded the seller's creditors a remedy analogous to the remedy for fraudulent conveyances: the creditors acquired the right to set aside the sale and reach the transferred inventory in the hands of the buyer. Like its predecessors, Article 6 (1987 Ocial Text) is remarkable in that it obligates buyers in bulk to incur costs to protect the interests of the seller's creditors, with whom they usually have no relationship. Even more striking is that Article 6 aords creditors a remedy against a good faith purchaser for full value without notice of any wrongdoing on the part of the seller. The Article thereby impedes normal business transactions, many of which can be expected to benet the seller's creditors. For this reason, Article 6 has been subjected to serious criticism. See, e.g., Rapson, U.C.C. Article 6: Should It Be Revised or Deep-Sixed? 38 Bus.Law. 1753 (1983). In the legal context in which Article 6 (1987 Ocial Text) and its nonuniform predecessors were enacted, the benets to creditors appeared to justify the costs of interfering with good faith transactions. Today, however, creditors are better able than ever to make informed decisions about whether to extend credit. Changes in technology have enabled credit reporting services to provide fast, accurate, and more complete credit histories at relatively little cost. A search of the public real estate and personal property records will disclose most encumbrances on a debtor's property with little inconvenience. In addition, changes in the law now aord creditors greater opportunities to collect their debts. The development of minimum contacts with the forum state as a basis for in personam jurisdiction and the universal promulgation of state long-arm statutes and rules have greatly improved the possibility of obtaining personal jurisdiction over a debtor who ees to another state. Widespread enactment of the Uniform Enforcement of Foreign Judgments Act has facilitated nation-wide collection of judgments. And to the extent that a bulk sale is fraudulent and the buyer is a party to fraud, aggrieved creditors have a remedy under the Uniform Fraudulent Transfer Act. Moreover, creditors of a merchant no longer face the choice of extending unsecured credit or no credit at all. Retaining an interest in inventory to secure its price has become relatively simple and inexpensive under Article 9. Finally, there is no evidence that, in today's economy, fraudulent bulk sales are frequent enough, or engender credit losses signicant enough, to require regulation of all bulk sales, including the vast majority that are conducted in good faith. Indeed, the experience of the Canadian Province of British Columbia, which repealed its Sale of Goods in Bulk Act in 1985, and of the United Kingdom, which never has enacted bulk sales legislation, suggests that regulation of bulk sales no longer is necessary. Recommendation. The National Conference of Commissioners on Uniform State Laws and the American Law Institute believe that changes in the business and legal contexts in which sales are conducted have made regulation of bulk sales unnecessary. The Conference and the Institute therefore withdraw their support for Article 6 of the Uniform Commercial Code and encourage those states that have enacted the Article to repeal it. The Conference and the Institute recognize that bulk sales may present a particular problem in some states and that some legislatures may wish to continue to regulate bulk sales. They believe that existing Article 6 has become inadequate for that purpose. For those states that are disinclined to repeal Article 6, they have promulgated a revised version of Article 6. The revised Article is designed to aord better protection to creditors while minimizing the impediments to good-faith transactions. The Ocial Comment to Section 6-101 explains the rationale underlying the revisions and highlights the major substantive changes reected in them. Of particular interest is Section 6-103(1)(a), which limits the application of the revised Article to bulk sales by sell592

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ers whose principal business is the sale of inventory from stock. In approving this provision, the Conference and the Institute were mindful that some states have expanded the coverage of existing Article 6 to include bulk sales conducted by sellers whose principal business is the operation of a restaurant or tavern. Expansion of the scope of revised Article 6 is inconsistent with the recommendation that Article 6 be repealed. Nevertheless, the inclusion of restaurants and taverns within the scope of the revised Article as it is enacted in particular jurisdictions would not disturb the internal logic and structure of the revised Article.

ALTERNATIVE A
[ 1. Repeal. 2. Amendment. 3. Amendment. 4. Savings Clause.

[ 1. Repeal. Article 6 and Section 9-111 of the Uniform Commercial Code are hereby repealed, eective . 2. Amendment. Section 1-105(2) of the Uniform Commercial Code is hereby amended to read as follows: (2) Where one of the following provisions of this Act species the applicable law, that provision governs and a contrary agreement is eective only to the extent permitted by the law (including the conict of laws rules) so specied: Rights of creditors against sold goods. Section 2-402. Applicability of the Article on Leases. Sections 2A-105 and 2A-106. Applicability of the Article on Bank Deposits and Collections. Section 4-102. Bulk transfers subject to the Article on Bulk Transfers. Section 6-102. Applicability of the Article on Investment Securities. Section 8-106. Perfection provisions of the Article on Secured Transactions. Section 9-103. 3. Amendment. Section 2-403(4) of the Uniform Commercial Code is hereby amended to read as follows:
(4) The rights of other purchasers of goods and of lien creditors are governed by the Articles on Secured Transactions (Article 9), Bulk Transfers (Article 6) and Documents of Title (Article 7).

4. Savings Clause. Rights and obligations that arose under Article 6 and Section 9-111 of the Uniform Commercial Code before their repeal remain valid and may be enforced as though those statutes had not been repealed.]
Legislative Note: To take account of dierences between former Article 9 and revised Article 9, a State that repeals Article 6 after revised Article 9 takes eect must make the following 593

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changes to Alternative A. First, inasmuch as revised Article 9 contains no counterpart of former Section 9-111, the reference to that section in Section 1 of the repealer should be deleted, and Section 4 of the repeal bill should allude to former Section 9-111. Second, the last entry in Section 1-105(2) should be amended as shown above in this Appendix. [END OF ALTERNATIVE A]

ALTERNATIVE B
[ 6-101. Short Title. 6-102. Denitions and Index of Denitions. 6-103. Applicability of Article. 6-104. Obligations of Buyer. 6-105. Notice to Claimants. 6-106. Schedule of Distribution. 6-107. Liability for Noncompliance. 6-108. Bulk Sales by Auction; Bulk Sales Conducted by Liquidator. 6-109. What Constitutes Filing; Duties of Filing Ocer; Information From Filing Ocer. 6-110. Limitation of Actions.

[ 6-101. Short Title. This Article shall be known and may be cited as Uniform Commercial CodeBulk Sales. Ocial Comment
Prior Uniform Statutory Provision: Section 6-101 (1987 Ocial Text). Change: This Article applies only to sales, as dened in Section 2-103(1), and not to other transfers. Purpose of Change: Transfers other than sales, e.g., grants of security interests, do not present risks to creditors necessitating advance notice in accordance with the provisions of this Article. The Uniform Fraudulent Transfer Act aords a remedy to creditors who are injured by donative transfers. Rationale for Revision of the Article: Article 6 (1987 Ocial Text) imposes upon transferees in bulk several duties toward creditors of the transferor. These duties include the duty to notify the creditors of the impending bulk transfer and, in those jurisdictions that have adopted optional Section 6-106, the duty to assure that the new consideration for the transfer is applied to pay debts of the transferor. Compliance with the provisions of Article 6 can be burdensome, particularly when the transferor has a large number of creditors. When the transferor is actively engaged in business at a number of locations, assembling a current list of creditors may not be possible. Mailing a notice to each creditor may prove costly. When the goods that are the subject of the transfer are located in several jurisdictions, the transferor may be obligated to comply with Article 6 as enacted in each jurisdiction. The widespread enactment of nonuniform amendments makes compliance with Article 6 in multiple-state transactions problematic. Moreover, the Article requires compliance even when there is no reason to believe that the transferor is conducting a fraudulent transfer, e.g., when the transferor is scaling down the business but remaining available to creditors. Article 6 imposes strict liability for noncompliance. Failure to comply with the provisions of the Article renders the transfer ineective, even when the transferor has attempted compliance in good faith, and even when no creditor has been injured by the noncompliance. The potential liability for minor noncompliance may be high. If the transferor should enter bankruptcy before the expiration of the limitation period, Bankruptcy Code 544(b), 550(a), 11 U.S.C. 544(b), 550(a), may enable the transferor's bankruptcy trustee to set 594

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aside the entire transaction and recover from the noncomplying transferee all the goods transferred or their value. The trustee has this power even though the noncompliance was with respect to only a single creditor holding a small claim. The benets that compliance aords to creditors do not justify the substantial burdens and risks that the Article imposes upon good faith purchasers of business assets. The Article requires that notice be sent only ten days before the transferee takes possession of the goods or pays for them, whichever happens rst. Given the delay between sending the notice and its receipt, creditors have scant opportunity to avail themselves of a judicial or nonjudicial remedy before the transfer has been consummated. In some cases Article 6 may have the unintended eect of injuring, rather than aiding, creditors of the transferor. Those transferees who recognize the burdens and risks that Article 6 imposes upon them sometimes agree to purchase only at a reduced price. Others refuse to purchase at all, leaving the creditors to realize only the liquidation value, rather than the going concern value, of the business goods. As a response to these inadequacies and others, the National Conference of Commissioners on Uniform State Laws has completely revised Article 6. This revision is designed to reduce the burdens and risks imposed upon good-faith buyers of business assets while increasing the protection aorded to creditors. Among the major changes it makes are the following: this Article applies only when the buyer has notice, or after reasonable inquiry would have had notice, that the seller will not continue to operate the same or a similar kind of business after the sale (Section 6-102(1)(c)). this Article does not apply to sales in which the value of the property otherwise available to creditors is less than $10,000 or those in which the value of the property is greater than $25,000,000 (Section 6-103(3)(l)). the choice-of-law provision (Sections 6-103(1)(b) and 6-103(2)) limits the applicable law to that of one jurisdiction. when the seller is indebted to a large number of persons, the buyer need neither obtain a list of those persons nor send individual notices to each person but instead may give notice by ling (Sections 6-105(2) and 6-104(2)). the notice period is increased from 10 days to 45 days (Section 6-105(5)), and the statute of limitations is extended from six months to one year (Section 6-110). the notice must include a copy of a schedule of distribution, which sets forth how the net contract price is to be distributed (Sections 6-105(3) and 6-106(1)). a buyer who makes a good faith eort to comply with the requirements of this Article or to exclude the sale from the application of this Article, or who acts on the good faith belief that this Article does not apply to the sale, is not liable for noncompliance (Section 6-107(3)). a buyer's noncompliance does not render the sale ineective or otherwise aect the buyer's title to the goods; rather, the liability of a noncomplying buyer is for damages caused by the noncompliance (Sections 6-107(1) and 6-107(8)). In addition to making these and other major substantive changes, revised Article 6 resolves the ambiguities that three decades of law practice, judicial construction, and scholarly inquiry have disclosed.

6-102. Denitions and Index of Denitions. (1) In this Article, unless the context otherwise requires: (a) Assets means the inventory that is the subject of a bulk sale and any tangible and intangible personal property used or held for use primarily in, or arising from, the sellers business and sold in connection with that inventory, but the term does not include: (i) xtures (section 9-102(a)(41)) other than readily removable factory and oce machines; (ii) the lessee's interest in a lease of real property; or (iii) property to the extent it is generally exempt from creditor process under nonbankruptcy law.
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(b) Auctioneer means a person whom the seller engages to direct, conduct, control, or be responsible for a sale by auction. (c) Bulk sale means: (i) in the case of a sale by auction or a sale or series of sales conducted by a liquidator on the seller's behalf, a sale or series of sales not in the ordinary course of the seller's business of more than half of the seller's inventory, as measured by value on the date of the bulksale agreement, if on that date the auctioneer or liquidator has notice, or after reasonable inquiry would have had notice, that the seller will not continue to operate the same or a similar kind of business after the sale or series of sales; and (ii) in all other cases, a sale not in the ordinary course of the seller's business of more than half the seller's inventory, as measured by value on the date of the bulk-sale agreement, if on that date the buyer has notice, or after reasonable inquiry would have had notice, that the seller will not continue to operate the same or a similar kind of business after the sale. (d) Claim means a right to payment from the seller, whether or not the right is reduced to judgment, liquidated, xed, matured, disputed, secured, legal, or equitable. The term includes costs of collection and attorney's fees only to the extent that the laws of this state permit the holder of the claim to recover them in an action against the obligor. (e) Claimant means a person holding a claim incurred in the seller's business other than: (i) an unsecured and unmatured claim for employment compensation and benets, including commissions and vacation, severance, and sick-leave pay; (ii) a claim for injury to an individual or to property, or for breach of warranty, unless: (A) a right of action for the claim has accrued; (B) the claim has been asserted against the seller; and (C) the seller knows the identity of the person asserting the claim and the basis upon which the person has asserted it; and (States To Select One Alternative) ALTERNATIVE A [(iii) a claim for taxes owing to a governmental unit.] ALTERNATIVE B [(iii) a claim for taxes owing to a governmental unit, if: (A) a statute governing the enforcement of the claim permits or requires notice of the bulk sale to be given to the governmental unit in a manner other than by compliance with the requirements of this Article; and (B) notice is given in accordance with the statute.] (f) Creditor means a claimant or other person holding a claim. (g) (i) Date of the bulk sale means: (A) f the sale is by auction or is conducted by a liquidator on the
596

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seller's behalf, the date on which more than ten percent of the net proceeds is paid to or for the benet of the seller; and (B) in all other cases, the later of the date on which: (I) more than ten percent of the net contract price is paid to or for the benet of the seller; or (II) more than ten percent of the assets, as measured by value, are transferred to the buyer. (ii) For purposes of this subsection: (A) Delivery of a negotiable instrument (Section 3-104(1)) to or for the benet of the seller in exchange for assets constitutes payment of the contract price pro tanto; (B) o the extent that the contract price is deposited in an escrow, the contract price is paid to or for the benet of the seller when the seller acquires the unconditional right to receive the deposit or when the deposit is delivered to the seller or for the benet of the seller, whichever is earlier; and (C) n asset is transferred when a person holding an unsecured claim can no longer obtain through judicial proceedings rights to the asset that are superior to those of the buyer arising as a result of the bulk sale. A person holding an unsecured claim can obtain those superior rights to a tangible asset at least until the buyer has an unconditional right, under the bulk-sale agreement, to possess the asset, and a person holding an unsecured claim can obtain those superior rights to an intangible asset at least until the buyer has an unconditional right, under the bulk-sale agreement, to use the asset. (h) Date of the bulk-sale agreement means: (i) in the case of a sale by auction or conducted by a liquidator (subsection (c)(i)), the date on which the seller engages the auctioneer or liquidator; and (ii) in all other cases, the date on which a bulk-sale agreement becomes enforceable between the buyer and the seller. (i) Debt means liability on a claim. (j) Liquidator means a person who is regularly engaged in the business of disposing of assets for businesses contemplating liquidation or dissolution. (k) Net contract price means the new consideration the buyer is obligated to pay for the assets less: (i) he amount of any proceeds of the sale of an asset, to the extent the proceeds are applied in partial or total satisfaction of a debt secured by the asset; and (ii) the amount of any debt to the extent it is secured by a security interest or lien that is enforceable against the asset before and after it has been sold to a buyer. If a debt is secured by an asset and other property of the seller, the amount of the debt secured by a security interest or lien that is enforceable against the asset is determined by multiplying the debt by a fraction, the numerator of which is the value of the new consideration for the asset on the date of the bulk sale and the denominator of which is the value of all property securing the debt on the date of the bulk sale.
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(l) Net proceeds means the new consideration received for assets sold at a sale by auction or a sale conducted by a liquidator on the seller's behalf less: (i) commissions and reasonable expenses of the sale; (ii) the amount of any proceeds of the sale of an asset, to the extent the proceeds are applied in partial or total satisfaction of a debt secured by the asset; and (iii) the amount of any debt to the extent it is secured by a security interest or lien that is enforceable against the asset before and after it has been sold to a buyer. If a debt is secured by an asset and other property of the seller, the amount of the debt secured by a security interest or lien that is enforceable against the asset is determined by multiplying the debt by a fraction, the numerator of which is the value of the new consideration for the asset on the date of the bulk sale and the denominator of which is the value of all property securing the debt on the date of the bulk sale. (m) A sale is in the ordinary course of the seller's business if the sale comports with usual or customary practices in the kind of business in which the seller is engaged or with the seller's own usual or customary practices. (n) United States includes its territories and possessions and the Commonwealth of Puerto Rico. (o) Value means fair market value. (p) Veried means signed and sworn to or armed. (2) The following denitions in other Articles apply to this Article: (a) (b) (c) (d) (e) Buyer. Equipment. Inventory. Sale. Seller. Section Section Section Section Section 2-103(1)(a). 9-102(a)(33). 9-102(a)(48). 2-106(1). 2-103(1)(d).

(3) In addition, Article 1 contains general denitions and principles of construction and interpretation applicable throughout this Article. As amended in 1999.
See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999.

Ocial Comment
1. (a) Assets. New. The term generally includes only personal property. Whether particular property is personal property is to be determined by law outside this Article; however, for purposes of this Article, (i) the term includes readily removable factory and oce machines (compare Section 9-334(e)(2)(A)), even if they are covered by applicable real estate law and thus are xtures as dened in Section 9-102(a)(41); (ii) the term does not include the lessee's interest in a lease of real property, even if that interest is considered to be personal property under other applicable law; and (iii) the term does not include property to the extent that it is generally exempt from creditor process under nonbankruptcy law. (b) Auctioneer. Compare Section 6-108(3) (1987 Ocial Text). (c) Bulk Sale. Bulk sales are of two kinds. Subsection (1)(c)(i) describes bulk sales 598

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conducted by a professional intermediary (i.e., an auctioneer or liquidator), as to which sales Section 6-108 applies. If these indirect sales occur as a series of related sales, then the entire series is treated as a single bulk sale and the term applies to the sales in the aggregate. Sales made directly by the seller to the buyer, described in subsection (1)(c)(ii), include sales conducted by an auctioneer or liquidator for its own account. The elements of both direct and indirect sales are the same. Some of these elements have been borrowed from the 1987 Ocial Text of Article 6 and restated. For example, the term includes only sales that are not in the ordinary course of the seller's business (subsection (1)(m)). The sale must be of more than half of the seller's inventory, as measured by value [subsection (1)(o)] on the date of the bulk-sale agreement [subsection (1)(h)]. All inventory owned by the seller should be included in the calculation, regardless of where it is located. Inventory that is encumbered by a security interest or lien should be counted at its gross value, although the fact that it is encumbered may aect the applicability of this Article to the sale. The determination whether a sale is a bulk sale and thus subject to this Article is not aected by whether other types of property are sold in connection with inventory. However, other provisions of this Article take account of the fact that other property may be sold in connection with inventory. For example, the availability of the exclusion in Section 6-103(3)(l) turns on the value of all the assets, not just the inventory. Similarly, the notice required by Section 6-105 must describe the assets, not just the inventory. And Section 6-107(4) measures the buyer's maximum cumulative liability for noncompliance by the value of the inventory and equipment sold in the bulk sale. In an eort to limit its coverage to sales posing the greatest risks to creditors, this Article adds an additional element to the denition of bulk sale. A sale is not a bulk sale unless the buyer, auctioneer, or liquidator has notice, or after a reasonable inquiry would have had notice, that the seller will not continue to operate the same or a similar kind of business after the sale. Whether a person has notice depends upon what the person knows and what the person would have known had the person conducted a reasonable inquiry. The issue of whether a transaction was a bulk sale is likely to be litigated only when the seller has absconded with the sale proceeds. This Article requires that the matters as to which the buyer, auctioneer, or liquidator had notice be determined only by reference to facts that the person knew or would have known at the date of the bulk-sale agreement. Reference to what actually occurred is inappropriate. Whether an inquiry is reasonable depends on the facts and circumstances of each case. These facts and circumstances may include the identities of the buyer and seller and the type of assets being sold. In some cases, a reasonable inquiry may consist of no inquiry at all concerning the seller's future. Not every change in business operations poses a substantial enough risk to creditors to justify the costs of compliance with this Article. Thus, in determining whether post-sale business is of a kind that is the same or similar to the business conducted before the sale, a court should consider whether, viewed from the perspective of the creditors of the seller, the change poses extraordinary risks or whether the change is a normal risk that creditors can be assumed to take. In particular, when the post-bulk sale business diers from the pre-bulk sale business only in the size of the business conducted, the seller should be considered to be continuing in the same or a similar kind of business and the sale should not be considered a bulk sale. The seller must continue to operate the same or a similar kind of business as owner. If the owner sells the business assets to a buyer and continues to manage the business as an employee of the buyer, the seller is not continuing to operate the business within the meaning of this Article. (d) Claim. New. The rst sentence derives from Bankruptcy Code 101(4), 11 U.S.C. 101(4). Changes, including the deletion of Section 101(4)(B), were made for stylistic purposes only. (e) Claimant. New. This term denes the category of claim holders who are the primary beneciaries of the duties that this Article imposes. Compare Creditor (subsection (1)(f)). States that choose not to aord taxing authorities the benets of this Article should adopt Alternative A. Adoption of Alternative B would aord the benets of this Article to taxing authorities except with respect to those taxes as to which there has been compliance with another statute requiring that notice of the bulk sale be given to the taxing authority. 599

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(f) Creditor. New. The term includes all holders of claims against the seller, even holders of claims arising from consumer transactions. Compare Claimant (subsection (1)(e)). (g) Date of the bulk sale. New. The parties are able to control the date of the bulk sale in several ways. They can keep the proceeds of the sale in escrow, thereby delaying the date of payment, or they can specically agree that the assets remain subject to the reach of the seller's creditors, thereby delaying the date that the assets are transferred. By adjusting the time that the buyer acquires an unconditional right to possess tangible assets and the time the buyer acquires an unconditional right to use intangible assets, the parties may aect the substantive rights of creditors and thereby control the date the assets are transferred. The connection between the time of transfer and the buyer's rights under the bulk-sale agreement appears only for purposes of sales to which this Article applies. Subsection (1)(g) does not purport to aect the rights of creditors of a seller of property for other purposes or under other circumstances. (h) Date of the bulk-sale agreement. New. Law outside this Article, including the provisions of Article 2, determines when an agreement for a bulk sale becomes enforceable between the buyer and the seller and when an auctioneer or liquidator is engaged. (i) Debt. New. This subsection is borrowed from Bankruptcy Code Section 101(11). (j) Liquidator. New. Although the denition of liquidator is quite broad, the term is used with respect to sales that are conducted by a liquidator on behalf of the seller. See subsection (1)(c)(i). Thus only those liquidators that conduct sales will be aected by this Article. (k) Net contract price. New. Consideration is not new consideration to the extent that it consists of the partial or total satisfaction of an antecedent debt owed to the buyer by the seller. When the buyer buys assets along with property other than assets, the net contract price is that portion of the new consideration allocable to the assets. (l) Net proceeds. New. The term appears, without denition, in Section 6-108 (1987 Ofcial Text). (m) In the ordinary course of the seller's business. New. (n) United States. New. This subsection derives from former Section 9-103(3)(c). (o) Value. New. The denition in Section 1-201(44) is not appropriate in the context of this Article. (p) Veried. New. 2. Good faith. This Article adopts the denition of good faith in Article 1 in all cases, even when the buyer is a merchant. Cross-References: Point 1(a): Sections 9-102, 9-334. Point 1(c): Sections 1-201 and 6-103. Point 1(g): Article 2 generally. Point 1(h): Section 2-201 and Article 2 generally.

6-103. Applicability of Article. (1) Except as otherwise provided in subsection (3), this Article applies to a bulk sale if: (a) the seller's principal business is the sale of inventory from stock; and (b) on the date of the bulk-sale agreement the seller is located in this state or, if the seller is located in a jurisdiction that is not a part of the United States, the seller's major executive oce in the United States is in this state. (2) A seller is deemed to be located at his [or her] place of business. If a seller has more than one place of business, the seller is deemed located at his [or her] chief executive oce. (3) This Article does not apply to: (a) a transfer made to secure payment or performance of an obligation;
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(b) a transfer of collateral to a secured party pursuant to Section 9-609; (c) a disposition of collateral pursuant to Section 9-610; (d) retention of collateral pursuant to Section 9-620; (e) a sale of an asset encumbered by a security interest or lien if (i) all the proceeds of the sale are applied in partial or total satisfaction of the debt secured by the security interest or lien or (ii) the security interest or lien is enforceable against the asset after it has been sold to the buyer and the net contract price is zero; (f) a general assignment for the benet of creditors or to a subsequent transfer by the assignee; (g) a sale by an executor, administrator, receiver, trustee in bankruptcy, or any public ocer under judicial process; (h) a sale made in the course of judicial or administrative proceedings for the dissolution or reorganization of an organization; (i) a sale to a buyer whose principal place of business is in the United States and who: (i) not earlier than 21 days before the date of the bulk sale, (A) obtains from the seller a veried and dated list of claimants of whom the seller has notice three days before the seller sends or delivers the list to the buyer or (B) conducts a reasonable inquiry to discover the claimants; (ii) assumes in full the debts owed to claimants of whom the buyer has knowledge on the date the buyer receives the list of claimants from the seller or on the date the buyer completes the reasonable inquiry, as the case may be; (iii) is not insolvent after the assumption; and (iv) gives written notice of the assumption not later than 30 days after the date of the bulk sale by sending or delivering a notice to the claimants identied in subparagraph (ii) or by ling a notice in the ofce of the [Secretary of State]; (j) a sale to a buyer whose principal place of business is in the United States and who: (i) assumes in full the debts that were incurred in the seller's business before the date of the bulk sale; (ii) is not insolvent after the assumption; and (iii) gives written notice of the assumption not later than 30 days after the date of the bulk sale by sending or delivering a notice to each creditor whose debt is assumed or by ling a notice in the oce of the [Secretary of State]; (k) a sale to a new organization that is organized to take over and continue the business of the seller and that has its principal place of business in the United States if: (i) the buyer assumes in full the debts that were incurred in the seller's business before the date of the bulk sale; (ii) the seller receives nothing from the sale except an interest in the new organization that is subordinate to the claims against the organization arising from the assumption; and
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(iii) the buyer gives written notice of the assumption not later than 30 days after the date of the bulk sale by sending or delivering a notice to each creditor whose debt is assumed or by ling a notice in the oce of the [Secretary of State]; (l) a sale of assets having: (i) a value, net of liens and security interests, of less than $10,000. If a debt is secured by assets and other property of the seller, the net value of the assets is determined by subtracting from their value an amount equal to the product of the debt multiplied by a fraction, the numerator of which is the value of the assets on the date of the bulk sale and the denominator of which is the value of all property securing the debt on the date of the bulk sale; or (ii) a value of more than $25,000,000 on the date of the bulk-sale agreement; or (m) a sale required by, and made pursuant to, statute. (4) The notice under subsection (3)(i)(iv) must state: (i) that a sale that may constitute a bulk sale has been or will be made; (ii) the date or prospective date of the bulk sale; (iii) the individual, partnership, or corporate names and the addresses of the seller and buyer; (iv) the address to which inquiries about the sale may be made, if dierent from the seller's address; and (v) that the buyer has assumed or will assume in full the debts owed to claimants of whom the buyer has knowledge on the date the buyer receives the list of claimants from the seller or completes a reasonable inquiry to discover the claimants. (5) The notice under subsections (3)(j)(iii) and (3)(k)(iii) must state: (i) that a sale that may constitute a bulk sale has been or will be made; (ii) the date or prospective date of the bulk sale; (iii) the individual, partnership, or corporate names and the addresses of the seller and buyer; (iv) the address to which inquiries about the sale may be made, if dierent from the seller's address; and (v) that the buyer has assumed or will assume the debts that were incurred in the seller's business before the date of the bulk sale. (6) For purposes of subsection (3)(l), the value of assets is presumed to be equal to the price the buyer agrees to pay for the assets. However, in a sale by auction or a sale conducted by a liquidator on the seller's behalf, the value of assets is presumed to be the amount the auctioneer or liquidator reasonably estimates the assets will bring at auction or upon liquidation. As amended in 1999.
See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999.

Ocial Comment
Prior Uniform Statutory Provision: Sections 6-102 and 6-103 (1987 Ocial Text). Changes: New choice-of-law provision; exclusions from the Article claried, revised, and expanded. Purposes of Changes and New Matter: 1. Subsection (1)(a) follows Section 6-102(3) of the 1987 Ocial Text and makes Article 6 applicable only when the seller's principal business is the sale of inventory from stock. This Article does not apply to a sale by a seller whose principal business is the sale of goods 602

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Bulk Transfers; Bulk Sales

6-103

other than inventory, e.g., a farmer, is the sale of inventory not from stock, e.g., a manufacturer who produces goods to order, or is the sale of services, e.g., a dry cleaner, barber, or operator of a hotel, tavern, or restaurant. 2. The choice-of-law rule in subsections (1)(b) and (2) derives from former Section 9-103(3) (now codied as Sections 9-301 and 9-307). Any agreement between the buyer and the seller with regard to the law governing a bulk sale does not aect the choice-of-law rule in this Article. 3. Some of the transactions excluded by subsection (3), e.g., those excluded by subsection (3)(a), may not be bulk sales. This Article nevertheless specically excludes them in order to allay any doubts about the Article's applicability. Certain transactions, e.g., the sale of fully encumbered inventory that remains subject to a security interest, may be excluded by more than one subsection. 4. Subsections (3)(a), (b), (c), (d), and (e) derive from subsections (1) and (3) of Section 6-103 (1987 Ocial Text). 5. Subsections (3)(f), (g), and (h) restate subsections (2), (4), and (5) of Section 6-103 with minor changes. 6. Subsections (3)(i), (j), and (k) relate to sales in which the buyer assumes specied debts of the seller. A bulk sale does not fall within any of these subsections unless the buyer's assumption of debts is binding and irrevocable. Subsection (3)(j) derives from subsection (6) of Section 6-103 (1987 Ocial Text) and is available to buyers who are not insolvent (as dened in Section 1-201(23)), assume all the seller's business debts in full, and give notice of the assumption. Subsection (3)(k) derives from subsection (7) of Section 6-103 (1987 Ocial Text) and excludes transactions in which the risks to creditors are minimal. Like subsection (3)(j), this subsection applies only if the buyer assumes all the seller's business debts in full and gives notice of the assumption. In addition, the buyer must be a new organization that is organized to take over and continue the seller's business, the seller must receive nothing from the sale other than an interest in the new organization, and the seller's interest must be subordinate to the claims arising from the assumption. Sales that may qualify for the exclusion include the incorporation of a partnership or sole proprietorship. Buyers often are reluctant to assume debts of which they have no knowledge. Subsection (3)(i), which is new, permits a qualifying buyer to exclude a sale from this Article by assuming only those debts owed to claimants of whom the buyer has knowledge after the buyer either conducts a reasonable inquiry to discover claimants or obtains a list of claimants from the seller. A buyer who takes a veried list from the seller is held to have knowledge of the claimants on the list and is entitled to rely in good faith on the list without making further inquiry. The protection aorded by the assumption of these debts, while not perfect, is suciently great to eliminate the need for compliance with Article 6. 7. Subsection (3)(l) is new. Although the bulk sale of even a very small business may be of concern to some creditors, losses to creditors from sales of assets in which the seller's equity is less than $10,000 are not likely to justify the costs of complying with this Article. Sales of assets having a value of more than $25,000,000 have not presented serious risks to creditors. Publicity normally attends sales of that magnitude, and the sellers are unlikely to be able successfully to remove the proceeds from the reach of creditors. As used in this subsection, price includes all consideration for the assets, not only new consideration. Compare Net contract price (Section 6-102(1)(k)). If the auctioneer or liquidator does not make an estimation, then no presumption arises. 8. Subsection (3)(m) is new. This Article assumes that creditors are aware of statutes that may require their debtors to conduct bulk sales under specied circumstances, e.g., upon the termination of a franchise or of a contract between a dealer and supplier, and are able to take account of any risk that those sales may impose. Cross-References: Point 1: Sections 9-102(a)(23), (33), (34), (44), (48). Point 2: Sections 1-105, 9-301, and 9-307. Point 3: Section 6-102. Point 4: Sections 9-609, 9-610, and 9-620. Point 6: Sections 1-201 and 1-203. Point 7: Section 6-102. Denitional Cross-References: 603

 6-103

Uniform Commercial Code

Art.

Asset. Section 6-102. Auctioneer. Section 6-102. Bulk sale. Section 6-102. Buyer. Section 2-103. Claimant. Section 6-102. Collateral. Section 9-102(a)(12). Date of the bulk sale. Section 6-102. Date of the bulk-sale agreement. Section 6-102. Debt. Section 6-102. Insolvent. Section 1-201. Inventory. Section 9-102(a)(48). Knowledge. Section 1-201. Liquidator. Section 6-102. Net contract price. Section 6-102. Notice. Section 1-201. Organization. Section 1-201. Presumed. Section 1-201. Proceeds. Section 9-102(a)(64). Sale. Section 2-106. Secured party. Section 9-102(a)(72). Security interest. Section 1-201. Seller. Section 2-103. Send. Section 1-201. United States. Section 6-102. Value. Section 6-102. Veried. Section 6-102.

6-104. Obligations of Buyer. (1) In a bulk sale as dened in Section 6-102(1)(c)(ii) the buyer shall: (a) obtain from the seller a list of all business names and addresses used by the seller within three years before the date the list is sent or delivered to the buyer; (b) unless excused under subsection (2), obtain from the seller a veried and dated list of claimants of whom the seller has notice three days before the seller sends or delivers the list to the buyer and including, to the extent known by the seller, the address of and the amount claimed by each claimant; (c) obtain from the seller or prepare a schedule of distribution (Section 6-106(1)); (d) give notice of the bulk sale in accordance with Section 6-105; (e) unless excused under Section 6-106(4), distribute the net contract price in accordance with the undertakings of the buyer in the schedule of distribution; and (f) unless excused under subsection (2), make available the list of claimants (subsection (1)(b)) by: (i) promptly sending or delivering a copy of the list without charge to any claimant whose written request is received by the buyer no later than six months after the date of the bulk sale; (ii) permitting any claimant to inspect and copy the list at any reasonable hour upon request received by the buyer no later than six months after the date of the bulk sale; or
604

Art.

Bulk Transfers; Bulk Sales

6-105

(iii) ling a copy of the list in the oce of the [Secretary of State] no later than the time for giving a notice of the bulk sale (Section 6-105(5)). A list led in accordance with this subparagraph must state the individual, partnership, or corporate name and a mailing address of the seller. (2) A buyer who gives notice in accordance with Section 6-105(2) is excused from complying with the requirements of subsections (1)(b) and (1)(f). Ocial Comment
Prior Uniform Statutory Provision: Section 6-104 (1987 Ocial Text). Changes: Revised and rewritten. Purposes of Changes and New Matter: 1. Subsection (1) sets forth the buyer's duties in a bulk sale conducted by the seller. The buyer's failure to perform these duties may result in liability under Section 6-107. An auctioneer in a bulk sale by auction and a liquidator in a bulk sale that the liquidator conducts on the seller's behalf have similar duties but may face somewhat dierent liability. See Section 6-108(1). The buyer's duties are designed to aord the seller's claimants the opportunity to learn of the bulk sale before the seller has removed the assets from their reach and has received payment that is easily secreted. 2. Section 6-104(3) (1987 Ocial Text) provides that [r]esponsibility for the completeness and accuracy of the list of creditors rests on the transferor, and the transfer is not rendered ineective by errors or omissions therein unless the transferee is shown to have had knowledge. This sentence has been deleted as superuous. Nothing in this Article suggests that the buyer is responsible for the completeness or accuracy of the list of claimants. The buyer's only obligations with respect to the list are to obtain it from the seller and to make it available. A buyer who sends or delivers notice of the bulk sale in accordance with Section 6-105(1) may rely in good faith on the list supplied by the seller unless, at the time the notice is sent or delivered, the buyer has knowledge of a claimant not on the list. A buyer who knows of a claimant not on the list is obligated to send notice of the bulk sale to that claimant. 3. The buyer's only obligation with respect to the net contract price is to comply with the schedule of distribution. The schedule may provide for the buyer to pay the entire net contract price to the seller. If so, the buyer complies with the requirements of Section 6-104(1)(e) by paying the entire net contract price to the seller. 4. The purpose of the list of claimants is to enable the buyer to give claimants notice of the bulk sale. If the buyer gives notice by ling in a public oce (Section 6-105(2)), then the buyer need not obtain or preserve a list of the seller's claimants. Cross-References: Point 1: Sections 6-107 and 6-108. Point 2: Sections 6-105 and 1-203. Point 3: Section 6-106. Point 4: Section 6-105. Denitional Cross-References: Buyer. Section 2-103. Bulk sale. Section 6-102. Claimant. Section 6-102. Date of the bulk sale. Section 6-102. Net contract price. Section 6-102. Notice. Section 1-201. Seller. Section 2-103. Veried. Section 6-102.

6-105. Notice to Claimants. (1) Except as otherwise provided in subsection (2), to comply with Section 6-104(1)(d), the buyer shall send or deliver a written notice of the bulk sale
605

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Uniform Commercial Code

Art.

to each claimant on the list of claimants (Section 6-104(1)(b)) and to any other claimant of whom the buyer has knowledge at the time the notice of the bulk sale is sent or delivered. (2) A buyer may comply with Section 6-104(1)(d) by ling a written notice of the bulk sale in the oce of the [Secretary of State] if: (a) on the date of the bulk-sale agreement the seller has 200 or more claimants, exclusive of claimants holding secured or matured claims for employment compensation and benets, including commissions and vacation, severance, and sick-leave pay; or (b) the buyer has received a veried statement from the seller stating that, as of the date of the bulk-sale agreement, the number of claimants, exclusive of claimants holding secured or matured claims for employment compensation and benets, including commissions and vacation, severance, and sick-leave pay, is 200 or more. (3) The written notice of the bulk sale must be accompanied by a copy of the schedule of distribution (Section 6-106(1)) and state at least: (a) that the seller and buyer have entered into an agreement for a sale that may constitute a bulk sale under the laws of the State of ; (b) the date of the agreement; (c) the date on or after which more than ten percent of the assets were or will be transferred; (d) the date on or after which more than ten percent of the net contract price was or will be paid, if the date is not stated in the schedule of distribution; (e) the name and a mailing address of the seller; (f) any other business name and address listed by the seller pursuant to Section 6-104(1)(a); (g) the name of the buyer and an address of the buyer from which information concerning the sale can be obtained; (h) a statement indicating the type of assets or describing the assets item by item; (i) the manner in which the buyer will make available the list of claimants (Section 6-104(1)(f)), if applicable; and (j) if the sale is in total or partial satisfaction of an antecedent debt owed by the seller, the amount of the debt to be satised and the name of the person to whom it is owed. (4) For purposes of subsections (3)(e) and (3)(g), the name of a person is the person's individual, partnership, or corporate name. (5) The buyer shall give notice of the bulk sale not less than 45 days before the date of the bulk sale and, if the buyer gives notice in accordance with subsection (1), not more than 30 days after obtaining the list of claimants. (6) A written notice substantially complying with the requirements of subsection (3) is eective even though it contains minor errors that are not seriously misleading. (7) A form substantially as follows is sucient to comply with subsection (3):
606

Art.

Bulk Transfers; Bulk Sales

6-105

Notice of Sale (1) , whose address is , is described in this notice as the seller. (2) , whose address is , is described in this notice as the buyer. (3) The seller has disclosed to the buyer that within the past three years the seller has used other business names, operated at other addresses, or both, as follows: . (4) The seller and the buyer have entered into an agreement dated , for a sale that may constitute a bulk sale under the laws of the state of . (5) The date on or after which more than ten percent of the assets that are the subject of the sale were or will be transferred is , and [if not stated in the schedule of distribution] the date on or after which more than ten percent of the net contract price was or will be paid is . (6) The following assets are the subject of the sale: . (7) [If applicable] The buyer will make available to claimants of the seller a list of the seller's claimants in the following manner: . (8) [If applicable] The sale is to satisfy $ of an antecedent debt owed by the seller to . (9) A copy of the schedule of distribution of the net contract price accompanies this notice. [End of Notice] Ocial Comment
Prior Uniform Statutory Provision: Sections 6-105 and 6-107 (1987 Ocial Text). Changes: Revised, alternative method of giving notice added, and form of notice added. Purposes of Changes and New Matter: 1. Subsection (1) sets forth the method by which the buyer may discharge the duty to notify the seller's claimants of the impending sale. The buyer has knowledge of a claimant only if the buyer has actual knowledge sucient to enable the buyer to send a notice to the claimant. A buyer who knows only that the seller has other, unidentied claimants complies with this subsection by giving notice to the claimants on the seller's list. 2. Subsection (2) is new. It aords the buyer the opportunity to publish notice in cases in which the number of claimantsand thus the costs of compliance and risk of inadvertent noncomplianceare large. Although a led notice will not inform every claimant of the impending sale, a led notice is expected to inform a sucient number of claimants (perhaps through credit reporting services) to enable them to stop an unfair or fraudulent transaction before it occurs. The buyer may give notice by ling if the seller actually has 200 or more claimants or if the buyer receives a veried statement that the seller has 200 or more claimants. Claimants who hold secured or matured claims for employment compensation and benets are not counted in determining the number of claimants for this purpose; however, they are entitled to receive notice of the bulk sale. The duty to give notice must be performed in good faith. A buyer who receives a veried statement from the seller but knows the statement to be false does not act in good faith and thus does not comply with subsection (2)(b). 3. Subsection (3) prescribes the contents of the notice. The contents are the same regardless of whether notice is sent to each claimant or led, except that the information in subsection (3)(i) is required only when notice is sent. The requirements of subsection (3) are the minimum; a notice that includes additional information is eective. The requirement in subsection (3)(h) for the description of assets is modeled on former Section 9-402(1) (now 607

 6-105

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Art.

codied as Sections 9-108, 9-502, and 9-504). Neither the identication of assets by serial number nor an item-by-item list of assets is required. Subsection (3)(j) applies when the sale satises a debt owed by the seller to the buyer or to a third party. Section 6-103(3) excludes certain sales of this kind from the application of this Article. 4. Subsection (4) requires that a notice give the proper name of the seller and the buyer. A trade name is insucient. See Section 9-503(c). However, subsection (3)(f) requires that trade names be added when the seller has provided them to the buyer. The list need not include trade names or other names that the seller has used but not listed, even if the buyer knows of the names. 5. Subsection (5) requires that notice be given not less than 45 days before the date of the bulk sale. The period was extended from the 10 days aorded by the 1987 Ocial Text to provide ample time for claimants to receive or discover the notice and to take any action that the law permits to collect their claims from the seller. For example, depending upon the facts of each case and upon applicable law, claimants might seek to enjoin the sale, acquire a judicial lien on the assets or the proceeds, threaten to refuse to deal with the buyer unless the seller's debt is paid, or le an involuntary bankruptcy petition against the seller. The date of the bulk sale is dened in such a way as to permit the seller to transfer the assets to the buyer or the buyer to pay the price to the seller (but not both) before or during the 45 days. 6. Subsection (6) derives from former Section 9-402(8) (now codied as Section 9-506). The purpose of ling is to give notice to claimants. Whether an error in the seller's name is seriously misleading should depend upon whether a claimant searching under the seller's correct name could have found the ling. Whether an error other than in the seller's name is seriously misleading should depend upon whether the error prejudiced the ability of claimants to assert their rights. Cross-References: Point 1: Sections 1-201 and 6-104. Point 2: Sections 1-203 and 6-104. Point 3: Sections 6-102, 6-104, 9-108, 9-502 and 9-504. Point 4: Sections 6-104 and 9-503. Point 5: Sections 6-102. Point 6: Sections 6-107 and 9-506. Denitional Cross-References: Asset. Section 6-102. Bulk sale. Section 6-102. Buyer. Section 2-103. Claim. Section 6-102. Claimant. Section 6-102. Date of the bulk sale. Section 6-102. Date of the bulk-sale agreement. Section 6-102. Debt. Section 6-102. Knowledge. Section 1-201. Net contract price. Section 6-102. Seller. Section 2-103. Send. Section 1-201. Veried. Section 6-102. Written. Section 1-201.

6-106. Schedule of Distribution. (1) The seller and buyer shall agree on how the net contract price is to be distributed and set forth their agreement in a written schedule of distribution. (2) The schedule of distribution may provide for distribution to any person at any time, including distribution of the entire net contract price to the seller.
608

Art.

Bulk Transfers; Bulk Sales

6-106

(3) The buyer's undertakings in the schedule of distribution run only to the seller. However, a buyer who fails to distribute the net contract price in accordance with the buyer's undertakings in the schedule of distribution is liable to a creditor only as provided in Section 6-107(1). (4) If the buyer undertakes in the schedule of distribution to distribute any part of the net contract price to a person other than the seller, and, after the buyer has given notice in accordance with Section 6-105, some or all of the anticipated net contract price is or becomes unavailable for distribution as a consequence of the buyer's or seller's having complied with an order of court, legal process, statute, or rule of law, the buyer is excused from any obligation arising under this Article or under any contract with the seller to distribute the net contract price in accordance with the buyer's undertakings in the schedule if the buyer: (a) distributes the net contract price remaining available in accordance with any priorities for payment stated in the schedule of distribution and, to the extent that the price is insucient to pay all the debts having a given priority, distributes the price pro rata among those debts shown in the schedule as having the same priority; (b) distributes the net contract price remaining available in accordance with an order of court; (c) commences a proceeding for interpleader in a court of competent jurisdiction and is discharged from the proceeding; or (d) reaches a new agreement with the seller for the distribution of the net contract price remaining available, sets forth the new agreement in an amended schedule of distribution, gives notice of the amended schedule, and distributes the net contract price remaining available in accordance with the buyer's undertakings in the amended schedule. (5) The notice under subsection (4)(d) must identify the buyer and the seller, state the ling number, if any, of the original notice, set forth the amended schedule, and be given in accordance with subsection (1) or (2) of Section 6-105, whichever is applicable, at least 14 days before the buyer distributes any part of the net contract price remaining available. (6) If the seller undertakes in the schedule of distribution to distribute any part of the net contract price, and, after the buyer has given notice in accordance with Section 6-105, some or all of the anticipated net contract price is or becomes unavailable for distribution as a consequence of the buyer's or seller's having complied with an order of court, legal process, statute, or rule of law, the seller and any person in control of the seller are excused from any obligation arising under this Article or under any agreement with the buyer to distribute the net contract price in accordance with the seller's undertakings in the schedule if the seller: (a) distributes the net contract price remaining available in accordance with any priorities for payment stated in the schedule of distribution and, to the extent that the price is insucient to pay all the debts having a given priority, distributes the price pro rata among those debts shown in the schedule as having the same priority; (b) distributes the net contract price remaining available in accordance with an order of court; (c) commences a proceeding for interpleader in a court of competent jurisdiction and is discharged from the proceeding; or
609

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Art.

(d) prepares a written amended schedule of distribution of the net contract price remaining available for distribution, gives notice of the amended schedule, and distributes the net contract price remaining available in accordance with the amended schedule. (7) The notice under subsection (6)(d) must identify the buyer and the seller, state the ling number, if any, of the original notice, set forth the amended schedule, and be given in accordance with subsection (1) or (2) of Section 6-105, whichever is applicable, at least 14 days before the seller distributes any part of the net contract price remaining available. Ocial Comment
Purposes: 1. A principal purpose of bulk sales legislation has been to impair the ability of a seller to liquidate inventory and abscond with the proceeds, leaving creditors unpaid. Toward this end, a signicant minority of jurisdictions adopted optional Section 6-106 (1987 Ocial Text), which imposes upon a transferee in bulk the duty to apply the new consideration for the transfer to the debts of the transferor pro rata. When one or more of these debts is unliquidated, disputed, or allegedly secured, making a pro rata distribution may prove quite dicult and distribution of the consideration may be delayed considerably. In addition, since preferences generally are permitted under state law, the appropriateness of mandating a pro rata distribution is questionable. Accordingly, this Article does not require the buyer to apply the consideration to payment of the seller's debts. This Article recognizes, however, that the seller's claimants have an interest in learning what will happen to the net contract price. If the contemplated distribution is objectionable, claimants should be able to avail themselves of whatever remedies state law or federal law allows to prevent the sale or tie up the price. On the other hand, if the price is to be distributed in a manner that is favorable to creditors, then advance knowledge of that fact will facilitate the sale by obviating any need for claimants to interfere with it. To aord advance notice of the intended distribution of the contract price, Section 6-105(3) requires the buyer to include with the notice of the sale a copy of the schedule of distributioni.e., of the agreement between the buyer and the seller on how the net contract price is to be distributed. 2. This Article does not require the net contract price to be applied in any particular fashion. Rather, the buyer and the seller may agree to whatever they wish. They must, however, disclose their agreement in ample time before the date of the bulk sale. See Section 6-105(5). The terms of the schedule of distribution in any given sale will be a function of the negotiations between buyer and seller as aected by any applicable non-Code law (e.g., corporate dissolution statutes) imposing distribution requirements in sales of the kind conducted. In formulating the schedule, the parties may be well advised to consider the likely reaction of claimants to the schedule. For example, a schedule that contemplates the distribution of the entire net contract price to the seller or to a single creditor may prompt the ling of an involuntary bankruptcy petition. A schedule that contemplates paying the net contract price into an escrow established for the benet of the seller's claimants may be more favorably received. The seller may incur additional debt between the time the schedule is published and the time the net contract price is paid. The schedule may provide for payment of those debts from the net contract price. 3. Unless otherwise agreed, the buyer's only liability to creditors for failure to comply with his undertakings in the schedule of distribution is set forth in Section 6-107(1). A creditor named in the schedule may not rely on the creation or publication of the schedule as the basis for imposing liability against the buyer on any other theory, including that of estoppel or third-party beneciary. The seller may wish to undertake to pay some of the price to creditors. The seller may, but need not, include this undertaking in the schedule of distribution. The buyer is not responsible for performance of the seller's undertakings. Thus, if the seller makes an undertaking with respect to payment of the net contract price and fails to perform in accordance with it, the buyer faces no liability. However, certain persons in control of the seller 610

Art.

Bulk Transfers; Bulk Sales

6-107

may be liable under those circumstances. See Section 6-107(11). 4. In some cases, the precise amount of the net contract price may be unknown at the time that the schedule of distribution is formulated and notice of the bulk sale is given. In other cases, the net contract price may prove to be less than originally anticipated. Parties who fail to provide for these contingencies in the schedule of distribution and are unable to abide by the original schedule may be required to give a new notice with a new schedule. The inability to abide by the schedule may be due to an external legal event, e.g., the suffering of a garnishment lien on the net contract price, the ling of a bankruptcy petition, or compliance with a corporate dissolution statute. If so, subsection (4), which applies to the extent that the net contract price is within the control of the buyer, may aord relief to the buyer, and subsection (6), which applies to the extent the net contract price is within the control of the seller, may aord relief to a person in control of the seller. Although this Article imposes no obligation on sellers with respect to distribution of the net contract price (or otherwise), a seller may incur an obligation of this kind by agreement with the buyer. Accordingly, subsection (6) provides the means by which the seller as well as a person in control of the seller may be excused from any such obligation. Subsections (4)(a) and (6)(a) permit the buyer or seller respectively to distribute the net contract price remaining available in accordance with any priorities for payment. A schedule need not aord priority to particular debts. If the schedule contains no priorities, then the debts are treated as if they are all of the same priority, and the buyer or seller, as the case may be, may distribute the price pro rata in partial satisfaction of the debts set forth in the schedule. Law other than this Article determines whether a court order or a proceeding for interpleader is available for purposes of subsections (4)(b), (4)(c), (6)(b), and (6)(c). Cross-References: Point 1: Sections 6-104 and 6-105. Point 2: Sections 6-105. Point 3: Sections 1-102 and 6-107. Denitional Cross-References: Buyer. Section 2-103. Contract. Section 1-201. Creditor. Section 1-201. Debt. Section 6-102. Net contract price. Section 6-102. Person. Section 1-201. Seller. Section 2-103. Written. Section 1-201.

6-107. Liability for Noncompliance. (1) Except as provided in subsection (3), and subject to the limitation in subsection (4): (a) a buyer who fails to comply with the requirements of Section 6-104(1) (e) with respect to a creditor is liable to the creditor for damages in the amount of the claim, reduced by any amount that the creditor would not have realized if the buyer had complied; and (b) a buyer who fails to comply with the requirements of any other subsection of Section 6-104 with respect to a claimant is liable to the claimant for damages in the amount of the claim, reduced by any amount that the claimant would not have realized if the buyer had complied. (2) In an action under subsection (1), the creditor has the burden of establishing the validity and amount of the claim, and the buyer has the burden of establishing the amount that the creditor would not have realized if the buyer had complied. (3) A buyer who: (a) made a good faith and commercially reasonable eort to comply
611

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Uniform Commercial Code

Art.

with the requirements of Section 6-104(1) or to exclude the sale from the application of this Article under Section 6-103(3); or (b) on or after the date of the bulk-sale agreement, but before the date of the bulk sale, held a good faith and commercially reasonable belief that this Article does not apply to the particular sale is not liable to creditors for failure to comply with the requirements of Section 6-104. The buyer has the burden of establishing the good faith and commercial reasonableness of the eort or belief. (4) In a single bulk sale the cumulative liability of the buyer for failure to comply with the requirements of Section 6-104(1) may not exceed an amount equal to: (a) if the assets consist only of inventory and equipment, twice the net contract price, less the amount of any part of the net contract price paid to or applied for the benet of the seller or a creditor; or (b) if the assets include property other than inventory and equipment, twice the net value of the inventory and equipment less the amount of the portion of any part of the net contract price paid to or applied for the benet of the seller or a creditor which is allocable to the inventory and equipment. (5) For the purposes of subsection (4)(b), the net value of an asset is the value of the asset less (i) the amount of any proceeds of the sale of an asset, to the extent the proceeds are applied in partial or total satisfaction of a debt secured by the asset and (ii) the amount of any debt to the extent it is secured by a security interest or lien that is enforceable against the asset before and after it has been sold to a buyer. If a debt is secured by an asset and other property of the seller, the amount of the debt secured by a security interest or lien that is enforceable against the asset is determined by multiplying the debt by a fraction, the numerator of which is the value of the asset on the date of the bulk sale and the denominator of which is the value of all property securing the debt on the date of the bulk sale. The portion of a part of the net contract price paid to or applied for the benet of the seller or a creditor that is allocable to the inventory and equipment is the portion that bears the same ratio to that part of the net contract price as the net value of the inventory and equipment bears to the net value of all of the assets. (6) A payment made by the buyer to a person to whom the buyer is, or believes he [or she] is, liable under subsection (1) reduces pro tanto the buyer's cumulative liability under subsection (4). (7) No action may be brought under subsection (1)(b) by or on behalf of a claimant whose claim is unliquidated or contingent. (8) A buyer's failure to comply with the requirements of Section 6-104(1) does not (i) impair the buyer's rights in or title to the assets, (ii) render the sale ineective, void, or voidable, (iii) entitle a creditor to more than a single satisfaction of his [or her] claim, or (iv) create liability other than as provided in this Article. (9) Payment of the buyer's liability under subsection (1) discharges pro tanto the seller's debt to the creditor. (10) Unless otherwise agreed, a buyer has an immediate right of reimbursement from the seller for any amount paid to a creditor in partial or total satisfaction of the buyer's liability under subsection (1).
612

Art.

Bulk Transfers; Bulk Sales

6-107

(11) If the seller is an organization, a person who is in direct or indirect control of the seller, and who knowingly, intentionally, and without legal justication fails, or causes the seller to fail, to distribute the net contract price in accordance with the schedule of distribution is liable to any creditor to whom the seller undertook to make payment under the schedule for damages caused by the failure. Ocial Comment
Prior Uniform Statutory Provision: None. Purposes: 1. This section sets forth the consequences of noncompliance with the requirements of Section 6-104. Although other legal consequences may result from a bulk salee.g., the buyer may be liable to the seller under Article 2 or to the seller's creditors under the Uniform Fraudulent Transfer Actno other consequences may be imposed by reason of the buyer's failure to comply with the requirements of this Article. The two subsections of Section 6-107(1) reect the duties set forth in Section 6-104. The duties generally run only to claimants, but the duty to distribute the net contract price in accordance with the schedule of distribution (Section 6-104(1)(e)) may run also to certain creditors. 2. Article 6 (1987 Ocial Text), like many of its nonuniform predecessors, makes a noncomplying transfer ineective against aggrieved creditors. In contrast, noncompliance with this Article neither renders the sale ineective nor otherwise aects the buyer's rights in or title to the assets. Liability under this Article is for breach of a statutory duty. The buyer's only liability is personal (in personam) liability. Aggrieved creditors may only recover money damages. In rem remedies, which are available upon noncompliance with Article 6 (1987 Ocial Text), are not available under this Article. Thus, aggrieved creditors no longer may treat the sale as if it had not occurred and use the judicial process to apply assets purchased by the buyer toward the satisfaction of their claims against the seller. The change in the theory of liability and in the available remedy should be of particular signicance if the seller enters bankruptcy after the sale is consummated. When an aggrieved creditor of the transferor has a nonbankruptcy right to avoid a transfer in whole or in part, as may be the case under Article 6 (1987 Ocial Text), the transferor's bankruptcy trustee may avoid the entire transfer. See Bankruptcy Code 544(b), 11 U.S.C. 544(b). Under this Article, a person who is aggrieved by the buyer's noncompliance may not avoid the sale. Rather, the person is entitled only to recover damages as provided in this section. Because no creditor has the right to avoid the transaction or to assert a remedy that is the functional equivalent of avoidance, the seller's bankruptcy trustee likewise should be unable to do so. 3. This Article makes explicit what is implicit in Article 6 (1987 Ocial Text): only those persons as to whom there has been noncompliance are entitled to a remedy. For example, if notices are sent to each claimant other than claimant A, claimant B cannot recover. Similarly, a creditor who acquires a claim after notice is given has no remedy unless the buyer undertakes in the schedule of distribution to pay that creditor and the buyer fails to meet the obligation. 4. Unlike Article 6 (1987 Ocial Text), which imposes strict liability upon a noncomplying transferee, this Article imposes liability for noncompliance only when the failure to comply actually has injured a creditor and only to the extent of the injury. Each creditor's damages are measured by the injury that the particular creditor sustained as a consequence of the buyer's failure to comply. This measure is stated as the amount of the debt reduced by any amount that the person would not have realized if the buyer had complied. Compare Section 4-103(5). 5. A buyer is liable only for the buyer's own noncompliance with the requirements of Section 6-104. Under that section, the only step the buyer must take to discover the identity of the seller's claimants is to obtain a list of claimants from the seller. If the seller's list is incomplete and the buyer lacks knowledge of claimant C, then claimant C has no remedy under subsection (1)(b) of this section. 6. The creditor has the burden of establishing the validity and amount of the debt owed 613

 6-107

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Art.

by the seller as well as the fact of the buyer's noncompliance. In contesting the allegation of noncompliance, the buyer may introduce evidence tending to show either that the sale was not a bulk sale or that the sale was a bulk sale to which this Article does not apply. In contesting the validity and amount of the debt, the buyer may introduce evidence tending to show that the seller had a defense to the debt. The buyer has the burden of establishing the amount that the creditor would not have realized even if the buyer had complied. Implicit in subsection (2) is that certain failures to comply with the requirements of this Article will cause no injury and thus result in no liability. The following examples illustrate the operation of subsection (2): Example 1: The buyer fails to give notice of the bulk sale. Claimant D, who appears on seller's list of claimants, admits to having had actual knowledge of the impending sale two months before it occurred. The buyer is likely to be able to meet the burden of establishing that even had the buyer given notice of the sale, claimant D would not have recovered any more than the claimant actually recovered. Example 2: The buyer failed to obtain a list of seller's business names (Section 6-104(1) (a)) or to make available the list of claimants (Section 6-104(1)(f)). In many cases, the buyer may be able to meet the burden of establishing that compliance with those subsections would not have enabled claimants to recover any more than they actually recovered. 7. Subsection (3) may aord a complete defense to a noncomplying buyer. This defense is available to buyers who establish that they made a good faith eort to comply with the requirements of this Article or made a good faith eort to exclude the sale from the application of this Article (e.g., by assuming debts and attempting to comply with the notice requirements of Section 6-103(3)(i), (j), or (k)). When a buyer makes a good faith eort to comply with this Article or to exclude the transaction from its coverage, the injury caused by noncompliance is likely to be de minimis. In any event, the primary responsibility for satisfying claims rests with the creditors, and this Article imposes no greater duty upon buyers who attempt to comply with this Article or to exclude a sale from its application than to make a good faith eort to do so. The defense of subsection (3) also is available to buyers who act on the good faith belief that this Article does not apply to the sale (e.g., because the sale is not a bulk sale or is excluded under Section 6-103). The good-faith-belief defense is an acknowledgement that reasonable people may disagree over whether a given transaction is or is not a bulk sale and over whether Section 6-103 excludes a particular transaction. A buyer acting in good faith should be protected from the liability that this Article otherwise would impose on buyers who may be completely innocent of wrongdoing. A buyer who is unaware of the requirements of this Article holds no belief concerning the applicability of the Article and so may not use the defense. 8. Even a buyer who completely fails to comply with this Article may not be liable in an amount equal to sum of the seller's debts. Subsection (4) limits the aggregate recovery for any one bulk sale, which term includes a series of sales by a liquidator. The maximum cumulative liability for noncompliance with this Article parallels the maximum recovery generally available to creditors under the 1987 Ocial Text of Article 6. Under that Article, the noncomplying transferee may have to pay twice for the goods. First, the transferee may pay the purchase price to the transferor; then, the transferee may lose the goods to aggrieved creditors. Under this Article, the maximum cumulative liability is an amount equal to twice the net contract price of the inventory and equipment (i.e., twice the amount that would be available to unsecured creditors from the inventory and equipment), less the amount of any portion of that net contract price paid to or applied for the benet of the seller or a creditor of the seller. Unless the buyer receives credit for amounts paid to the seller (which amounts the creditors have a right to apply to payment of their claims), the buyer might wind up paying an amount equal to the net contract price three times (once to the seller and twice to aggrieved creditors). The grant of credit for amounts paid to the seller's creditors recognizes that ordinarily the seller has no obligation to pay creditors pro rata. When the assets sold consist of only inventory and equipment, calculation of the maximum cumulative liability is relatively simple. But when the assets sold include property in addition to inventory and equipment, the calculation becomes more dicult. When inventory or equipment secures a debt that also is secured by other collateral and the aggregate value of the collateral exceeds the secured debt, a determination of the amount in clause (ii) of subsection (5) may require an allocation of the collateral to the debt in accor614

Art.

Bulk Transfers; Bulk Sales

6-107

dance with the statutory formula. In addition, one may need to determine which portion of payments of the net contract price is allocable to inventory and equipment. Subsection (5) directs that this allocation be made by multiplying the part of the net contract price paid to or applied for the benet of the seller or a creditor by a fraction whose nominator is the net value of the inventory and equipment and whose denominator is the net value of all the assets. Sometimes the seller may receive the net contract price and pay some or all of it to one or more creditors. In determining whether a payment to a creditor was made from the net contract price or from another source, courts are free to employ tracing rules. Amounts paid to secured parties usually are taken into account in determining the net contract price; if so, the buyer should not receive credit for them. 9. The buyer need not wait for judgment to be entered before paying a person believed to be a creditor of the seller. Indeed, the buyer is entitled to credit for amounts paid to persons who in fact may not be creditors of the seller, as long as the buyer acts with the belief that the seller is so indebted. As is the case with respect to all obligations under the Code, the buyer's belief must be held in good faith. 10. Any amounts paid by the buyer in satisfaction of the liability created by Section 6-107(1) reduce the seller's liability to the recipient pro tanto. Consequently, the buyer is entitled to immediate reimbursement of those amounts from the seller. The right of reimbursement is available only for amounts paid to actual creditors. Amounts paid to those whom the buyer incorrectly believes to be creditors ordinarily are not recoverable from the seller, although the buyer is entitled to credit for those amounts against the aggregate liability in subsection (4). Of course, the buyer and seller may vary the seller's reimbursement obligation by agreement. 11. Because of the diculty in valuing claims that are unliquidated or contingent, persons holding claims of that kind may not bring an action under subsection (1)(b). If the claim remains unliquidated or contingent throughout the limitation period in Section 6-110, then these creditors have no remedy for noncompliance under that subsection. They may, however, be entitled to a remedy under subsection (1)(a) of (11) for failure to distribute the net contract price in accordance with the schedule of distribution. 12. In certain circumstances, subsection (11) imposes liability on a person in direct or indirect control of a seller that is an organization. Excuse under Section 6-106(6) is a legal justication that prevents liability from attaching under subsection (11). No special provision applies to the seller who fails to comply with the schedule. The seller already owes the debt to the creditor, and other law governs the consequences of a debtor who fails to pay a debt when promised. Cross-References: Point 1: Section 6-104. Point 4: Section 4-103. Point 5: Sections 6-104 and 6-105. Point 6: Sections 1-201, 6-102, 6-103, and 6-104. Point 7: Sections 1-102, 1-201, 6-102 and 6-103. Point 8: Section 6-102. Point 9: Section 1-203. Point 10: Section 1-102. Point 11: Sections 6-102 and 6-110. Point 12: Section 6-106. Denitional Cross-References: Assets. Section 6-102. Bulk sale. Section 6-102. Burden of establishing. Section 1-201. Buyer. Section 2-103. Claim. Section 6-102. Claimant. Section 6-102. Creditor. Section 6-102. Date of the bulk sale. Section 6-102. Equipment. Section 6-102. Good faith. Section 6-102. 615

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Inventory. Section 9-102(a)(48). Net contract price. Section 6-102. Organization. Section 1-201. Person. Section 1-201. Proceeds. Section 9-102(a)(64). Security interest. Section 1-201. Seller. Section 2-103. Written. Section 1-201.

6-108. Bulk Sales by Auction; Bulk Sales Conducted by Liquidator. (1) Sections 6-104, 6-105, 6-106, and 6-107 apply to a bulk sale by auction and a bulk sale conducted by a liquidator on the seller's behalf with the following modications: (a) buyer refers to auctioneer or liquidator, as the case may be; (b) net contract price refers to net proceeds of the auction or net proceeds of the sale, as the case may be; (c) the written notice required under Section 6-105(3) must be accompanied by a copy of the schedule of distribution (Section 6-106(1)) and state at least: (i) that the seller and the auctioneer or liquidator have entered into an agreement for auction or liquidation services that may constitute an agreement to make a bulk sale under the laws of the State of ; (ii) the date of the agreement; (iii) the date on or after which the auction began or will begin or the date on or after which the liquidator began or will begin to sell assets on the seller's behalf; (iv) the date on or after which more than ten percent of the net proceeds of the sale were or will be paid, if the date is not stated in the schedule of distribution; (v) the name and a mailing address of the seller; (vi) any other business name and address listed by the seller pursuant to Section 6-104(1)(a); (vii) the name of the auctioneer or liquidator and an address of the auctioneer or liquidator from which information concerning the sale can be obtained; (viii) a statement indicating the type of assets or describing the assets item by item; (ix) the manner in which the auctioneer or liquidator will make available the list of claimants (Section 6-104(1)(f)), if applicable; and (x) if the sale is in total or partial satisfaction of an antecedent debt owed by the seller, the amount of the debt to be satised and the name of the person to whom it is owed; and (d) in a single bulk sale the cumulative liability of the auctioneer or liquidator for failure to comply with the requirements of this section may not exceed the amount of the net proceeds of the sale allocable to inventory and equipment sold less the amount of the portion of any part of the net proceeds paid to or applied for the benet of a creditor which is allocable to the inventory and equipment.
616

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(2) A payment made by the auctioneer or liquidator to a person to whom the auctioneer or liquidator is, or believes he [or she] is, liable under this section reduces pro tanto the auctioneer's or liquidator's cumulative liability under subsection (1)(d). (3) A form substantially as follows is sucient to comply with subsection (1)(c): Notice of Sale (1) , whose address is , is described in this notice as the seller. (2) , whose address is , is described in this notice as the auctioneer or liquidator. (3) The seller has disclosed to the auctioneer or liquidator that within the past three years the seller has used other business names, operated at other addresses, or both, as follows: . (4) The seller and the auctioneer or liquidator have entered into an agreement dated for auction or liquidation services that may constitute an agreement to make a bulk sale under the laws of the State of . (5) The date on or after which the auction began or will begin or the date on or after which the liquidator began or will begin to sell assets on the seller's behalf is , and [if not stated in the schedule of distribution] the date on or after which more than ten percent of the net proceeds of the sale were or will be paid is . (6) The following assets are the subject of the sale: . (7) [If applicable] The auctioneer or liquidator will make available to claimants of the seller a list of the seller's claimants in the following manner: . (8) [If applicable] The sale is to satisfy $ of an antecedent debt owed by the seller to . (9) A copy of the schedule of distribution of the net proceeds accompanies this notice. [End of Notice] (4) A person who buys at a bulk sale by auction or conducted by a liquidator need not comply with the requirements of Section 6-104(1) and is not liable for the failure of an auctioneer or liquidator to comply with the requirements of this section. Ocial Comment
Prior Uniform Statutory Provision: Section 6-108. Changes: Revised, expanded to include sales conducted by a liquidator on the seller's behalf, and form of notice added. Purposes of Changes and New Matter: 1. This section applies only to bulk sales by auction or conducted by a liquidator on the seller's behalf, as dened in Section 6-102(1)(c). Bulk sales conducted by an auctioneer or liquidator on its own behalf are treated as ordinary bulk sales and are not subject to this section. 2. Regardless of whether the assets are sold directly from the seller to the buyer, are sold to a variety of buyers at auction, or are sold on the seller's behalf by a liquidator to one or more buyers, a going-out-of-business sale of inventory presents similar risks to claimants. 617

 6-108

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Art.

Auctioneers and liquidators are likely to be in a better position to ascertain whether the sale they are conducting is, or is part of, a bulk sale than are their customers. Accordingly, buyers at auctions and from liquidators selling assets of others need not be concerned with complying with this Article. Instead, this section imposes upon auctioneers and liquidators duties and liabilities that are similar, but not always identical, to those of a buyer under Sections 6-104(1) and 6-107. Except to the extent that this section treats bulk sales by auctioneers and liquidators dierently from those conducted by the seller on its own behalf, the Ocial Comments to Sections 6-104(1) and 6-107, as well as the Comments to Sections 6-105 and 6-106, which those sections incorporate by reference, are applicable to sales to which this section applies. 3. Subsection (1)(d) sets forth the maximum cumulative liability for auctioneers and liquidators in any one bulk sale, which term includes a series of sales by a liquidator. This liability is to be calculated in a manner similar to that set forth in Sections 6-107(4) and 6-107(5). The term net proceeds of the auction or sale allocable to inventory and equipment is analogous to the term net value of the inventory and equipment; however, the former takes into account the reasonable expenses of the auction or sale whereas the latter does not. Also, the latter is doubled whereas the former is not. The amount of the portion of any part of the net proceeds paid to or applied for the benet of a creditor which is allocable to inventory and equipment is determined by multiplying the part of the net proceeds paid to or applied for the benet of a creditor by a fraction whose numerator is the net proceeds of the sale allocable to inventory and equipment and whose denominator is the total net proceeds of the auction or sale. Because the amount of the net proceeds allocable to inventory and equipment is not doubled, the auctioneer or liquidator is not entitled to credit for payments made to the seller. 4. Section 6-107(3) applies to all bulk sales. Accordingly, an auctioneer or liquidator who makes a good faith eort to comply with the requirements of this Article or to exclude the sale from this Article or who acts under a good faith belief that this Article does not apply to the sale faces no liability whatsoever. Cross-References: Point 1: Section 6-102. Point 2: Sections 6-102, 6-104, 6-105, 6-106, and 6-107. Point 3: Sections 6-102 and 6-107. Point 4: Section 6-107. Denitional Cross-References: Assets. Section 6-102. Auctioneer. Section 6-102. Bulk sale. Section 6-102. Claimants. Section 6-102. Creditor. Section 6-102. Debt. Section 6-102. Equipment. Section 9-102(a)(33). Inventory. Section 9-102(a)(48). Liquidator. Section 6-102. Net proceeds. Section 6-102. Person. Section 1-201. Seller. Section 2-103. Written. Section 1-201.

6-109. What Constitutes Filing; Duties of Filing Ocer; Information From Filing Ocer. (1) Presentation of a notice or list of claimants for ling and tender of the ling fee or acceptance of the notice or list by the ling ocer constitutes ling under this Article. (2) The ling ocer shall: (a) mark each notice or list with a le number and with the date and hour of ling;
618

Art.

Bulk Transfers; Bulk Sales

6-110

(b) hold the notice or list or a copy for public inspection; (c) index the notice or list according to each name given for the seller and for the buyer; and (d) note in the index the le number and the addresses of the seller and buyer given in the notice or list. (3) If the person ling a notice or list furnishes the ling ocer with a copy, the ling ocer upon request shall note upon the copy the le number and date and hour of the ling of the original and send or deliver the copy to the person. (4) The fee for ling and indexing and for stamping a copy furnished by the person ling to show the date and place of ling is $ for the rst page and $ for each additional page. The fee for indexing each name more than two is $ . (5) Upon request of any person, the ling ocer shall issue a certicate showing whether any notice or list with respect to a particular seller or buyer is on le on the date and hour stated in the certicate. If a notice or list is on le, the certicate must give the date and hour of ling of each notice or list and the name and address of each seller, buyer, auctioneer, or liquidator. The fee for the certicate is $ if the request for the certicate is in the standard form prescribed by the [Secretary of State] and otherwise is $ . Upon request of any person, the ling ocer shall furnish a copy of any led notice or list for a fee of $ . (6) The ling ocer shall keep each notice or list for two years after it is led. Ocial Comment
Prior Uniform Statutory Provision: None. Purposes of New Matter: This Article contemplates public ling of bulk sale notices and lists of claimants in a single ling oce in each state. This section, which derives substantially from former Sections 9-403 and 9-407 (now codied as Sections 9-515, 9-516, 9-519, 9-522, 9-523, and 9-525), governs ling. The ling system is designed to enable one seeking information about a sale to discover any led notices or lists by searching under either the seller's or the buyer's (but not the auctioneer's or liquidator's) individual, partnership, or corporate name. Cross-References: Sections 6-103, 6-105, 9-403, and 9-407. Denitional Cross-References: Auctioneer. Section 6-102. Buyer. Section 2-103. Liquidator. Section 6-102. Person. Section 1-201. Seller. Section 2-103. Send. Section 1-201.

6-110. Limitation of Actions. (1) Except as provided in subsection (2), an action under this Article against a buyer, auctioneer, or liquidator must be commenced within one year after the date of the bulk sale. (2) If the buyer, auctioneer, or liquidator conceals the fact that the sale has occurred, the limitation is tolled and an action under this Article may be commenced within the earlier of (i) one year after the person bringing
619

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Art.

the action discovers that the sale has occurred or (ii) one year after the person bringing the action should have discovered that the sale has occurred, but no later than two years after the date of the bulk sale. Complete noncompliance with the requirements of this Article does not of itself constitute concealment. (3) An action under Section 6-107(11) must be commenced within one year after the alleged violation occurs.] Ocial Comment
Prior Uniform Statutory Provision: Section 6-111 (1987 Ocial Text). Changes: Statute of limitations extended and claried. Purposes of Changes and New Matter: 1. This Article imposes liability upon only those who do not make a good faith and commercially reasonable eort to comply with the requirements of the Article or to exclude the sale from the application of the Article and who do not hold a good faith and commercially reasonable belief that the Article is inapplicable to the sale. Consequently, it extends the six-month limitation period of the 1987 Ocial Text, which applies to good faith transferees as well as those not in good faith, to one year. The period commences with the date of the bulk sale. 2. Cases decided under the 1987 Ocial Text of Article 6 disagree over whether the complete failure to comply with the requirements of that Article constitutes a concealment that tolls the limitation. This Article adopts the view that noncompliance does not of itself constitute concealment. 3. This Article does not contemplate tolling the limitation for actions against a person in control of the seller who fails to distribute the net contract price in accordance with the schedule of distribution. Those actions must be commenced within one year after the alleged violation occurs. Cross-References: Point 1: Sections 1-201, 6-102, 6-107 and 6-108. Point 3: Section 6-107. Denitional Cross-References: Action. Section 1-201. Auctioneer. Section 6-102. Buyer. Section 2-103. Date of the bulk sale. Section 6-102. Liquidator. Section 6-102. [End of Alternative B] CONFORMING AMENDMENT TO SECTION 1-105 States adopting Alternative B should amend Section 1-105(2) of the Uniform Commercial Code to read as follows: (2) Where one of the following provisions of this Act species the applicable law, that provision governs and a contrary agreement is eective only to the extent permitted by the law (including the conict of laws rules) so specied: Rights of creditors against sold goods. Section 2-402. Applicability of the Article on Leases. Sections 2A-105 and 2A-106. Applicability of the Article on Bank Deposits and Collections. Section 4-102. Bulk transfers sales subject to the Article on Bulk Transfers Sales. Section 6-102 6-103. Applicability of the Article on Investment Securities. Section 8-106. Perfection provisions of the Article on Secured Transactions. Section 9-103. CONFORMING AMENDMENT TO SECTION 2-403 States adopting Alternative B should amend Section 2-403(4) of the Uniform Commercial Code to read as follows: (4) The rights of other purchasers of goods and of lien creditors are governed by the Articles on Secured Transactions (Article 9), Bulk Transfers Sales (Article 6) and Documents of Title (Article 7). 620

ARTICLE 7. DOCUMENTS OF TITLE*

PART 1. GENERAL
7-101. 7-102. 7-103. 7-104. 7-105. 7-106. Short Title. Denitions and Index of Denitions. Relation of Article to Treaty or Statute. Negotiable and Nonnegotiable Document of Title. Reissuance in Alternative Medium. Control of Electronic Document of Title.

PART 2. WAREHOUSE RECEIPTS: SPECIAL PROVISIONS

7-201. 7-202. 7-203. 7-204. 7-205. 7-206. 7-207. 7-208. 7-209. 7-210. Person That May Issue a Warehouse Receipt; Storage Under Bond. Form of Warehouse Receipt; Eect of Omission. Liability for Nonreceipt or Misdescription. Duty of Care; Contractual Limitation of Warehouse's Liability. Title Under Warehouse Receipt Defeated in Certain Cases. Termination of Storage at Warehouse's Option. Goods Must Be Kept Separate; Fungible Goods. Altered Warehouse Receipts. Lien of Warehouse. Enforcement of Warehouse's Lien.

PART 3. BILLS OF LADING: SPECIAL PROVISIONS

7-301. Liability for Nonreceipt or Misdescription; Said to Contain; Shipper's Weight, Load, and Count; Improper Handling. 7-302. Through Bills of Lading and Similar Documents of Title. 7-303. Diversion; Reconsignment; Change of Instructions. 7-304. Tangible Bills of Lading in a Set. 7-305. Destination Bills. 7-306. Altered Bills of Lading. 7-307. Lien of Carrier. 7-308. Enforcement of Carrier's Lien. 7-309. Duty of Care; Contractual Limitation of Carrier's Liability.

PART 4. WAREHOUSE RECEIPTS AND BILLS OF LADING: GENERAL OBLIGATIONS

7-401. Irregularities in Issue of Receipt or Bill or Conduct of Issuer. 7-402. Duplicate Document of Title; Overissue. 7-403. Obligation of Bailee to Deliver; Excuse.
*Article 7 was revised in 2003. Prerevision Article 7 may be found in Appendix R.

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7-404. No Liability for Good-Faith Delivery Pursuant to Document of Title.

PART 5. WAREHOUSE RECEIPTS AND BILLS OF LADING: NEGOTIATION AND TRANSFER

7-501. 7-502. 7-503. 7-504. 7-505. 7-506. 7-507. 7-508. 7-509. Form of Negotiation and Requirements of Due Negotiation. Rights Acquired by Due Negotiation. Document of Title to Goods Defeated in Certain Cases. Rights Acquired in Absence of Due Negotiation; Eect of Diversion; Stoppage of Delivery. Indorser not Guarantor for Other Parties. Delivery Without Indorsement: Right to Compel Indorsement. Warranties on Negotiation or Delivery of Document of Title. Warranties of Collecting Bank as to Documents of Title. Adequate Compliance with Commercial Contract.

PART 6. WAREHOUSE RECEIPTS AND BILLS OF LADING: MISCELLANEOUS PROVISIONS

7-601. Lost, Stolen, or Destroyed Documents of Title. 7-602. Judicial Process Against Goods Covered by Negotiable Document of Title. 7-603. Conicting Claims; Interpleader.

PART 7. MISCELLANEOUS PROVISIONS

7-701. 7-702. 7-703. 7-704. Eective Date. Repeals. Applicability. Savings Clause.

APPENDIX I. CONFORMING AMENDMENTS TO OTHER ARTICLES

622

DRAFTING COMMITTEE TO REVISE UNIFORM COMMERCIAL CODE ARTICLE 7, DOCUMENTS OF TITLE

The Committee acting for the National Conference of Commissioners on Uniform State Laws and the American Law Institute in preparing the Revised Uniform Commercial Code Article 7 is as follows: HENRY DEEB GABRIEL, JR., Loyola University, School of Law, 526 Pine St., New Orleans, LA 70118, Chair EDWARD V. CATTELL, JR., Suite 2000, 1628 John F. Kennedy Blvd., Philadelphia, PA 19103, The American Law Institute Representative PATRICIA BRUMFIELD FRY, University of Missouri-Columbia, School of Law, Missouri Ave. & Conley Ave., Columbia, MO 65211 SANDRA S. STERN, 909 Third Ave., 5th Floor, New York, New York 10022 NEAL OSSEN, 21 Oak St., Suite 201, Hartford, CT 06106, Enactment Plan Coordinator DREW KERSHEN, University of Oklahoma, College of Law, 300 Timberdell Road, Norman, OK 73019, Co-Reporter LINDA J. RUSCH, Hamline University, School of Law, 1536 Hewitt Ave., St. Paul, MN 55104, The American Law Institute Representative and Co-Reporter EX OFFICIO K. KING BURNETT, P.O. Box 910, Salisbury, MD 21803-0910, President JOSEPH P. MAZUREK, Box 797, Helena, MT 59624, Division Chair AMERICAN BAR ASSOCIATION ADVISOR WILLIAM H. TOWLE, P.O. Box 3267, Missoula, MT 59806-3267, American Bar Association Advisor EXECUTIVE DIRECTOR WILLIAM H. HENNING, University of Alabama, School of Law, Box 870382, Tuscaloosa, AL 35487-0382, Executive Director WILLIAM J. PIERCE, 1505 Roxbury Road, Ann Arbor, MI 48104, Executive Director Emeritus PREFATORY NOTE Article 7 is the last of the articles of the Uniform Commercial Code to be revised. The genesis of this project is twofold: to provide a framework for the further development of electronic documents of title and to update the article for modern times in light of state, federal and international developments. Each section has been reviewed to determine its suitability given modern practice, the need for medium and gender neutrality, and modern statutory drafting. To provide for electronic documents of title, several denitions in Article 1 were revised including bearer, bill of lading, delivery, document of title, holder, and warehouse receipt. The concept of an electronic document of title allows for commercial practice to determine whether records issued by bailees are in the regular course of business or nancing and are treated as adequately evidencing that the person in possession or control of the record is entitled to receive, control, hold, and dispose of the record and the goods the record covers. Rev. Section 1-201(b)(16). Such records in electronic form are electronic documents of title and in tangible form are tangible documents of title. Conforming amendments to other Articles of the UCC are also necessary to fully integrate electronic documents of title into the UCC. Conforming amendments to other Articles of the UCC are contained in Appendix I. Key to the integration of the electronic document of title scheme is the concept of control dened in Section 7-106. This denition is adapted from the Uniform Electronic Transac623

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tions Act 16 on Transferrable Records and from Uniform Commercial Code 9-105 concerning control of electronic chattel paper. Control of an electronic document of title is the conceptual equivalent to possession and indorsement of a tangible document of title. Of equal importance is the acknowledgment that parties may desire to substitute an electronic document of title for an already-issued paper document and vice versa. Section 7-105 sets forth the minimum requirements that need to be fullled in order to give eect to the substitute document issued in the alternate medium. To the extent possible, the rules for electronic documents of title are the same or as similar as possible to the rules for tangible documents of title. If a rule is meant to be limited to one medium or the other, that is clearly stated. Rules that reference documents of title, warehouse receipts, or bills of lading without a designation to electronic or tangible apply to documents of title in either medium. As with tangible negotiable documents of title, electronic negotiable documents of title may be negotiated and duly negotiated. Section 7-501. Other changes that have been made are: 1. New denitions of carrier, good faith, record, sign and shipper in Section 7-102. 2. Deletion of references to taris or led classications given the deregulation of the affected industries. See e.g. section 7-103 and 7-309, 3. Clarifying the rules regarding when a document is nonnegotiable. Section 7-104. 4. Making clear when rules apply just to warehouse receipts or bills of lading, thus eliminating the need for former section 7-105. 5. Clarifying that particular terms need not be included in order to have a valid warehouse receipt. Section 7-202. 6. Broadening the ability of the warehouse to make an eective limitation of liability in its warehouse receipt or storage agreement in accord with commercial practice. Section 7-204. 7. Allowing a warehouse to have a lien on goods covered by a storage agreement and clarifying the priority rules regarding the claim of a warehouse lien as against other interests. Section 7-209. 8. Conforming language usage to modern shipping practice. Sections 7-301 and 7-302. 9. Clarifying the extent of the carrier's lien. Section 7-307. 10. Adding references to Article 2A when appropriate. See e.g. Sections 7-503, 7-504, 7-509. 11. Clarifying that the warranty made by negotiation or delivery of a document of title should apply only in the case of a voluntary transfer of possession or control of the document. Section 7-507. 12. Providing greater exibility to a court regarding adequate protection against loss when ordering delivery of the goods or issuance of a substitute document. Section 7-601. 13. Providing conforming amendments to the other Articles of the Uniform Commercial Code to accommodate electronic documents of title. Legislative Note: All cross-references in this draft to Article 1 are to Revised Article 1 (2001). In the event a state has not enacted Revised Article 1, the cross-references should be changed to refer to the relevant sections in former Article 1.

PART 1. GENERAL
7-101. Short Title. This article may be cited as Uniform Commercial Code-Documents of Title. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-101. Changes: Revised for style only. This Article is a revision of the 1962 Ocial Text with Comments as amended since 1962. The 1962 Ocial Text was a consolidation and revision of the Uniform Warehouse Receipts Act and the Uniform Bills of Lading Act, and embraced the provisions of the Uniform Sales Act relating to negotiation of documents of title. 624

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This Article does not contain the substantive criminal provisions found in the Uniform Warehouse Receipts and Bills of Lading Acts. These criminal provisions are inappropriate to a Commercial Code, and for the most part duplicate portions of the ordinary criminal law relating to frauds. This revision deletes the former Section 7-105 that provided that courts could apply a rule from Parts 2 and 3 by analogy to a situation not explicitly covered in the provisions on warehouse receipts or bills of lading when it was appropriate. This is, of course, an unexceptional proposition and need not be stated explicitly in the statute. Thus former Section 7-105 has been deleted. Whether applying a rule by analogy to a situation is appropriate depends upon the facts of each case. The Article does not attempt to dene the tort liability of bailees, except to hold certain classes of bailees to a minimum standard of reasonable care. For important classes of bailees, liabilities in case of loss, damages or destruction, as well as other legal questions associated with particular documents of title, are governed by federal statutes, international treaties, and in some cases regulatory state laws, which supersede the provisions of this Article in case of inconsistency. See Section 7-103.

7-102. Denitions and Index of Denitions. (a) In this article, unless the context otherwise requires: (1) Bailee means a person that by a warehouse receipt, bill of lading, or other document of title acknowledges possession of goods and contracts to deliver them. (2) Carrier means a person that issues a bill of lading. (3) Consignee means a person named in a bill of lading to which or to whose order the bill promises delivery. (4) Consignor means a person named in a bill of lading as the person from which the goods have been received for shipment. (5) Delivery order means a record that contains an order to deliver goods directed to a warehouse, carrier, or other person that in the ordinary course of business issues warehouse receipts or bills of lading. (6) Good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing. (7) Goods means all things that are treated as movable for the purposes of a contract for storage or transportation. (8) Issuer means a bailee that issues a document of title or, in the case of an unaccepted delivery order, the person that orders the possessor of goods to deliver. The term includes a person for which an agent or employee purports to act in issuing a document if the agent or employee has real or apparent authority to issue documents, even if the issuer did not receive any goods, the goods were misdescribed, or in any other respect the agent or employee violated the issuer's instructions. (9) Person entitled under the document means the holder, in the case of a negotiable document of title, or the person to which delivery of the goods is to be made by the terms of, or pursuant to instructions in a record under, a nonnegotiable document of title. (10) Record means information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form. (11) Sign means, with present intent to authenticate or adopt a record: (A) to execute or adopt a tangible symbol; or (B) to attach to or logically associate with the record an electronic sound, symbol, or process.
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(12) Shipper means a person that enters into a contract of transportation with a carrier. (13) Warehouse means a person engaged in the business of storing goods for hire. (b) Denitions in other articles applying to this article and the sections in which they appear are: (1) Contract for sale, Section 2-106. (2) Lessee in ordinary course, Section 2A-103. (3) Receipt of goods, Section 2-103. (c) In addition, Article 1 contains general denitions and principles of construction and interpretation applicable throughout this article.
Legislative Note: If the state has enacted Revised Article 1, the denitions of good faith in subsection (a)(6) and record in (a)(10) need not be enacted in this section as they are contained in Article 1, Section 1-201. These subsections should be marked as reserved in order to provide for uniform numbering of subsections.

Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-102. Changes: New denitions of carrier, good faith, record, sign, and shipper. Other denitions revised to accommodate electronic mediums. Purposes: 1. Bailee is used in this Article as a blanket term to designate carriers, warehousemen and others who normally issue documents of title on the basis of goods which they have received. The denition does not, however, require actual possession of the goods. If a bailee acknowledges possession when it does not have possession, the bailee is bound by sections of this Article which declare the bailee's obligations. (See denition of Issuer in this section and Sections 7-203 and 7-301 on liability in case of non-receipt.) A carrier is one type of bailee and is dened as a person that issues a bill of lading. A shipper is a person who enters into the contract of transportation with the carrier. The denitions of bailee, consignee, consignor, goods, and issuer, are unchanged in substance from prior law. Document of title is dened in Article 1, and may be in either tangible or electronic form. 2. The denition of warehouse receipt contained in the general denitions section of this Act (Section 1-201) does not require that the issuing warehouse be lawfully engaged in business or for prot. The warehouse's compliance with applicable state regulations such as the ling of a bond has no bearing on the substantive issues dealt with in this Article. Certainly the issuer's violations of law should not diminish its responsibility on documents the issuer has put in commercial circulation. But it is still essential that the business be storing goods for hire (Section 1-201 and this section). A person does not become a warehouse by storing its own goods. 3. When a delivery order has been accepted by the bailee it is for practical purposes indistinguishable from a warehouse receipt. Prior to such acceptance there is no basis for imposing obligations on the bailee other than the ordinary obligation of contract which the bailee may have assumed to the depositor of the goods. Delivery orders may be either electronic or tangible documents of title. See denition of document of title in Section 1-201. 4. The obligation of good faith imposed by this Article and by Article 1, Section 1-304 includes the observance of reasonable commercial standards of fair dealing. 5. The denitions of record and sign are included to facilitate electronic mediums. See comment 9 to Section 9-102 discussing record and the comment to amended Section 2-103 discussing sign. 6. Person entitled under the document is moved from former Section 7-403. 7. These denitions apply in this Article unless the context otherwise requires. The context is intended to refer to the context in which the dened term is used in the Uniform Commercial Code. The denition applies whenever the dened term is used unless the context in which the dened term is used in the statute indicates that the term was not 626

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used in its dened sense. See comment to Section 1-201. Cross References: Point 1: Sections 1-201, 7-203 and 7-301. Point 2: Sections 1-201 and 7-203. Point 3: Section 1-201. Point 4: Section 1-304. Point 5: Section 9-102 and 2-103. See general comment to document of title in Section 1-201. Denitional Cross References: Bill of lading. Section 1-201. Contract. Section 1-201. Contract for sale. Section 2-106. Delivery. Section 1-201. Document of title. Section 1-201. Person. Section 1-201. Purchase. Section 1-201. Receipt of goods. Section 2-103. Right. Section 1-201. Warehouse receipt. Section 1-201.

7-103. Relation of Article to Treaty or Statute. (a) This article is subject to any treaty or statute of the United States or regulatory statute of this state to the extent the treaty, statute, or regulatory statute is applicable. (b) This article does not modify or repeal any law prescribing the form or content of a document of title or the services or facilities to be aorded by a bailee, or otherwise regulating a bailee's business in respects not specically treated in this article. However, violation of such a law does not affect the status of a document of title that otherwise is within the denition of a document of title. (c) This [act] modies, limits, and supersedes the federal Electronic Signatures in Global and National Commerce Act (15 U.S.C. Section 7001, et. seq.) but does not modify, limit, or supersede Section 101(c) of that act (15 U.S.C. Section 7001(c)) or authorize electronic delivery of any of the notices described in Section 103(b) of that act (15 U.S.C. Section 7003(b)). (d) To the extent there is a conict between [the Uniform Electronic Transactions Act] and this article, this article governs.
Legislative Note: In states that have not enacted the Uniform Electronic Transactions Act in some form, states should consider their own state laws to determine whether there is a conict between the provisions of this article and those laws particularly as those other laws may aect electronic documents of title.

Ocial Comment
Prior Uniform Statutory Provision: Former Sections 7-103 and 10-104. Changes: Deletion of references to taris and classications; incorporation of former Section 10-104 into subsection (b), provide for intersection with federal and state law governing electronic transactions. Purposes: 1. To make clear what would of course be true without the Section, that applicable Federal law is paramount. 2. To make clear also that regulatory state statutes (such as those xing or authorizing a commission to x rates and prescribe services, authorizing dierent charges for goods of dierent values, and limiting liability for loss to the declared value on which the charge was based) are not aected by the Article and are controlling on the matters which they 627

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cover unless preempted by federal law. The reference in former Section 7-103 to taris, classications, and regulations led or issued pursuant to regulatory state statutes has been deleted as inappropriate in the modern era of diminished regulation of carriers and warehouses. If a regulatory scheme requires a carrier or warehouse to issue a tari or classication, that tari or classication would be given eect via the state regulatory scheme that this Article recognizes as controlling. Permissive taris or classications would not displace the provisions of this act, pursuant to this section, but may be given eect through the ability of parties to incorporate those terms by reference into their agreement. 3. The document of title provisions of this act supplement the federal law and regulatory state law governing bailees. This Article focuses on the commercial importance and usage of documents of title. State ex. rel Public Service Commission v. Gunkelman & Sons, Inc., 219 N.W.2d 853 (N.D. 1974). 4. Subsection (c) is included to make clear the interrelationship between the federal Electronic Signatures in Global and National Commerce Act and this article and the conforming amendments to other articles of the Uniform Commercial Code promulgated as part of the revision of this article. Section 102 of the federal act allows a State statute to modify, limit, or supersede the provisions of Section 101 of the federal act. See the comments to Revised Article 1, Section 1-108. 5. Subsection (d) makes clear that once this article is in eect, its provisions regarding electronic commerce and regarding electronic documents of title control in the event there is a conict with the provisions of the Uniform Electronic Transactions Act or other applicable state law governing electronic transactions. Cross References: Sections 1-108, 7-201, 7-202, 7-204, 7-206, 7-309, 7-401, 7-403. Denitional Cross Reference: Bill of lading. Section 1-201.

7-104. Negotiable and Nonnegotiable Document of Title. (a) Except as otherwise provided in subsection (c), a document of title is negotiable if by its terms the goods are to be delivered to bearer or to the order of a named person. (b) A document of title other than one described in subsection (a) is nonnegotiable. A bill of lading that states that the goods are consigned to a named person is not made negotiable by a provision that the goods are to be delivered only against an order in a record signed by the same or another named person. (c) A document of title is nonnegotiable if, at the time it is issued, the document has a conspicuous legend, however expressed, that it is nonnegotiable. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-104. Changes: Subsection (a) is revised to reect modern style and trade practice. Subsection (b) is revised for style and medium neutrality. Subsection (c) is new. Purposes: 1. This Article deals with a class of commercial paper representing commodities in storage or transportation. This commodity paper is to be distinguished from what might be called money paper dealt with in the Article of this Act on Commercial Paper (Article 3) and investment paper dealt with in the Article of this Act on Investment Securities (Article 8). The class of commodity paper is designated document of title following the terminology of the Uniform Sales Act Section 76. Section 1-201. The distinctions between negotiable and nonnegotiable documents in this section makes the most important subclassication employed in the Article, in that the holder of negotiable documents may acquire more rights than its transferor had (See Section 7-502). The former Section 7-104, which provided that a document of title was negotiable if it runs to a named person or assigns if such designation was recognized in overseas trade, has been deleted as not necessary in 628

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light of current commercial practice. A document of title is negotiable only if it satises this section. Deliverable on proper indorsement and surrender of this receipt will not render a document negotiable. Bailees often include such provisions as a means of insuring return of nonnegotiable receipts for record purposes. Such language may be regarded as insistence by the bailee upon a particular kind of receipt in connection with delivery of the goods. Subsection (a) makes it clear that a document is not negotiable which provides for delivery to order or bearer only if written instructions to that eect are given by a named person. Either tangible or electronic documents of title may be negotiable if the document meets the requirement of this section. 2. Subsection (c) is derived from Section 3-104(d). Prior to issuance of the document of title, an issuer may stamp or otherwise provide by a notation on the document that it is nonnegotiable even if the document would otherwise comply with the requirement of subsection (a). Once issued as a negotiable document of title, the document cannot be changed from a negotiable document to a nonnegotiable document. A document of title that is nonnegotiable cannot be made negotiable by stamping or providing a notation that the document is negotiable. The only way to make a document of title negotiable is to comply with subsection (a). A negotiable document of title may fail to be duly negotiated if the negotiation does not comply with the requirements for due negotiation stated in Section 7-501. Cross Reference: Sections 7-501 and 7-502. Denitional Cross References: Bearer. Section 1-201. Bill of lading. Section 1-201. Delivery. Section 1-201. Document of title. Section 1-201. Person. Section 1-201. Sign. Section 7-102 Warehouse receipt. Section 1-201.

7-105. Reissuance in Alternative Medium. (a) Upon request of a person entitled under an electronic document of title, the issuer of the electronic document may issue a tangible document of title as a substitute for the electronic document if: (1) the person entitled under the electronic document surrenders control of the document to the issuer; and (2) the tangible document when issued contains a statement that it is issued in substitution for the electronic document. (b) Upon issuance of a tangible document of title in substitution for an electronic document of title in accordance with subsection (a): (1) the electronic document ceases to have any eect or validity; and (2) the person that procured issuance of the tangible document warrants to all subsequent persons entitled under the tangible document that the warrantor was a person entitled under the electronic document when the warrantor surrendered control of the electronic document to the issuer. (c) Upon request of a person entitled under a tangible document of title, the issuer of the tangible document may issue an electronic document of title as a substitute for the tangible document if: (1) the person entitled under the tangible document surrenders possession of the document to the issuer; and (2) the electronic document when issued contains a statement that it is issued in substitution for the tangible document.
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(d) Upon issuance of an electronic document of title in substitution for a tangible document of title in accordance with subsection (c): (1) the tangible document ceases to have any eect or validity; and (2) the person that procured issuance of the electronic document warrants to all subsequent persons entitled under the electronic document that the warrantor was a person entitled under the tangible document when the warrantor surrendered possession of the tangible document to the issuer. Ocial Comment
Prior Uniform Statutory Provisions: None. Other relevant law: UNCITRAL Draft Instrument on the Carriage of Goods by SeaTransport Law. Purpose: 1. This section allows for documents of title issued in one medium to be reissued in another medium. This section applies to both negotiable and nonnegotiable documents. This section sets forth minimum requirements for giving the reissued document eect and validity. The issuer is not required to issue a document in an alternative medium and if the issuer chooses to do so, it may impose additional requirements. Because a document of title imposes obligations on the issuer of the document, it is imperative for the issuer to be the one who issues the substitute document in order for the substitute document to be eective and valid. 2. The request must be made to the issuer by the person entitled to enforce the document of title (Section 7-102(a)(9)) and that person must surrender possession or control of the original document to the issuer. The reissued document must have a notation that it has been issued as a substitute for the original document. These minimum requirements must be met in order to give the substitute document eect and validity. If these minimum requirements are not met for issuance of a substitute document of title, the original document of title continues to be eective and valid. Section 7-402. However, if the minimum requirements imposed by this section are met, in addition to any other requirements that the issuer may impose, the substitute document will be the document that is eective and valid. 3. To protect parties who subsequently take the substitute document of title, the person who procured issuance of the substitute document warrants that it was a person entitled under the original document at the time it surrendered possession or control of the original document to the issuer. This warranty is modeled after the warranty found in Section 4-209. Cross Reference: Sections 7-106, 7-402 and 7-601. Denitional Cross Reference: Person entitled to enforce, Section 7-102.

7-106. Control of Electronic Document of Title. (a) A person has control of an electronic document of title if a system employed for evidencing the transfer of interests in the electronic document reliably establishes that person as the person to which the electronic document was issued or transferred. (b) A system satises subsection (a), and a person is deemed to have control of an electronic document of title, if the document is created, stored, and assigned in such a manner that: (1) a single authoritative copy of the document exists which is unique, identiable, and, except as otherwise provided in paragraphs (4), (5), and (6), unalterable; (2) the authoritative copy identies the person asserting control as:
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(A) the person to which the document was issued; or (B) if the authoritative copy indicates that the document has been transferred, the person to which the document was most recently transferred; (3) the authoritative copy is communicated to and maintained by the person asserting control or its designated custodian; (4) copies or amendments that add or change an identied assignee of the authoritative copy can be made only with the consent of the person asserting control; (5) each copy of the authoritative copy and any copy of a copy is readily identiable as a copy that is not the authoritative copy; and (6) any amendment of the authoritative copy is readily identiable as authorized or unauthorized. Ocial Comment
Prior Uniform Statutory Provision: Uniform Electronic Transactions Act Section 16. Purpose: 1. The section denes control for electronic documents of title and derives its rules from the Uniform Electronic Transactions Act 16 on transferrable records. Unlike UETA 16, however, a document of title may be reissued in an alternative medium pursuant to Section 7-105. At any point in time in which a document of title is in electronic form, the control concept of this section is relevant. As under UETA 16, the control concept embodied in this section provides the legal framework for developing systems for electronic documents of title. 2. Control of an electronic document of title substitutes for the concept of indorsement and possession in the tangible document of title context. See Section 7-501. A person with a tangible document of title delivers the document by voluntarily transferring possession and a person with an electronic document of title delivers the document by voluntarily transferring control. (Delivery is dened in Section 1-201). 3. Subsection (a) sets forth the general rule that the system employed for evidencing the transfer of interests in the electronic document reliably establishes that person as the person to which the electronic document was issued or transferred. The key to having a system that satises this test is that identity of the person to which the document was issued or transferred must be reliably established. Of great importance to the functioning of the control concept is to be able to demonstrate, at any point in time, the person entitled under the electronic document. For example, a carrier may issue an electronic bill of lading by having the required information in a database that is encrypted and accessible by virtue of a password. If the computer system in which the required information is maintained identies the person as the person to which the electronic bill of lading was issued or transferred, that person has control of the electronic document of title. That identication may be by virtue of passwords or other encryption methods. Registry systems may satisfy this test. For example, see the electronic warehouse receipt system established pursuant to 7 C.F.R. Part 735. This Article leaves to the market place the development of sucient technologies and business practices that will meet the test. An electronic document of title is evidenced by a record consisting of information stored in an electronic medium. Section 1-201. For example, a record in a computer database could be an electronic document of title assuming that it otherwise meets the denition of document of title. To the extent that third parties wish to deal in paper mediums, Section 7-105 provides a mechanism for exiting the electronic environment by having the issuer reissue the document of title in a tangible medium. Thus if a person entitled to enforce an electronic document of title causes the information in the record to be printed onto paper without the issuer's involvement in issuing the document of title pursuant to Section 7-105, that paper is not a document of title. 4. Subsection (a) sets forth the general test for control. Subsection (b) sets forth a safe harbor test that if satised, results in control under the general test in subsection (a). The test in subsection (b) is also used in Section 9-105 although Section 9-105 does not include 631

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the general test of subsection (a). Under subsection (b), at any point in time, a party should be able to identify the single authoritative copy which is unique and identiable as the authoritative copy. This does not mean that once created that the authoritative copy need be static and never moved or copied from its original location. To the extent that backup systems exist which result in multiple copies, the key to this idea is that at any point in time, the one authoritative copy needs to be unique and identiable. Parties may not by contract provide that control exists. The test for control is a factual test that depends upon whether the general test in subsection (a) or the safe harbor in subsection (b) is satised. 5. Article 7 has historically provided for rights under documents of title and rights of transferees of documents of title as those rights relate to the goods covered by the document. Third parties may possess or have control of documents of title. While misfeasance or negligence in failure to transfer or misdelivery of the document by those third parties may create serious issues, this Article has never dealt with those issues as it relates to tangible documents of title, preferring to leave those issues to the law of contracts, agency and tort law. In the electronic document of title regime, third party registry systems are just beginning to develop. It is very dicult to write rules regulating those third parties without some denitive sense of how the third party registry systems will be structured. Systems that are evolving to date tend to be closed systems in which all participants must sign on to the master agreement which provides for rights as against the registry system as well as rights among the members. In those closed systems, the document of title never leaves the system so the parties rely upon the master agreement as to rights against the registry for its failures in dealing with the document. This article contemplates that those closed systems will continue to evolve and that the control mechanism in this statute provides a method for the participants in the closed system to achieve the benets of obtaining control allowed by this article. This article also contemplates that parties will evolve open systems where parties need not be subject to a master agreement. In an open system a party that is expecting to obtain rights through an electronic document may not be a party to the master agreement. To the extent that open systems evolve by use of the control concept contained in this section, the law of contracts, agency, and torts as it applies to the registry's misfeasance or negligence concerning the transfer of control of the electronic document will allocate the risks and liabilities of the parties as that other law now does so for third parties who hold tangible documents and fail to deliver the documents. Cross Reference: Sections 7-105 and 7-501. Denitional Cross-References: Delivery, 1-201. Document of title, 1-201.

PART 2. WAREHOUSE RECEIPTS: SPECIAL PROVISIONS

7-201. Person That May Issue a Warehouse Receipt; Storage Under Bond. (a) A warehouse receipt may be issued by any warehouse. (b) If goods, including distilled spirits and agricultural commodities, are stored under a statute requiring a bond against withdrawal or a license for the issuance of receipts in the nature of warehouse receipts, a receipt issued for the goods is deemed to be a warehouse receipt even if issued by a person that is the owner of the goods and is not a warehouse. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-201. Changes: Update for style only. Purposes: 632

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It is not intended by re-enactment of subsection (a) to repeal any provisions of special licensing or other statutes regulating who may become a warehouse. Limitations on the transfer of the receipts and criminal sanctions for violation of such limitations are not impaired. Section 7-103. Compare Section 7-401(4) on the liability of the issuer in such cases. Subsection (b) covers receipts issued by the owner for whiskey or other goods stored in bonded warehouses under such statutes as 26 U.S.C. Chapter 51. Cross References: Sections 7-103, 7-401. Denitional Cross References: Warehouse receipt. Section 1-201. Warehouse. Section 7-102.

7-202. Form of Warehouse Receipt; Eect of Omission. (a) A warehouse receipt need not be in any particular form. (b) Unless a warehouse receipt provides for each of the following, the warehouse is liable for damages caused to a person injured by its omission: (1) a statement of the location of the warehouse facility where the goods are stored; (2) the date of issue of the receipt; (3) the unique identication code of the receipt; (4) a statement whether the goods received will be delivered to the bearer, to a named person, or to a named person or its order; (5) the rate of storage and handling charges, unless goods are stored under a eld warehousing arrangement, in which case a statement of that fact is sucient on a nonnegotiable receipt; (6) a description of the goods or the packages containing them; (7) the signature of the warehouse or its agent; (8) if the receipt is issued for goods that the warehouse owns, either solely, jointly, or in common with others, a statement of the fact of that ownership; and (9) a statement of the amount of advances made and of liabilities incurred for which the warehouse claims a lien or security interest, unless the precise amount of advances made or liabilities incurred, at the time of the issue of the receipt, is unknown to the warehouse or to its agent that issued the receipt, in which case a statement of the fact that advances have been made or liabilities incurred and the purpose of the advances or liabilities is sucient. (c) A warehouse may insert in its receipt any terms that are not contrary to [the Uniform Commercial Code] and do not impair its obligation of delivery under Section 7-403 or its duty of care under Section 7-204. Any contrary provision is ineective. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-202. Changes: Language is updated to accommodate electronic commerce and to reect modern style. Purposes: 1. This section does not displace any particular legislation that requires other terms in a warehouse receipt or that may require a particular form of a warehouse receipt. This section does not require that a warehouse receipt be issued. A warehouse receipt that is issued need not contain any of the terms listed in subsection (b) in order to qualify as a warehouse 633

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receipt as long as the receipt falls within the denition of warehouse receipt in Article 1. Thus the title has been changed to eliminate the phrase essential terms as provided in prior law. The only consequence of a warehouse receipt not containing any term listed in subsection (b) is that a person injured by a term's omission has a right as against the warehouse for harm caused by the omission. Cases, such as In re Celotex Corp., 134 B. R. 993 (Bankr. M.D. Fla. 1991), that held that in order to have a valid warehouse receipt all of the terms listed in this section must be contained in the receipt, are disapproved. 2. The unique identication code referred to in subsection (b)(3) can include any combination of letters, number, signs, and/or symbols that provide a unique identication. Whether an electronic or tangible warehouse receipt contains a signature will be resolved with the denition of sign in Section 7-102. Cross References: Sections 7-103 and 7-401. Denitional Cross References: Bearer. Section 1-201. Delivery. Section 1-201. Goods. Section 7-102. Person. Section 1-201. Security interest. Section 1-201. Sign. Section 7-102. Term. Section 1-201. Warehouse receipt. Section 1-201. Warehouse. Section 7-102.

7-203. Liability for Nonreceipt or Misdescription. A party to or purchaser for value in good faith of a document of title, other than a bill of lading, that relies upon the description of the goods in the document may recover from the issuer damages caused by the nonreceipt or misdescription of the goods, except to the extent that: (1) the document conspicuously indicates that the issuer does not know whether all or part of the goods in fact were received or conform to the description, such as a case in which the description is in terms of marks or labels or kind, quantity, or condition, or the receipt or description is qualied by contents, condition, and quality unknown, said to contain, or words of similar import, if the indication is true; or (2) the party or purchaser otherwise has notice of the nonreceipt or misdescription. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-203. Changes: Changes to this section are for style only. Purpose: This section is a simplied restatement of existing law as to the method by which a bailee may avoid responsibility for the accuracy of descriptions which are made by or in reliance upon information furnished by the depositor. The issuer is liable on documents issued by an agent, contrary to instructions of its principal, without receiving goods. No disclaimer of the latter liability is permitted. Cross Reference: Section 7-301. Denitional Cross References: Conspicuous. Section 1-201. Document of title. Section 1-201. Goods. Section 7-102. Good Faith. Section 1-201. [7-102] Issuer. Section 7-102. 634

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Notice. Section 1-202. Party. Section 1-201. Purchaser. Section 1-201. Receipt of goods. Section 2-103. Value. Section 1-204.

7-204. Duty of Care; Contractual Limitation of Warehouse's Liability. (a) A warehouse is liable for damages for loss of or injury to the goods caused by its failure to exercise care with regard to the goods that a reasonably careful person would exercise under similar circumstances. Unless otherwise agreed, the warehouse is not liable for damages that could not have been avoided by the exercise of that care. (b) Damages may be limited by a term in the warehouse receipt or storage agreement limiting the amount of liability in case of loss or damage beyond which the warehouse is not liable. Such a limitation is not eective with respect to the warehouse's liability for conversion to its own use. On request of the bailor in a record at the time of signing the storage agreement or within a reasonable time after receipt of the warehouse receipt, the warehouse's liability may be increased on part or all of the goods covered by the storage agreement or the warehouse receipt. In this event, increased rates may be charged based on an increased valuation of the goods. (c) Reasonable provisions as to the time and manner of presenting claims and commencing actions based on the bailment may be included in the warehouse receipt or storage agreement. [(d) This section does not modify or repeal [Insert reference to any statute that imposes a higher responsibility upon the warehouse or invalidates a contractual limitation that would be permissible under this Article].]
Legislative Note: Insert in subsection (d) a reference to any statute which imposes a higher responsibility upon the warehouse or invalidates a contractual limitation that would be permissible under this Article. If no such statutes exist, this section should be deleted.

Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-204. Changes: Updated to reect modern, standard commercial practices. Purposes of Changes: 1. Subsection (a) continues the rule without change from former Section 7-204 on the warehouse's obligation to exercise reasonable care. 2. Former Section 7-204(2) required that the term limiting damages do so by setting forth a specic liability per article or item or of a value per unit of weight. This requirement has been deleted as out of step with modern industry practice. Under subsection (b) a warehouse may limit its liability for damages for loss of or damage to the goods by a term in the warehouse receipt or storage agreement without the term constituting an impermissible disclaimer of the obligation of reasonable care. The parties cannot disclaim by contract the warehouse's obligation of care. Section 1-302. For example, limitations based upon per unit of weight, per package, per occurrence, or per receipt as well as limitations based upon a multiple of the storage rate may be commercially appropriate. As subsection (d) makes clear, the states or the federal government may supplement this section with more rigid standards of responsibility for some or all bailees. 3. Former Section 7-204(2) also provided that an increased rate can not be charged if contrary to a tari. That language has been deleted. If a tari is required under state or federal law, pursuant to Section 7-103(a), the tari would control over the rule of this section allowing an increased rate. The provisions of a non-mandatory tari may be 635

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incorporated by reference in the parties' agreement. See Comment 2 to Section 7-103. Subsection (c) deletes the reference to taris for the same reason that the reference has been omitted in subsection (b). 4. As under former Section 7-204(2), subsection (b) provides that a limitation of damages is ineective if the warehouse has converted the goods to its own use. A mere failure to redeliver the goods is not conversion to the warehouse's own use. See Adams v. Ryan & Christie Storage, Inc., 563 F. Supp. 409 (E.D. Pa. 1983) a'd 725 F.2d 666 (3rd Cir. 1983). Cases such as I.C.C. Metals Inc. v. Municipal Warehouse Co., 409 N.E. 2d 849 (N.Y. Ct. App. 1980) holding that mere failure to redeliver results in a presumption of conversion to the warehouse's own use are disapproved. Conversion to its own use is narrower than the idea of conversion generally. Cases such as Lipman v. Peterson, 575 P.2d 19 (Kan. 1978) holding to the contrary are disapproved. 5. Storage agreements commonly establish the contractual relationship between warehouses and depositors who have an on-going relationship. The storage agreement may allow for the movement of goods into and out of a warehouse without the necessity of issuing or amending a warehouse receipt upon each entry or exit of goods from the warehouse. Cross References: Sections 1-302, 7-103, 7-309 and 7-403. Denitional Cross References: Goods. Section 7-102. Reasonable time. Section 1-204. Sign. Section 7-102. Term. Section 1-201. Value. Section 1-204. Warehouse receipt. Section 1-201. Warehouse. Section 7-102.

7-205. Title Under Warehouse Receipt Defeated in Certain Cases. A buyer in ordinary course of business of fungible goods sold and delivered by a warehouse that is also in the business of buying and selling such goods takes the goods free of any claim under a warehouse receipt even if the receipt is negotiable and has been duly negotiated. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-205. Changes: Changes for style only. Purposes: 1. The typical case covered by this section is that of the warehouse-dealer in grain, and the substantive question at issue is whether in case the warehouse becomes insolvent the receipt holders shall be able to trace and recover grain shipped to farmers and other purchasers from the elevator. This was possible under the old acts, although courts were eager to nd estoppels to prevent it. The practical diculty of tracing fungible grain means that the preservation of this theoretical right adds little to the commercial acceptability of negotiable grain receipts, which really circulate on the credit of the warehouse. Moreover, on default of the warehouse, the receipt holders at least share in what grain remains, whereas retaking the grain from a good faith cash purchaser reduces the purchaser completely to the status of general creditor in a situation where there was very little the purchaser could do to guard against the loss. Compare 15 U.S.C. Section 714p enacted in 1955. 2. This provision applies to both negotiable and nonnegotiable warehouse receipts. The concept of due negotiation is provided for in 7-501. The denition of buyer in ordinary course is in Article 1 and provides, among other things, that a buyer must either have possession or a right to obtain the goods under Article 2 in order to be a buyer in ordinary course. This section requires actual delivery of the fungible goods to the buyer in ordinary course. Delivery requires voluntary transfer of possession of the fungible goods to the buyer. See amended Section 2-103. This section is not satised by the delivery of the docu636

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Documents of Title

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ment of title to the buyer in ordinary course. Cross References: Sections 2-403 and 9-320. Denitional Cross References: Buyer in ordinary course of business. Section 1-201. Delivery. Section 1-201. Duly negotiate. Section 7-501. Fungible goods. Section 1-201. Goods. Section 7-102. Value. Section 1-204. Warehouse receipt. Section 1-201. Warehouse. Section 7-102.

7-206. Termination of Storage at Warehouse's Option. (a) A warehouse, by giving notice to the person on whose account the goods are held and any other person known to claim an interest in the goods, may require payment of any charges and removal of the goods from the warehouse at the termination of the period of storage xed by the document of title or, if a period is not xed, within a stated period not less than 30 days after the warehouse gives notice. If the goods are not removed before the date specied in the notice, the warehouse may sell them pursuant to Section 7-210. (b) If a warehouse in good faith believes that goods are about to deteriorate or decline in value to less than the amount of its lien within the time provided in subsection (a) and Section 7-210, the warehouse may specify in the notice given under subsection (a) any reasonable shorter time for removal of the goods and, if the goods are not removed, may sell them at public sale held not less than one week after a single advertisement or posting. (c) If, as a result of a quality or condition of the goods of which the warehouse did not have notice at the time of deposit, the goods are a hazard to other property, the warehouse facilities, or other persons, the warehouse may sell the goods at public or private sale without advertisement or posting on reasonable notication to all persons known to claim an interest in the goods. If the warehouse, after a reasonable eort, is unable to sell the goods, it may dispose of them in any lawful manner and does not incur liability by reason of that disposition. (d) A warehouse shall deliver the goods to any person entitled to them under this article upon due demand made at any time before sale or other disposition under this section. (e) A warehouse may satisfy its lien from the proceeds of any sale or disposition under this section but shall hold the balance for delivery on the demand of any person to which the warehouse would have been bound to deliver the goods. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-206. Changes: Changes for style. Purposes: 1. This section provides for three situations in which the warehouse may terminate storage for reasons other then enforcement of its lien as permitted by Section 7-210. Most warehousing is for an indenite term, the bailor being entitled to delivery on reasonable 637

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demand. It is necessary to dene the warehouse's power to terminate the bailment, since it would be commercially intolerable to allow warehouses to order removal of the goods on short notice. The thirty day period provided where the document does not carry its own period of termination corresponds to commercial practice of computing rates on a monthly basis. The right to terminate under subsection (a) includes a right to require payment of any charges, but does not depend on the existence of unpaid charges. 2. In permitting expeditious disposition of perishable and hazardous goods the pre-Code Uniform Warehouse Receipts Act, Section 34, made no distinction between cases where the warehouse knowingly undertook to store such goods and cases where the goods were discovered to be of that character subsequent to storage. The former situation presents no such emergency as justies the summary power of removal and sale. Subsections (b) and (c) distinguish between the two situations. The reason of this section should apply if the goods become hazardous during the course of storage. The process for selling the goods described in Section 7-210 governs the sale of goods under this section except as provided in subsections (b) and (c) for the situations described in those subsections respectively. 3. Protection of its lien is the only interest which the warehouse has to justify summary sale of perishable goods which are not hazardous. This same interest must be recognized when the stored goods, although not perishable, decline in market value to a point which threatens the warehouse's security. 4. The right to order removal of stored goods is subject to provisions of the public warehousing laws of some states forbidding warehouses from discriminating among customers. Nor does the section relieve the warehouse of any obligation under the state laws to secure the approval of a public ocial before disposing of deteriorating goods. Such regulatory statutes and the regulations under them remain in force and operative. Section 7-103. Cross References: Sections 7-103 and 7-403. Denitional Cross References: Delivery. Section 1-201. Document of title. Section 1-102. Good faith. Section 1-201 [7-102]. Goods. Section 7-102. Notice. Section 1-202. Notication. Section 1-202. Person. Section 1-201. Reasonable time. Section 1-205. Value. Section 1-204. Warehouse. Section 7-102.

7-207. Goods Must Be Kept Separate; Fungible Goods. (a) Unless the warehouse receipt provides otherwise, a warehouse shall keep separate the goods covered by each receipt so as to permit at all times identication and delivery of those goods. However, dierent lots of fungible goods may be commingled. (b) If dierent lots of fungible goods are commingled, the goods are owned in common by the persons entitled thereto and the warehouse is severally liable to each owner for that owner's share. If, because of overissue, a mass of fungible goods is insucient to meet all the receipts the warehouse has issued against it, the persons entitled include all holders to which overissued receipts have been duly negotiated. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-207. Changes: Changes for style only. Purposes: No change of substance is made from former Section 7-207. Holders to whom overissued 638

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receipts have been duly negotiated shall share in a mass of fungible goods. Where individual ownership interests are merged into claims on a common fund, as is necessarily the case with fungible goods, there is no policy reason for discriminating between successive purchasers of similar claims. Denitional Cross References: Delivery. Section 1-201. Duly negotiate. Section 7-501. Fungible goods. Section 1-201. Goods. Section 7-102. Holder. Section 1-201. Person. Section 1-201. Warehouse receipt. Section 1-201. Warehouse. Section 7-102.

7-208. Altered Warehouse Receipts. If a blank in a negotiable tangible warehouse receipt has been lled in without authority, a good-faith purchaser for value and without notice of the lack of authority may treat the insertion as authorized. Any other unauthorized alteration leaves any tangible or electronic warehouse receipt enforceable against the issuer according to its original tenor. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-208. Changes: To accommodate electronic documents of title. Purpose: 1. The execution of tangible warehouse receipts in blank is a dangerous practice. As between the issuer and an innocent purchaser the risks should clearly fall on the former. The purchaser must have purchased the tangible negotiable warehouse receipt in good faith and for value to be protected under the rule of the rst sentence which is a limited exception to the general rule in the second sentence. Electronic document of title systems should have protection against unauthorized access and unauthorized changes. See 7-106. Thus the protection for good faith purchasers found in the rst sentence is not necessary in the context of electronic documents. 2. Under the second sentence of this section, an unauthorized alteration whether made with or without fraudulent intent does not relieve the issuer of its liability on the warehouse receipt as originally executed. The unauthorized alteration itself is of course ineective against the warehouse. The rule stated in the second sentence applies to both tangible and electronic warehouse receipts. Denitional Cross References: Good faith. Section 1-201 [7-102]. Issuer. Section 7-102. Notice. Section 1-202. Purchaser. Section 1-201. Value. Section 1-204. Warehouse receipt. Section 1-201.

7-209. Lien of Warehouse. (a) A warehouse has a lien against the bailor on the goods covered by a warehouse receipt or storage agreement or on the proceeds thereof in its possession for charges for storage or transportation, including demurrage and terminal charges, insurance, labor, or other charges, present or future, in relation to the goods, and for expenses necessary for preservation of the goods or reasonably incurred in their sale pursuant to law. If the person on whose account the goods are held is liable for similar charges or expenses in relation to other goods whenever deposited and it is stated in the
639

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warehouse receipt or storage agreement that a lien is claimed for charges and expenses in relation to other goods, the warehouse also has a lien against the goods covered by the warehouse receipt or storage agreement or on the proceeds thereof in its possession for those charges and expenses, whether or not the other goods have been delivered by the warehouse. However, as against a person to which a negotiable warehouse receipt is duly negotiated, a warehouse's lien is limited to charges in an amount or at a rate specied in the warehouse receipt or, if no charges are so specied, to a reasonable charge for storage of the specic goods covered by the receipt subsequent to the date of the receipt. (b) A warehouse may also reserve a security interest against the bailor for the maximum amount specied on the receipt for charges other than those specied in subsection (a), such as for money advanced and interest. The security interest is governed by Article 9. (c) A warehouse's lien for charges and expenses under subsection (a) or a security interest under subsection (b) is also eective against any person that so entrusted the bailor with possession of the goods that a pledge of them by the bailor to a good-faith purchaser for value would have been valid. However, the lien or security interest is not eective against a person that before issuance of a document of title had a legal interest or a perfected security interest in the goods and that did not: (1) deliver or entrust the goods or any document of title covering the goods to the bailor or the bailor's nominee with: (A) actual or apparent authority to ship, store, or sell; (B) power to obtain delivery under Section 7-403; or (C) power of disposition under Sections 2-403, 2A-304(2), 2A-305(2), 9-320, or 9-321(c) or other statute or rule of law; or (2) acquiesce in the procurement by the bailor or its nominee of any document. (d) A warehouse's lien on household goods for charges and expenses in relation to the goods under subsection (a) is also eective against all persons if the depositor was the legal possessor of the goods at the time of deposit. In this subsection, household goods means furniture, furnishings, or personal eects used by the depositor in a dwelling. (e) A warehouse loses its lien on any goods that it voluntarily delivers or unjustiably refuses to deliver. Ocial Comment
Prior Uniform Statutory Provision: Former Sections 7-209 and 7-503. Changes: Expanded to recognize warehouse lien when a warehouse receipt is not issued but goods are covered by a storage agreement. Purposes: 1. Subsection (a) denes the warehouse's statutory lien. Other than allowing a warehouse to claim a lien under this section when there is a storage agreement and not a warehouse receipt, this section remains unchanged in substance from former Section 7-209(1). Under the rst sentence, a specic lien attaches automatically without express notation on the receipt or storage agreement with regard to goods stored under the receipt or the storage agreement. That lien is limited to the usual charges arising out of a storage transaction. Example 1: Bailor stored goods with a warehouse and the warehouse issued a warehouse receipt. A lien against those goods arose as set forth in subsection (a), the rst sentence, for the charges for storage and the other expenses of those goods. The 640

Art. 7

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warehouse may enforce its lien under Section 7-210 as against the bailor. Whether the warehouse receipt is negotiable or nonnegotiable is not important to the warehouse's rights as against the bailor. Under the second sentence, by notation on the receipt or storage agreement, the lien can be made a general lien extending to like charges in relation to other goods. Both the specic lien and general lien are as to goods in the possession of the warehouse and extend to proceeds from the goods as long as the proceeds are in the possession of the warehouse. The same rules apply whether the receipt is negotiable or non-negotiable. Example 2: Bailor stored goods (lot A) with a warehouse and the warehouse issued a warehouse receipt for those goods. In the warehouse receipt it is stated that the warehouse will also have a lien on goods covered by the warehouse receipt for storage charges and the other expenses for any other goods that are stored with the warehouse by the bailor. The statement about the lien on other goods does not specify an amount or a rate. Bailor then stored other goods (lot B) with the warehouse. Under subsection (a), rst sentence, the warehouse has a lien on the specic goods (lot A) covered by the warehouse receipt. Under subsection (a), second sentence, the warehouse has a lien on the goods in lot A for the storage charges and the other expenses arising from the goods in lot B. That lien is enforceable as against the bailor regardless of whether the receipt is negotiable or nonnegotiable. Under the third sentence, if the warehouse receipt is negotiable, the lien as against a holder of that receipt by due negotiation is limited to the amount or rate specied on the receipt for the specic lien or the general lien, or, if none is specied, to a reasonable charge for storage of the specic goods covered by the receipt for storage after the date of the receipt. Example 3: Same facts as Example 1 except that the warehouse receipt is negotiable and has been duly negotiated (Section 7-501) to a person other than the bailor. Under the last sentence of subsection (a), the warehouse may enforce its lien against the bailor's goods stored in the warehouse as against the person to whom the negotiable warehouse receipt has been duly negotiated. Section 7-502. That lien is limited to the charges or rates specied in the receipt or a reasonable charge for storage as stated in the last sentence of subsection (a). Example 4: Same facts as Example 2 except that the warehouse receipt is negotiable and has been duly negotiated (Section 7-501) to a person other than the bailor. Under the last sentence of subsection (a), the lien on lot A goods for the storage charges and the other expenses arising from storage of lot B goods is not enforceable as against the person to whom the receipt has been duly negotiated. Without a statement of a specied amount or rate for the general lien, the warehouse's general lien is not enforceable as against the person to whom the negotiable document has been duly negotiated. However, the warehouse lien for charges and expenses related to storage of lot A goods is still enforceable as against the person to whom the receipt was duly negotiated. Example 5. Same facts as Examples 2 and 4 except the warehouse had stated on the negotiable warehouse receipt a specied amount or rate for the general lien on other goods (lot B). Under the last sentence of subsection (a), the general lien on lot A goods for the storage charges and the other expenses arising from storage of lot B goods is enforceable as against the person to whom the receipt has been duly negotiated. 2. Subsection (b) provides for a security interest based upon agreement. Such a security interest arises out of relations between the parties other than bailment for storage or transportation, as where the bailee assumes the role of nancier or performs a manufacturing operation, extending credit in reliance upon the goods covered by the receipt. Such a security interest is not a statutory lien. Compare Sections 9-109 and 9-333. It is governed in all respects by Article 9, except that subsection (b) requires that the receipt specify a maximum amount and limits the security interest to the amount specied. A warehouse could also take a security interest to secure its charges for storage and the other expenses listed in subsection (a) to protect these claims upon the loss of the statutory possessory warehouse lien if the warehouse loses possession of the goods as provided in subsection (e). Example 6: Bailor stores goods with a warehouse and the warehouse issues a warehouse receipt that states that the warehouse is taking a security interest in the bailed goods for charges of storage, expenses, for money advanced, for manufacturing services rendered, and all other obligations that the bailor may owe the warehouse. That is a security interest covered in all respects by Article 9. Subsection (b). As allowed by 641

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this section, a warehouse may rely upon its statutory possessory lien to protect its charges for storage and the other expenses related to storage. For those storage charges covered by the statutory possessory lien, the warehouse is not required to use a security interest under subsection (b). 3. Subsections (a) and (b) validate the lien and security interest against the bailor. Under basic principles of derivative rights as provided in Section 7-504, the warehouse lien is also valid as against parties who obtain their rights from the bailor except as otherwise provided in subsection (a), third sentence, or subsection (c). Example 7: Bailor stores goods with a warehouse and the warehouse issues a nonnegotiable warehouse receipt that also claims a general lien in other goods stored with the warehouse. A lien on the bailed goods for the charges for storage and the other expenses arises under subsection (a). Bailor noties the warehouse that the goods have been sold to Buyer and the bailee acknowledges that fact to the Buyer. Section 2-503. The warehouse lien for storage of those goods is eective against Buyer for both the specic lien and the general lien. Section 7-504. Example 8: Bailor stores goods with a warehouse and the warehouse issues a nonnegotiable warehouse receipt. A lien on the bailed goods for the charges for storage and the other expenses arises under subsection (a). Bailor grants a security interest in the goods while the goods are in the warehouse's possession to Secured Party (SP) who properly perfects a security interest in the goods. See Revised 9-312(d). The warehouse lien is superior in priority over SP's security interest. See Revised 9-203(b)(2) (debtor can grant a security interest to the extent of debtor's rights in the collateral). Example 9: Bailor stores goods with a warehouse and the warehouse issues a negotiable warehouse receipt. A lien on the bailed goods for the charges for storage and the other expenses arises under subsection (a). Bailor grants a security interest in the negotiable document to SP. SP properly perfects its interest in the negotiable document by taking possession through a due negotiation. Revised 9-312(c). SP's security interest is subordinate to the warehouse lien. Section 7-209(a), third sentence. Given that bailor's rights are subject to the warehouse lien, the bailor cannot grant to the SP greater rights than the bailor has under Section 9-203(b)(2), perfection of the security interest in the negotiable document and the goods covered by the document through SP's ling of a nancing statement should not give a dierent result. As against third parties who have interests in the goods prior to the storage with the warehouse, subsection (c) continues the rule under the prior uniform statutory provision that to validate the lien or security interest of the warehouse, the owner must have entrusted the goods to the depositor, and that the circumstances must be such that a pledge by the depositor to a good faith purchaser for value would have been valid. Thus the owner's interest will not be subjected to a lien or security interest arising out of a deposit of its goods by a thief. The warehouse may be protected because of the actual, implied or apparent authority of the depositor, because of a Factor's Act, or because of other circumstances which would protect a bona de pledgee, unless those circumstances are denied effect under the second sentence of subsection (c). The language of Section 7-503 is brought into subsection (c) for purposes of clarity. The comments to Section 7-503 are helpful in interpreting delivery, entrustment or acquiescence. Where the third party is the holder of a security interest, obtained prior to the issuance of a negotiable warehouse receipt, the rights of the warehouse depend on the priority given to a hypothetical bona de pledgee by Article 9, particularly Section 9-322. Thus the special priority granted to statutory liens by Section 9-333 does not apply to liens under subsection (a) of this section, since subsection (c), second sentence, expressly provides otherwise within the meaning of Section 9-333. As to household goods, however, subsection (d) makes the warehouse's lien for charges and expenses in relation to the goods eective against all persons if the depositor was the legal possessor. The purpose of the exception is to permit the warehouse to accept household goods for storage in sole reliance on the value of the goods themselves, especially in situations of family emergency. Example 10: Bailor grants a perfected security interest in the goods to SP prior to storage of the goods with the warehouse. Bailor then stores goods with the warehouse and the warehouse issues a warehouse receipt for the goods. A warehouse lien on the bailed goods for the charges for storage or other expenses arises under subsection (a). The warehouse lien is not eective as against SP unless SP entrusted the goods to the 642

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bailor with actual or apparent authority to ship store, or sell the goods or with power of disposition under subsection (c)(1) or acquiesced in the bailor's procurement of a document of title under subsection (c)(2). This result obtains whether the receipt is negotiable or nonnegotiable. Example 11: Sheri who had lawfully repossessed household goods in an eviction action stored the goods with a warehouse. A lien on the bailed goods arises under subsection (a). The lien is eective as against the owner of the goods. Subsection (d). 4. As under previous law, this section creates a statutory possessory lien in favor of the warehouse on the goods stored with the warehouse or on the proceeds of the goods. The warehouse loses its lien if it loses possession of the goods or the proceeds. Subsection (e). 5. Where goods have been stored under a non-negotiable warehouse receipt and are sold by the person to whom the receipt has been issued, frequently the goods are not withdrawn by the new owner. The obligations of the seller of the goods in this situation are set forth in Section 2-503(4) on tender of delivery and include procurement of an acknowledgment by the bailee of the buyer's right to possession of the goods. If a new receipt is requested, such an acknowledgment can be withheld until storage charges have been paid or provided for. The statutory lien for charges on the goods sold, granted by the rst sentence of subsection (a), continues valid unless the bailee gives it up. See Section 7-403. But once a new receipt is issued to the buyer, the buyer becomes the person on whose account the goods are held under the second sentence of subsection (a); unless the buyer undertakes liability for charges in relation to other goods stored by the seller, there is no general lien against the buyer for such charges. Of course, the bailee may preserve the general lien in such a case either by an arrangement by which the buyer is liable for such charges, or by reserving a security interest under subsection (b). 6. A possessory warehouse lien arises as provided under subsection (a) if the parties to the bailment have a storage agreement or a warehouse receipt is issued. In the modern warehouse, the bailor and the bailee may enter into a master contract governing the bailment with the bailee and bailor keeping track of the goods stored pursuant to the master contract by notation on their respective books and records and the parties send notication via electronic communication as to what goods are covered by the master contract. Warehouse receipts are not issued. See Comment 4 to Section 7-204. There is no particular form for a warehouse receipt and failure to contain any of the terms listed in Section 7-202 does not deprive the warehouse of its lien that arises under subsection (a). See the comment to Section 7-202. Cross References: Point 1: Sections 7-501 and 7-502. Point 2: Sections 9-109 and 9-333. Point 3: Sections 2-503, 7-503, 7-504, 9-203, 9-312, and 9-322. Point 4: Sections 2-503, 7-501, 7-502, 7-504, 9-312, 9-331, 9-333, 9-401. Point 5: Sections 2-503 and 7-403. Point 6: Sections 7-202 and 7-204. Denitional Cross References: Delivery. Section 1-201. Document of Title. Section 1-201 Goods. Section 7-102. Money. Section 1-201. Person. Section 1-201. Purchaser. Section 1-201. Right. Section 1-201. Security interest. Section 1-201. Value. Section 1-204. Warehouse receipt. Section 1-201. Warehouse. Section 7-102.

7-210. Enforcement of Warehouse's Lien. (a) Except as otherwise provided in subsection (b), a warehouse's lien may be enforced by public or private sale of the goods, in bulk or in pack643

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ages, at any time or place and on any terms that are commercially reasonable, after notifying all persons known to claim an interest in the goods. The notication must include a statement of the amount due, the nature of the proposed sale, and the time and place of any public sale. The fact that a better price could have been obtained by a sale at a dierent time or in a method dierent from that selected by the warehouse is not of itself sufcient to establish that the sale was not made in a commercially reasonable manner. The warehouse sells in a commercially reasonable manner if the warehouse sells the goods in the usual manner in any recognized market therefor, sells at the price current in that market at the time of the sale, or otherwise sells in conformity with commercially reasonable practices among dealers in the type of goods sold. A sale of more goods than apparently necessary to be oered to ensure satisfaction of the obligation is not commercially reasonable, except in cases covered by the preceding sentence. (b) A warehouse may enforce its lien on goods, other than goods stored by a merchant in the course of its business, only if the following requirements are satised: (1) All persons known to claim an interest in the goods must be notied. (2) The notication must include an itemized statement of the claim, a description of the goods subject to the lien, a demand for payment within a specied time not less than 10 days after receipt of the notication, and a conspicuous statement that unless the claim is paid within that time the goods will be advertised for sale and sold by auction at a specied time and place. (3) The sale must conform to the terms of the notication. (4) The sale must be held at the nearest suitable place to where the goods are held or stored. (5) After the expiration of the time given in the notication, an advertisement of the sale must be published once a week for two weeks consecutively in a newspaper of general circulation where the sale is to be held. The advertisement must include a description of the goods, the name of the person on whose account the goods are being held, and the time and place of the sale. The sale must take place at least 15 days after the rst publication. If there is no newspaper of general circulation where the sale is to be held, the advertisement must be posted at least 10 days before the sale in not fewer than six conspicuous places in the neighborhood of the proposed sale. (c) Before any sale pursuant to this section, any person claiming a right in the goods may pay the amount necessary to satisfy the lien and the reasonable expenses incurred in complying with this section. In that event, the goods may not be sold but must be retained by the warehouse subject to the terms of the receipt and this article. (d) A warehouse may buy at any public sale held pursuant to this section. (e) A purchaser in good faith of goods sold to enforce a warehouse's lien takes the goods free of any rights of persons against which the lien was valid, despite the warehouse's noncompliance with this section. (f) A warehouse may satisfy its lien from the proceeds of any sale pursu644

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7-210

ant to this section but shall hold the balance, if any, for delivery on demand to any person to which the warehouse would have been bound to deliver the goods. (g) The rights provided by this section are in addition to all other rights allowed by law to a creditor against a debtor. (h) If a lien is on goods stored by a merchant in the course of its business, the lien may be enforced in accordance with subsection (a) or (b). (i) A warehouse is liable for damages caused by failure to comply with the requirements for sale under this section and, in case of willful violation, is liable for conversion. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-210. Changes: Update to accommodate electronic commerce and for style. Purposes: 1. Subsection (a) makes commercial reasonableness the standard for foreclosure proceedings in all cases except non-commercial storage with a warehouse. The latter category embraces principally storage of household goods by private owners; and for such cases the detailed provisions as to notication, publication and public sale are retained in subsection (b) with one change. The requirement in former Section 7-210(2)(b) that the notication must be sent in person or by registered or certied mail has been deleted. Notication may be sent by any reasonable means as provided in Section 1-202. The swifter, more exible procedure of subsection (a) is appropriate to commercial storage. Compare seller's power of resale on breach by buyer under the provisions of the Article on Sales (Section 2-706). Commercial reasonableness is a exible concept that allows for a wide variety of actions to satisfy the rule of this section, including electronic means of posting and sale. 2. The provisions of subsections (d) and (e) permitting the bailee to bid at public sales and conrming the title of purchasers at foreclosure sales are designed to secure more bidding and better prices and remain unchanged from former Section 7-210. 3. A warehouses may have recourse to an interpleader action in appropriate circumstances. See Section 7-603. 4. If a warehouse has both a warehouse lien and a security interest, the warehouse may enforce both the lien and the security interest simultaneously by using the procedures of Article 9. Section 7-210 adopts as its touchstone commercial reasonableness for the enforcement of a warehouse lien. Following the procedures of Article 9 satises commercial reasonableness. Cross Reference: Sections 2-706, 7-403, 7-603 and Part 6 of Article 9. Denitional Cross References: Bill of lading. Section 1-201. Conspicuous. Section 1-201. Creditor. Section 1-201. Delivery. Section 1-201. Document of Title. Section 1-201. Good faith. Section 1-201 [7-102]. Goods. Section 7-102. Notication. Section 1-202. Noties. Section 1-202. Person. Section 1-201. Purchaser. Section 1-201. Rights. Section 1-201. Term. Section 1-201. Warehouse. Section 7-102. 645

Uniform Commercial Code

Art. 7

PART 3. BILLS OF LADING: SPECIAL PROVISIONS

7-301. Liability for Nonreceipt or Misdescription; Said to Contain; Shipper's Weight, Load, and Count; Improper Handling. (a) A consignee of a nonnegotiable bill of lading which has given value in good faith, or a holder to which a negotiable bill has been duly negotiated, relying upon the description of the goods in the bill or upon the date shown in the bill, may recover from the issuer damages caused by the misdating of the bill or the nonreceipt or misdescription of the goods, except to the extent that the bill indicates that the issuer does not know whether any part or all of the goods in fact were received or conform to the description, such as in a case in which the description is in terms of marks or labels or kind, quantity, or condition or the receipt or description is qualied by contents or condition of contents of packages unknown, said to contain, shipper's weight, load, and count, or words of similar import, if that indication is true. (b) If goods are loaded by the issuer of a bill of lading; (1) the issuer shall count the packages of goods if shipped in packages and ascertain the kind and quantity if shipped in bulk; and (2) words such as shipper's weight, load, and count, or words of similar import indicating that the description was made by the shipper are ineective except as to goods concealed in packages. (c) If bulk goods are loaded by a shipper that makes available to the issuer of a bill of lading adequate facilities for weighing those goods, the issuer shall ascertain the kind and quantity within a reasonable time after receiving the shipper's request in a record to do so. In that case, shipper's weight or words of similar import are ineective. (d) The issuer of a bill of lading, by including in the bill the words shipper's weight, load, and count, or words of similar import, may indicate that the goods were loaded by the shipper, and, if that statement is true, the issuer is not liable for damages caused by the improper loading. However, omission of such words does not imply liability for damages caused by improper loading. (e) A shipper guarantees to an issuer the accuracy at the time of shipment of the description, marks, labels, number, kind, quantity, condition, and weight, as furnished by the shipper, and the shipper shall indemnify the issuer against damage caused by inaccuracies in those particulars. This right of indemnity does not limit the issuer's responsibility or liability under the contract of carriage to any person other than the shipper. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-301. Changes: Changes for clarity, style and to recognize deregulation in the transportation industry. Purposes: 1. This section continues the rules from former Section 7-301 with one substantive change. The obligations of the issuer of the bill of lading under former subsections (2) and (3) were limited to issuers who were common carriers. Subsections (b) and (c) apply the same rules to all issuers not just common carriers. This section is compatible with the policies stated in the federal Bills of Lading Act, 49 U.S.C. 80113 (2000). 646

Art. 7

Documents of Title

7-302

2. The language of the pre-Code Uniform Bills of Lading Act suggested that a carrier is ordinarily liable for damage caused by improper loading, but may relieve itself of liability by disclosing on the bill that shipper actually loaded. A more accurate statement of the law is that the carrier is not liable for losses caused by act or default of the shipper, which would include improper loading. D. H. Overmyer Co. v. Nelson Brantley Glass Go., 168 S.E.2d 176 (Ga. Ct. App. 1969). There was some question whether under pre-Code law a carrier was liable even to a good faith purchaser of a negotiable bill for such losses, if the shipper's faulty loading in fact caused the loss. Subsection (d) permits the carrier to bar, by disclosure of shipper's loading, liability to a good faith purchaser. There is no implication that decisions such as Modern Tool Corp. v. Pennsylvania R. Co., 100 F.Supp. 595 (D.N.J. 1951), are disapproved. 3. This section is a restatement of existing law as to the method by which a bailee may avoid responsibility for the accuracy of descriptions which are made by or in reliance upon information furnished by the depositor or shipper. The wording in this section-contents or condition of contents of packages unknown or shipper's weight, load and count-to indicate that the shipper loaded the goods or that the carrier does not know the description, condition, or contents of the loaded packages continues to be appropriate as commonly understood in the transportation industry. The reasons for this wording are as important in 2002 as when the prior section initially was approved. The issuer is liable on documents issued by an agent, contrary to instructions of his principal, without receiving goods. No disclaimer of this liability is permitted since it is not a matter either of the care of the goods or their description. 4. The shipper's erroneous report to the carrier concerning the goods may cause damage to the carrier. Subsection (e) therefore provides appropriate indemnity. 5. The word freight in the former Section 7-301 has been changed to goods to conform to international and domestic land transport usage in which freight means the price paid for carriage of the goods and not the goods themselves. Hence, changing the word freight to the word goods is a clarifying change that ts both international and domestic practice. Cross References: Sections 7-203, 7-309 and 7-501. Denitional Cross References: Bill of lading. Section 1-201. Consignee. Section 7-102. Document of Title. Section 1-201. Duly negotiate. Section 7-501. Good faith. Section 1-201. [7-102]. Goods. Section 7-102. Holder. Section 1-201. Issuer. Section 7-102. Notice. Section 1-202. Party. Section 1-201. Purchaser. Section 1-201. Receipt of Goods. Section 2-103. Value. Section 1-204.

7-302. Through Bills of Lading and Similar Documents of Title. (a) The issuer of a through bill of lading, or other document of title embodying an undertaking to be performed in part by a person acting as its agent or by a performing carrier, is liable to any person entitled to recover on the bill or other document for any breach by the other person or the performing carrier of its obligation under the bill or other document. However, to the extent that the bill or other document covers an undertaking to be performed overseas or in territory not contiguous to the continental United States or an undertaking including matters other than transportation, this liability for breach by the other person or the performing carrier may be varied by agreement of the parties.
647

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(b) If goods covered by a through bill of lading or other document of title embodying an undertaking to be performed in part by a person other than the issuer are received by that person, the person is subject, with respect to its own performance while the goods are in its possession, to the obligation of the issuer. The person's obligation is discharged by delivery of the goods to another person pursuant to the bill or other document and does not include liability for breach by any other person or by the issuer. (c) The issuer of a through bill of lading or other document of title described in subsection (a) is entitled to recover from the performing carrier, or other person in possession of the goods when the breach of the obligation under the bill or other document occurred: (1) the amount it may be required to pay to any person entitled to recover on the bill or other document for the breach, as may be evidenced by any receipt, judgment, or transcript of judgment; and (2) the amount of any expense reasonably incurred by the issuer in defending any action commenced by any person entitled to recover on the bill or other document for the breach. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-302. Changes: To conform to current terminology and for style. Purposes: 1. This section continues the rules from former Section 7-302 without substantive change. The term performing carrier is substituted for the term connecting carrier to conform the terminology of this section with terminology used in recent UNCITRAL and OAS proposals concerning transportation and through bills of lading. This change in terminology is not substantive. This section is compatible with liability on carriers under federal law. See 49 U.S.C. 11706, 14706 and 15906. The purpose of this section is to subject the initial carrier under a through bill to suit for breach of the contract of carriage by any performing carrier and to make it clear that any such performing carrier holds the goods on terms which are dened by the document of title even though such performing carrier did not issue the document. Since the performing carrier does hold the goods on the terms of the document, it must honor a proper demand for delivery or a diversion order just as the original bailee would have to. Similarly it has the benets of the excuses for non-delivery and limitations of liability provided for the original bailee who issued the bill. Unlike the original bailee-issuer, the performing carrier's responsibility is limited to the period while the goods are in its possession. The section does not impose any obligation to issue through bills. 2. The reference to documents other than through bills looks to the possibility that multipurpose documents may come into use, e.g., combination warehouse receipts and bills of lading. As electronic documents of title come into common usage, storage documents (e.g. warehouse receipts) and transportation documents (e.g. bills of lading) may merge seamlessly into one electronic document that can serve both the storage and transportation segments of the movement of goods. 3. Under subsection (a) the issuer of a through bill of lading may become liable for the fault of another person. Subsection (c) gives the issuer appropriate rights of recourse. 4. Despite the broad language of subsection (a), Section 7-302 is subject to preemption by federal laws and treaties. Section 7-103. The precise scope of federal preemption in the transportation sector is a question determined under federal law. Cross reference: Section 7-103 Denitional Cross References: Agreement. Section 1-201. Bailee. Section 7-102. Bill of lading. Section 1-201. 648

Art. 7

Documents of Title

7-303

Delivery. Section 1-201. Document of title. Section 1-201. Goods. Section 7-102. Issuer. Section 7-102. Party. Section 1-201. Person. Section 1-201.

7-303. Diversion; Reconsignment; Change of Instructions. (a) Unless the bill of lading otherwise provides, a carrier may deliver the goods to a person or destination other than that stated in the bill or may otherwise dispose of the goods, without liability for misdelivery, on instructions from: (1) the holder of a negotiable bill; (2) the consignor on a nonnegotiable bill, even if the consignee has given contrary instructions; (3) the consignee on a nonnegotiable bill in the absence of contrary instructions from the consignor, if the goods have arrived at the billed destination or if the consignee is in possession of the tangible bill or in control of the electronic bill; or (4) the consignee on a nonnegotiable bill, if the consignee is entitled as against the consignor to dispose of the goods. (b) Unless instructions described in subsection (a) are included in a negotiable bill of lading, a person to which the bill is duly negotiated may hold the bailee according to the original terms. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-303. Changes: To accommodate electronic documents and for style. Purposes: 1. Diversion is a very common commercial practice which defeats delivery to the consignee originally named in a bill of lading. This section continues former Section 7-303's safe harbor rules for carriers in situations involving diversion and adapts those rules to electronic documents of title. This section works compatibly with Section 2-705. Carriers may as a business matter be willing to accept instructions from consignees in which case the carrier will be liable for misdelivery if the consignee was not the owner or otherwise empowered to dispose of the goods under subsection (a)(4). The section imposes no duty on carriers to undertake diversion. The carrier is of course subject to the provisions of mandatory led taris as provided in Section 7-103. 2. It should be noted that the section provides only an immunity for carriers against liability for misdelivery. It does not, for example, defeat the title to the goods which the consignee-buyer may have acquired from the consignor-seller upon delivery of the goods to the carrier under a non-negotiable bill of lading. Thus if the carrier, upon instructions from the consignor, returns the goods to the consignor, the consignee may recover the goods from the consignor or the consignor's insolvent estate. However, under certain circumstances, the consignee's title may be defeated by diversion of the goods in transit to a dierent consignee. The rights that arise between the consignor-seller and the consignee-buyer out of a contract for the sale of goods are governed by Article 2. Cross References: Point 1: Sections 2-705 and 7-103. Point 2: Article 2, Sections 7-403 and 7-504(3). Denitional Cross References: Bailee. Section 7-102. Bill of lading. Section 1-201. Carrier. Section 7-102 649

 7-303
Consignee. Section 7-102. Consignor. Section 7-102. Delivery. Section 1-201. Goods. Section 7-102. Holder. Section 1-201. Notice. Section 1-202. Person. Section 1-201. Purchaser. Section 1-201. Term. Section 1-201.

Uniform Commercial Code

Art. 7

7-304. Tangible Bills of Lading in a Set. (a) Except as customary in international transportation, a tangible bill of lading may not be issued in a set of parts. The issuer is liable for damages caused by violation of this subsection. (b) If a tangible bill of lading is lawfully issued in a set of parts, each of which contains an identication code and is expressed to be valid only if the goods have not been delivered against any other part, the whole of the parts constitutes one bill. (c) If a tangible negotiable bill of lading is lawfully issued in a set of parts and dierent parts are negotiated to dierent persons, the title of the holder to which the rst due negotiation is made prevails as to both the document of title and the goods even if any later holder may have received the goods from the carrier in good faith and discharged the carrier's obligation by surrendering its part. (d) A person that negotiates or transfers a single part of a tangible bill of lading issued in a set is liable to holders of that part as if it were the whole set. (e) The bailee shall deliver in accordance with Part 4 against the rst presented part of a tangible bill of lading lawfully issued in a set. Delivery in this manner discharges the bailee's obligation on the whole bill. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-304. Changes: To limit bills in a set to tangible bills of lading and to use terminology more consistent with modern usage. Purposes: 1. Tangible bills of lading in a set are still used in some nations in international trade. Consequently, a tangible bill of lading part of a set could be at issue in a lawsuit that might come within Article 7. The statement of the legal eect of a lawfully issued set is in accord with existing commercial law relating to maritime and other international tangible bills of lading. This law has been codied in the Hague and Warsaw Conventions and in the Carriage of Goods by Sea Act, the provisions of which would ordinarily govern in situations where bills in a set are recognized by this Article. Tangible bills of lading in a set are prohibited in domestic trade. 2. Electronic bills of lading in domestic or international trade will not be issued in a set given the requirements of control necessary to deliver the bill to another person. An electronic bill of lading will be a single, authoritative copy. Section 7-106. Hence, this section dierentiates between electronic bills of lading and tangible bills of lading. This section does not prohibit electronic data messages about goods in transit because these electronic data messages are not the issued bill of lading. Electronic data messages contain information for the carrier's management and handling of the cargo but this information for the carrier's use is not the issued bill of lading. Cross Reference: Section 7-103, 7-303 and 7-106. 650

Art. 7

Documents of Title

7-305

Denitional Cross References: Bailee. Section 7-102. Bill of lading. Section 1-201. Delivery. Section 1-201. Document of title. Section 1-201. Duly negotiate. Section 7-501. Good faith. Section 1-201. [7-102]. Goods. Section 7-102. Holder. Section 1-201. Issuer. Section 7-102. Person. Section 1-201. Receipt of goods. Section 2-103.

7-305. Destination Bills. (a) Instead of issuing a bill of lading to the consignor at the place of shipment, a carrier, at the request of the consignor, may procure the bill to be issued at destination or at any other place designated in the request. (b) Upon request of any person entitled as against a carrier to control the goods while in transit and on surrender of possession or control of any outstanding bill of lading or other receipt covering the goods, the issuer, subject to Section 7-105, may procure a substitute bill to be issued at any place designated in the request. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-305. Changes: To accommodate electronic bills of lading and for style. Purposes: 1. Subsection (a) continues the rules of former Section 7-305(1) without substantive change. This proposal is designed to facilitate the use of order bills in connection with fast shipments. Use of order bills on high speed shipments is impeded by the fact that the goods may arrive at destination before the documents, so that no one is ready to take delivery from the carrier. This is especially inconvenient for carriers by truck and air, who do not have terminal facilities where shipments can be held to await the consignee's appearance. Order bills would be useful to take advantage of bank collection. This may be preferable to C.O.D. shipment in which the carrier, e.g. a truck driver, is the collecting and remitting agent. Financing of shipments under this plan would be handled as follows: seller at San Francisco delivers the goods to an airline with instructions to issue a bill in New York to a named bank. Seller receives a receipt embodying this undertaking to issue a destination bill. Airline wires its New York freight agent to issue the bill as instructed by the seller. Seller wires the New York bank a draft on buyer. New York bank indorses the bill to buyer when the buyer honors the draft. Normally seller would act through its own bank in San Francisco, which would extend credit in reliance on the airline's contract to deliver a bill to the order of its New York correspondent. This section is entirely permissive; it imposes no duty to issue such bills. Whether a performing carrier will act as issuing agent is left to agreement between carriers. 2. Subsection (b) continues the rule from former Section 7-305(2) with accommodation for electronic bills of lading. If the substitute bill changes from an electronic to a tangible medium or vice versa, the issuance of the substitute bill must comply with Section 7-105 to give the substitute bill validity and eect. Cross Reference: Section 7-105. Denitional Cross References: Bill of lading. Section 1-201. Consignor. Section 7-102. Goods. Section 7-102. Issuer. Section 7-102. 651

 7-305

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Receipt of goods. Section 2-103.

7-306. Altered Bills of Lading. An unauthorized alteration or lling in of a blank in a bill of lading leaves the bill enforceable according to its original tenor. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-306. Changes: None Purposes: An unauthorized alteration or lling in of a blank, whether made with or without fraudulent intent, does not relieve the issuer of its liability on the document as originally executed. This section applies to both tangible and electronic bills of lading, applying the same rule to both types of bills of lading. The control concept of Section 7-106 requires that any changes to the electronic document of title be readily identiable as authorized or unauthorized. Section 7-306 should be compared to Section 7-208 where a dierent rule applies to the unauthorized lling in of a blank for tangible warehouse receipts. Cross Reference: Sections 7-106 and 7-208. Denitional Cross References: Bill of lading. Section 1-201. Issuer. Section 7-102.

7-307. Lien of Carrier. (a) A carrier has a lien on the goods covered by a bill of lading or on the proceeds thereof in its possession for charges after the date of the carrier's receipt of the goods for storage or transportation, including demurrage and terminal charges, and for expenses necessary for preservation of the goods incident to their transportation or reasonably incurred in their sale pursuant to law. However, against a purchaser for value of a negotiable bill of lading, a carrier's lien is limited to charges stated in the bill or the applicable taris or, if no charges are stated, a reasonable charge. (b) A lien for charges and expenses under subsection (a) on goods that the carrier was required by law to receive for transportation is eective against the consignor or any person entitled to the goods unless the carrier had notice that the consignor lacked authority to subject the goods to those charges and expenses. Any other lien under subsection (a) is eective against the consignor and any person that permitted the bailor to have control or possession of the goods unless the carrier had notice that the bailor lacked authority. (c) A carrier loses its lien on any goods that it voluntarily delivers or unjustiably refuses to deliver. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-307. Changes: Expanded to cover proceeds of the goods transported. Purposes: 1. The section is intended to give carriers a specic statutory lien for charges and expenses similar to that given to warehouses by the rst sentence of Section 7-209(a) and extends that lien to the proceeds of the goods as long as the carrier has possession of the proceeds. But because carriers do not commonly claim a lien for charges in relation to other goods or lend money on the security of goods in their hands, provisions for a general lien or a security interest similar to those in Section 7-209(a) and (b) are omitted. Carriers may utilize Article 9 to obtain a security interest and become a secured party or a carrier may agree to 652

Art. 7

Documents of Title

7-308

limit its lien rights in a transportation agreement with the shipper. As the lien given by this section is specic, and the storage or transportation often preserves or increases the value of the goods, subsection (b) validates the lien against anyone who permitted the bailor to have possession of the goods. Where the carrier is required to receive the goods for transportation, the owner's interest may be subjected to charges and expenses arising out of deposit of his goods by a thief. The crucial mental element is the carrier's knowledge or reason to know of the bailor's lack of authority. If the carrier does not know or have reason to know of the bailor's lack of authority, the carrier has a lien under this section against any person so long as the conditions of subsection (b) are satised. In light of the crucial mental element, Sections 7-307 and 9-333 combine to give priority to a carrier's lien over security interests in the goods. In this regard, the judicial decision in In re Sharon Steel Corp., 25 U.C.C. Rep.2d 503, 176 B.R. 384 (W.D. Pa. 1995) is correct and is the controlling precedent. 2. The reference to charges in this section means charges relating to the bailment relationship for transportation. Charges does not mean that the bill of lading must state a specic rate or a specic amount. However, failure to state a specic rate or a specic amount has legal consequences under the second sentence of subsection (a). 3. The carrier's specic lien under this section is a possessory lien. See subsection (c). Part 3 of Article 7 does not require any particular form for a bill of lading. The carrier's lien arises when the carrier has issued a bill of lading. Cross References: Point 1: Sections 7-209, 9-109 and 9-333. Point 3. Section 7-202 and 7-209. Denitional Cross References: Bill of lading. Section 1-201. Carrier. Section 7-102. Consignor. Section 7-102. Delivery. Section 1-201. Goods. Section 7-102. Person. Section 1-201. Purchaser. Section 1-201. Value. Section 1-204.

7-308. Enforcement of Carrier's Lien. (a) A carrier's lien on goods may be enforced by public or private sale of the goods, in bulk or in packages, at any time or place and on any terms that are commercially reasonable, after notifying all persons known to claim an interest in the goods. The notication must include a statement of the amount due, the nature of the proposed sale, and the time and place of any public sale. The fact that a better price could have been obtained by a sale at a dierent time or in a method dierent from that selected by the carrier is not of itself sucient to establish that the sale was not made in a commercially reasonable manner. The carrier sells goods in a commercially reasonable manner if the carrier sells the goods in the usual manner in any recognized market therefor, sells at the price current in that market at the time of the sale, or otherwise sells in conformity with commercially reasonable practices among dealers in the type of goods sold. A sale of more goods than apparently necessary to be oered to ensure satisfaction of the obligation is not commercially reasonable, except in cases covered by the preceding sentence. (b) Before any sale pursuant to this section, any person claiming a right in the goods may pay the amount necessary to satisfy the lien and the reasonable expenses incurred in complying with this section. In that event, the goods may not be sold but must be retained by the carrier, subject to the terms of the bill of lading and this article.
653

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Art. 7

(c) A carrier may buy at any public sale pursuant to this section. (d) A purchaser in good faith of goods sold to enforce a carrier's lien takes the goods free of any rights of persons against which the lien was valid, despite the carrier's noncompliance with this section. (e) A carrier may satisfy its lien from the proceeds of any sale pursuant to this section but shall hold the balance, if any, for delivery on demand to any person to which the carrier would have been bound to deliver the goods. (f) The rights provided by this section are in addition to all other rights allowed by law to a creditor against a debtor. (g) A carrier's lien may be enforced pursuant to either subsection (a) or the procedure set forth in Section 7-210(b). (h) A carrier is liable for damages caused by failure to comply with the requirements for sale under this section and, in case of willful violation, is liable for conversion. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-308. Changes: To conform language to modern usage and for style. Purposes: This section is intended to give the carrier an enforcement procedure of its lien coextensive with that given the warehouse in cases other than those covering noncommercial storage by the warehouse. See Section 7-210 and comments. Cross Reference: Section 7-210. Denitional Cross References: Bill of lading. Section 1-201. Carrier. Section 7-102. Creditor. Section 1-201. Delivery. Section 1-201. Good faith. Section 1-201. [7-102] Goods. Section 7-102. Notication. Section 1-202. Noties. Section 1-202. Person. Section 1-201. Purchaser. Section 1-201. Rights. Section 1-201. Term. Section 1-201.

7-309. Duty of Care; Contractual Limitation of Carrier's Liability. (a) A carrier that issues a bill of lading, whether negotiable or nonnegotiable, shall exercise the degree of care in relation to the goods which a reasonably careful person would exercise under similar circumstances. This subsection does not aect any statute, regulation, or rule of law that imposes liability upon a common carrier for damages not caused by its negligence. (b) Damages may be limited by a term in the bill of lading or in a transportation agreement that the carrier's liability may not exceed a value stated in the bill or transportation agreement if the carrier's rates are dependent upon value and the consignor is aorded an opportunity to declare a higher value and the consignor is advised of the opportunity.
654

Art. 7

Documents of Title

7-309

However, such a limitation is not eective with respect to the carrier's liability for conversion to its own use. (c) Reasonable provisions as to the time and manner of presenting claims and commencing actions based on the shipment may be included in a bill of lading or a transportation agreement. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-309. Changes: References to taris eliminated because of deregulation, adding reference to transportation agreements, and for style. Purposes: 1. A bill of lading may also serve as the contract between the carrier and the bailor. Parties in their contract should be able to limit the amount of damages for breach of that contract including breach of the duty to take reasonable care of the goods. The parties cannot disclaim by contract the carrier's obligation of care. Section 1-302. Federal statutes and treaties for air, maritime and rail transport may alter the standard of care. These federal statutes and treaties preempt this section when applicable. Section 7-103. Subsection (a) does not impair any rule of law imposing the liability of an insurer on a common carrier in intrastate commerce. Subsection (b), however, applies to the common carrier's liability as an insurer as well as to liability based on negligence. Subsection (b) allows the term limiting damages to appear either in the bill of lading or in the parties' transportation agreement. Compare 7-204(b). Subsection (c) allows the parties to agree to provisions regarding time and manner of presenting claims or commencing actions if the provisions are either in the bill of lading or the transportation agreement. Compare 7-204(c). Transportation agreements are commonly used to establish agreed terms between carriers and shippers that have an on-going relationship. 2. References to public taris in former Section 7-309(2) and (3) have been deleted in light of the modern era of deregulation. See Comment 2 to Section 7-103. If a tari is required under state or federal law, pursuant to Section 7-103(a), the tari would control over the rule of this section. As governed by contract law, parties may incorporate by reference the limits on the amount of damages or the reasonable provisions as to the time and manner of presenting claims set forth in applicable taris, e.g. a maximum unit value beyond which goods are not taken or a disclaimer of responsibility for undeclared articles of extraordinary value. 3. As under former Section 7-309(2), subsection (b) provides that a limitation of damages is ineective if the carrier has converted the goods to its own use. A mere failure to redeliver the goods is not conversion to the carrier's own use. Conversion to its own use is narrower than the idea of conversion generally. Art Masters Associates, Ltd. v. United Parcel Service, 77 N.Y.2d 200, 567 N.E.2d 226 (1990); See, Kemper Ins. Co. v. Fed. Ex. Corp., 252 F.3d 509 (1st Cir), cert. denied 534 U.S. 1020 (2001) (opinion interpreting federal law). 4. As used in this section, damages may include damages arising from delay in delivery. Delivery dates and times are often specied in the parties' contract. See Section 7-403. Cross Reference: Sections 1-302, 7-103, 7-204, 7-403. Denitional Cross References: Action. Section 1-201. Bill of lading. Section 1-201. Carrier. Section 7-102. Consignor. Section 7-102. Document of Title. Section 1-102. Goods. Section 7-102. Value. Section 1-204.

655

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PART 4. WAREHOUSE RECEIPTS AND BILLS OF LADING: GENERAL OBLIGATIONS

7-401. Irregularities in Issue of Receipt or Bill or Conduct of Issuer. The obligations imposed by this article on an issuer apply to a document of title even if: (1) the document does not comply with the requirements of this article or of any other statute, rule, or regulation regarding its issuance, form, or content; (2) the issuer violated laws regulating the conduct of its business; (3) the goods covered by the document were owned by the bailee when the document was issued; or (4) the person issuing the document is not a warehouse but the document purports to be a warehouse receipt. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-401. Changes: Changes for style only. Purposes: The bailee's liability on its document despite non-receipt or misdescription of the goods is armed in Sections 7-203 and 7-301. The purpose of this section is to make it clear that regardless of irregularities a document which falls within the denition of document of title imposes on the issuer the obligations stated in this Article. For example, a bailee will not be permitted to avoid its obligation to deliver the goods (Section 7-403) or its obligation of due care with respect to them (Sections 7-204 and 7-309) by taking the position that no valid document was issued because it failed to le a statutory bond or did not pay stamp taxes or did not disclose the place of storage in the document. Tate v. Action Moving & Storage, Inc., 383 S.E.2d 229 (N.C. App. 1989), rev. denied 389 S.E.2d 104 (N.C. 1990). Sanctions against violations of statutory or administrative duties with respect to documents should be limited to revocation of license or other measures prescribed by the regulation imposing the duty. See Section 7-103. Cross References: Sections 7-103, 7-203, 7-204, 7-301, 7-309. Denitional Cross References: Bailee. Section 7-102. Document of title. Section 1-201. Goods. Section 7-102. Issuer. Section 7-102. Person. Section 1-201. Warehouse receipt. Section 1-201. Warehouse. Section 7-102.

7-402. Duplicate Document of Title; Overissue. A duplicate or any other document of title purporting to cover goods already represented by an outstanding document of the same issuer does not confer any right in the goods, except as provided in the case of tangible bills of lading in a set of parts, overissue of documents for fungible goods, substitutes for lost, stolen, or destroyed documents, or substitute documents issued pursuant to Section 7-105. The issuer is liable for damages caused by its overissue or failure to identify a duplicate document by a conspicuous notation.
656

Art. 7

Documents of Title

7-403

Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-402. Changes: Changes to accommodate electronic documents. Purposes: 1. This section treats a duplicate which is not properly identied as a duplicate like any other overissue of documents: a purchaser of such a document acquires no title but only a cause of action for damages against the person that made the deception possible, except in the cases noted in the section. But parts of a tangible bill lawfully issued in a set of parts are not overissue (Section 7-304). Of course, if the issuer has clearly indicated that a document is a duplicate so that no one can be deceived by it, and in fact the duplicate is a correct copy of the original, the issuer is not liable for preparing and delivering such a duplicate copy. Section 7-105 allows documents of title to be reissued in another medium. Re-issuance of a document in an alternative medium under Section 7-105 requires that the original document be surrendered to the issuer in order to make the substitute document the eective document. If the substitute document is not issued in compliance with section 7-105, then the document should be treated as a duplicate under this section. 2. The section applies to nonnegotiable documents to the extent of providing an action for damages for one who acquires an unmarked duplicate from a transferor who knew the facts and would therefore have had no cause of action against the issuer of the duplicate. Ordinarily the transferee of a nonnegotiable document acquires only the rights of its transferor. 3. Overissue is dened so as to exclude the common situation where two valid documents of dierent issuers are outstanding for the same goods at the same time. Thus freight forwarders commonly issue bills of lading to their customers for small shipments to be combined into carload shipments for which the railroad will issue a bill of lading to the forwarder. So also a warehouse receipt may be outstanding against goods, and the holder of the receipt may issue delivery orders against the same goods. In these cases dealings with the subsequently issued documents may be eective to transfer title; e.g. negotiation of a delivery order will eectively transfer title in the ordinary case where no dishonesty has occurred and the goods are available to satisfy the orders. Section 7-503 provides for cases of conict between documents of dierent issuers. Cross References: Point 1: Sections 7-105, 7-207, 7-304, and 7-601. Point 3: Section 7-503. Denitional Cross References: Bill of lading. Section 1-201. Conspicuous. Section 1-201. Document of title. Section 1-201. Fungible goods. Section 1-201. Goods. Section 7-102. Issuer. Section 7-102. Right. Section 1-201.

7-403. Obligation of Bailee to Deliver; Excuse. (a) A bailee shall deliver the goods to a person entitled under a document of title if the person complies with subsections (b) and (c), unless and to the extent that the bailee establishes any of the following: (1) delivery of the goods to a person whose receipt was rightful as against the claimant; (2) damage to or delay, loss, or destruction of the goods for which the bailee is not liable; (3) previous sale or other disposition of the goods in lawful enforcement of a lien or on a warehouse's lawful termination of storage; (4) the exercise by a seller of its right to stop delivery pursuant to
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Section 2-705 or by a lessor of its right to stop delivery pursuant to Section 2A-526; (5) a diversion, reconsignment, or other disposition pursuant to Section 7-303; (6) release, satisfaction, or any other personal defense against the claimant; or (7) any other lawful excuse. (b) A person claiming goods covered by a document of title shall satisfy the bailee's lien if the bailee so requests or if the bailee is prohibited by law from delivering the goods until the charges are paid. (c) Unless a person claiming the goods is a person against which the document of title does not confer a right under Section 7-503(a): (1) the person claiming under a document shall surrender possession or control of any outstanding negotiable document covering the goods for cancellation or indication of partial deliveries; and (2) the bailee shall cancel the document or conspicuously indicate in the document the partial delivery or the bailee is liable to any person to which the document is duly negotiated. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-403. Changes: Denition in former Section 7-403(4) moved to Section 7-102; bracketed language in former Section 7-403(1)(b) deleted; added cross reference to Section 2A-526; changes for style. Purposes: 1. The present section, following former Section 7-403, is constructed on the basis of stating what previous deliveries or other circumstances operate to excuse the bailee's normal obligation on the document. Accordingly, justied deliveries under the pre-Code uniform acts now nd their place as excuse under subsection (a). 2. The principal case covered by subsection (a)(1) is delivery to a person whose title is paramount to the rights represented by the document. For example, if a thief deposits stolen goods in a warehouse facility and takes a negotiable receipt, the warehouse is not liable on the receipt if it has surrendered the goods to the true owner, even though the receipt is held by a good faith purchaser. See Section 7-503(a). However, if the owner entrusted the goods to a person with power of disposition, and that person deposited the goods and took a negotiable document, the owner receiving delivery would not be rightful as against a holder to whom the negotiable document was duly negotiated, and delivery to the owner would not give the bailee a defense against such a holder. See Sections 7-502(a) (2), 7-503(a)(1). 3. Subsection (a)(2) amounts to a cross reference to all the tort law that determines the varying responsibilities and standards of care applicable to commercial bailees. A restatement of this tort law would be beyond the scope of this Act. Much of the applicable law as to responsibility of bailees for the preservation of the goods and limitation of liability in case of loss has been codied for particular classes of bailees in interstate and foreign commerce by federal legislation and treaty and for intrastate carriers and other bailees by the regulatory state laws preserved by Section 7-103. In the absence of governing legislation the common law will prevail subject to the minimum standard of reasonable care prescribed by Sections 7-204 and 7-309 of this Article. The bracketed language found in former Section 7-403(1)(b) has been deleted thereby leaving the allocations of the burden of going forward with the evidence and the burden of proof to the procedural law of the various states. Subsection (a)(4) contains a cross reference to both the seller's and the lessor's rights to stop delivery under Article 2 and Article 2A respectively. 4. As under former Section 7-403, there is no requirement that a request for delivery must be accompanied by a formal tender of the amount of the charges due. Rather, the 658

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bailee must request payment of the amount of its lien when asked to deliver, and only in case this request is refused is it justied in declining to deliver because of nonpayment of charges. Where delivery without payment is forbidden by law, the request is treated as implicit. Such a prohibition reects a policy of uniformity to prevent discrimination by failure to request payment in particular cases. Subsection (b) must be read in conjunction with the priorities given to the warehouse lien and the carrier lien under Section 7-209 and 7-307, respectively. If the parties are in dispute about whether the request for payment of the lien is legally proper, the bailee may have recourse to interpleader. See Section 7-603. 5. Subsection (c) states the obvious duty of a bailee to take up a negotiable document or note partial deliveries conspicuously thereon, and the result of failure in that duty. It is subject to only one exception, that stated in subsection (a)(1) of this section and in Section 7-503(a). Subsection (c) is limited to cases of delivery to a claimant; it has no application, for example, where goods held under a negotiable document are lawfully sold to enforce the bailee's lien. 6. When courts are considering subsection (a)(7), any other lawful excuse, among others, refers to compliance with court orders under Sections 7-601, 7-602 and 7-603. Cross References: Point 2: Sections 7-502 and 7-503. Point 3: Sections 2-705, 2A-526, 7-103, 7-204, and 7-309 and 10-103. Point 4: Sections 7-209, 7-307 and 7-603. Point 5: Section 7-503(1). Point 6: Sections 7-601, 7-602, and 7-603. Denitional Cross References: Bailee. Section 7-102. Conspicuous. Section 1-201. Delivery. Section 1-201. Document of title. Section 1-201. Duly negotiate. Section 7-501. Goods. Section 7-102. Lessor. Section 2A-103. Person. Section 1-201. Receipt of goods. Section 2-103. Right. Section 1-201. Terms. Section 1-201. Warehouse. Section 7-102.

7-404. No Liability for Good-Faith Delivery Pursuant to Document of Title. A bailee that in good faith has received goods and delivered or otherwise disposed of the goods according to the terms of a document of title or pursuant to this article is not liable for the goods even if: (1) the person from which the bailee received the goods did not have authority to procure the document or to dispose of the goods; or (2) the person to which the bailee delivered the goods did not have authority to receive the goods. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-404. Changes: Changes reect the denition of good faith in Section 1-201 [7-102] and for style. Purposes: This section uses the test of good faith, as dened in Section 1-201 [7-102], to continue the policy of former Section 7-404. Good faith now means honesty in fact and the observance of reasonable commercial standards of fair dealing. The section states explicitly that the common law rule of innocent conversion by unauthorized intermeddling with another's property is inapplicable to the operations of commercial carriers and warehousemen that in good faith perform obligations that they have assumed and that generally they 659

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are under a legal compulsion to assume. The section applies to delivery to a fraudulent holder of a valid document as well as to delivery to the holder of an invalid document. Of course, in appropriate circumstances, a bailee may use interpleader or other dispute resolution process. See Section 7-603. Cross Reference: Section 7-603. Denitional Cross References: Bailee. Section 7-102. Delivery. Section 1-201. Document of title. Section 1-201. Good faith. Section 1-201. [7-102]. Goods. Section 7-102. Person. Section 1-201. Receipt of goods. Section 2-103. Term. Section 1-201.

PART 5. WAREHOUSE RECEIPTS AND BILLS OF LADING: NEGOTIATION AND TRANSFER

7-501. Form of Negotiation and Requirements of Due Negotiation. (a) The following rules apply to a negotiable tangible document of title: (1) If the document's original terms run to the order of a named person, the document is negotiated by the named person's indorsement and delivery. After the named person's indorsement in blank or to bearer, any person may negotiate the document by delivery alone. (2) If the document's original terms run to bearer, it is negotiated by delivery alone. (3) If the document's original terms run to the order of a named person and it is delivered to the named person, the eect is the same as if the document had been negotiated. (4) Negotiation of the document after it has been indorsed to a named person requires indorsement by the named person and delivery. (5) A document is duly negotiated if it is negotiated in the manner stated in this subsection to a holder that purchases it in good faith, without notice of any defense against or claim to it on the part of any person, and for value, unless it is established that the negotiation is not in the regular course of business or nancing or involves receiving the document in settlement or payment of a monetary obligation. (b) The following rules apply to a negotiable electronic document of title: (1) If the document's original terms run to the order of a named person or to bearer, the document is negotiated by delivery of the document to another person. Indorsement by the named person is not required to negotiate the document. (2) If the document's original terms run to the order of a named person and the named person has control of the document, the eect is the same as if the document had been negotiated. (3) A document is duly negotiated if it is negotiated in the manner stated in this subsection to a holder that purchases it in good faith, without notice of any defense against or claim to it on the part of any
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Documents of Title

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person, and for value, unless it is established that the negotiation is not in the regular course of business or nancing or involves taking delivery of the document in settlement or payment of a monetary obligation. (c) Indorsement of a nonnegotiable document of title neither makes it negotiable nor adds to the transferee's rights. (d) The naming in a negotiable bill of lading of a person to be notied of the arrival of the goods does not limit the negotiability of the bill or constitute notice to a purchaser of the bill of any interest of that person in the goods. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-501. Changes: To accommodate negotiable electronic documents of title. Purpose: 1. Subsection (a) has been limited to tangible negotiable documents of title but otherwise remains unchanged in substance from the rules in former Section 7-501. Subsection (b) is new and applies to negotiable electronic documents of title. Delivery of a negotiable electronic document is through voluntary transfer of control. Section 1-201 denition of delivery. The control concept as applied to negotiable electronic documents of title is the substitute for both possession and indorsement as applied to negotiable tangible documents of title. Section 7-106. Article 7 does not separately dene the term duly negotiated. However, the elements of duly negotiated are set forth in subsection (a)(5) for tangible documents and (b)(3) for electronic documents. As under former Section 7-501, in order to eect a due negotiation the negotiation must be in the regular course of business or nancing in order to transfer greater rights than those held by the person negotiating. The foundation of the mercantile doctrine of good faith purchase for value has always been, as shown by the case situations, the furtherance and protection of the regular course of trade. The reason for allowing a person, in bad faith or in error, to convey away rights which are not its own has from the beginning been to make possible the speedy handling of that great run of commercial transactions which are patently usual and normal. There are two aspects to the usual and normal course of mercantile dealings, namely, the person making the transfer and the nature of the transaction itself. The rst question which arises is: Is the transferor a person with whom it is reasonable to deal as having full powers? In regard to documents of title the only holder whose possession or control appears, commercially, to be in order is almost invariably a person in the trade. No commercial purpose is served by allowing a tramp or a professor to duly negotiate an order bill of lading for hides or cotton not their own, and since such a transfer is obviously not in the regular course of business, it is excluded from the scope of the protection of subsections (a)(5) or (b)(3). The second question posed by the regular course qualication is: Is the transaction one which is normally proper to pass full rights without inquiry, even though the transferor itself may not have such rights to pass, and even though the transferor may be acting in breach of duty? In raising this question the regular course criterion has the further advantage of limiting, the eective wrongful disposition to transactions whose protection will really further trade. Obviously, the snapping up of goods for quick resale at a price suspiciously below the market deserves no protection as a matter of policy: it is also clearly outside the range of regular course. Any notice on the document sucient to put a merchant on inquiry as to the regular course quality of the transaction will frustrate a due negotiation. Thus irregularity of the document or unexplained staleness of a bill of lading may appropriately be recognized as negating a negotiation in regular course. A pre-existing claim constitutes value, and due negotiation does not require new value. A usual and ordinary transaction in which documents are received as security for credit previously extended may be in regular course, even though there is a demand for additional collateral because the creditor deems himself insecure. But the matter has moved out of the regular course of nancing if the debtor is thought to be insolvent, the 661

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credit previously extended is in eect cancelled, and the creditor snatches a plank in the shipwreck under the guise of a demand for additional collateral. Where a money debt is paid in commodity paper, any question of regular course disappears, as the case is explicitly excepted from due negotiation. 2. Negotiation under this section may be made by any holder no matter how the holder acquired possession or control of the document. 3. Subsections (a)(3) and (b)(2) make explicit a matter upon which the intent of the preCode law was clear but the language somewhat obscure: a negotiation results from a delivery to a banker or buyer to whose order the document has been taken by the person making the bailment. There is no presumption of irregularity in such a negotiation; it may very well be in regular course. 4. This Article does not contain any provision creating a presumption of due negotiation to, and full rights in, a holder of a document of title akin to that created by Uniform Commercial Code Article 3. But the reason of the provisions of this Act (Section 1-307) on the prima facie authenticity and accuracy of third party documents, joins with the reason of the present section to work such a presumption in favor of any person who has power to make a due negotiation. It would not make sense for this Act to authorize a purchaser to indulge the presumption of regularity if the courts were not also called upon to do so. Allocations of the burden of going forward with the evidence and the burden of proof are left to the procedural law of the various states. 5. Subsections (c) and (d) are unchanged from prior law and apply to both tangible and electronic documents of title. Cross References: Sections 1-307, 7-502 and 7-503. Denitional Cross References: Bearer. Section 1-201. Control. Section 7-106. Delivery. Section 1-201. Document of title. Section 1-201. Good faith. Section 1-201 [7-102]. Holder. Section 1-201. Notice. Section 1-202. Person. Section 1-201. Purchase. Section 1-201. Rights. Section 1-201. Term. Section 1-201. Value. Section 1-204.

7-502. Rights Acquired by Due Negotiation. (a) Subject to Sections 7-205 and 7-503, a holder to which a negotiable document of title has been duly negotiated acquires thereby: (1) title to the document; (2) title to the goods; (3) all rights accruing under the law of agency or estoppel, including rights to goods delivered to the bailee after the document was issued; and (4) the direct obligation of the issuer to hold or deliver the goods according to the terms of the document free of any defense or claim by the issuer except those arising under the terms of the document or under this article, but in the case of a delivery order, the bailee's obligation accrues only upon the bailee's acceptance of the delivery order and the obligation acquired by the holder is that the issuer and any indorser will procure the acceptance of the bailee. (b) Subject to Section 7-503, title and rights acquired by due negotiation
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Documents of Title

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are not defeated by any stoppage of the goods represented by the document of title or by surrender of the goods by the bailee and are not impaired even if: (1) the due negotiation or any prior due negotiation constituted a breach of duty; (2) any person has been deprived of possession of a negotiable tangible document or control of a negotiable electronic document by misrepresentation, fraud, accident, mistake, duress, loss, theft, or conversion; or (3) a previous sale or other transfer of the goods or document has been made to a third person. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-502. Changes: To accommodate electronic documents of title and for style. Purpose: 1. This section applies to both tangible and electronic documents of title. The elements of duly negotiated, which constitutes a due negotiation, are set forth in Section 7-501. The several necessary qualications of the broad principle that the holder of a document acquired in a due negotiation is the owner of the document and the goods have been brought together in the next section (Section 7-503). 2. Subsection (a)(3) covers the case of feeding of a duly negotiated document by subsequent delivery to the bailee of such goods as the document falsely purported to cover; the bailee in such case is estopped as against the holder of the document. 3. The explicit statement in subsection (a)(4) of the bailee's direct obligation to the holder precludes the defense that the document in question was spent after the carrier had delivered the goods to a previous holder. But the holder is subject to such defenses as nonnegligent destruction even though not apparent on the document. The sentence on delivery orders applies only to delivery orders in negotiable form which have been duly negotiated. On delivery orders, see also Section 7-503(b) and Comment. 4. Subsection (b) continues the law which gave full eect to the issuance or due negotiation of a negotiable document. The subsection adds nothing to the eect of the rules stated in subsection (a), but it has been included since such explicit reference was provided under former Section 7-502 to preserve the right of a purchaser by due negotiation. The listing is not exhaustive. The languageany stoppage is included lest an inference be drawn that a stoppage of the goods before or after transit might cut o or otherwise impair the purchaser's rights. Cross References: Sections 7-103, 7-205, 7-403, 7-501, and 7-503. Denitional Cross References: Bailee. Section 7-102. Control. Section 7-106. Delivery. Section 1-201. Delivery order. Section 7-102. Document of title. Section 1-201. Duly negotiate. Section 7-501. Fungible. Section 1-201. Goods. Section 7-102. Holder. Section 1-201. Issuer. Section 7-102. Person. Section 1-201. Rights. Section 1-201. Term. Section 1-201. Warehouse receipt. Section 1-201.

7-503. Document of Title to Goods Defeated in Certain Cases. (a) A document of title confers no right in goods against a person that
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before issuance of the document had a legal interest or a perfected security interest in the goods and that did not: (1) deliver or entrust the goods or any document of title covering the goods to the bailor or the bailor's nominee with: (A) actual or apparent authority to ship, store, or sell; (B) power to obtain delivery under Section 7-403; or (C) power of disposition under Section 2-403, 2A-304(2), 2A-305(2), 9-320, or 9-321(c) or other statute or rule of law; or (2) acquiesce in the procurement by the bailor or its nominee of any document. (b) Title to goods based upon an unaccepted delivery order is subject to the rights of any person to which a negotiable warehouse receipt or bill of lading covering the goods has been duly negotiated. That title may be defeated under Section 7-504 to the same extent as the rights of the issuer or a transferee from the issuer. (c) Title to goods based upon a bill of lading issued to a freight forwarder is subject to the rights of any person to which a bill issued by the freight forwarder is duly negotiated. However, delivery by the carrier in accordance with Part 4 pursuant to its own bill of lading discharges the carrier's obligation to deliver. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-503. Changes: Changes to cross-reference to Article 2A and for style. Purposes: 1. In general it may be said that the title of a purchaser by due negotiation prevails over almost any interest in the goods which existed prior to the procurement of the document of title if the possession of the goods by the person obtaining the document derived from any action by the prior claimant which introduced the goods into the stream of commerce or carried them along that stream. A thief of the goods cannot indeed by shipping or storing them to the thief's own order acquire power to transfer them to a good faith purchaser. Nor can a tenant or mortgagor defeat any rights of a landlord or mortgagee which have been perfected under the local law merely by wrongfully shipping or storing a portion of the crop or other goods. However, acquiescence by the landlord or mortgagee does not require active consent under subsection (a)(2) and knowledge of the likelihood of storage or shipment with no objection or eort to control it is sucient to defeat the landlord's or the mortgagee's rights as against one who takes by due negotiation of a negotiable document. In re Sharon Steel, 176 B.R. 384 (Bankr. W.D. Pa. 1995); In re R.V. Segars Co, 54 B.R. 170 (Bankr. S.C. 1985); In re Jamestown Elevators, Inc., 49 B.R. 661 (Bankr. N.D. 1985). On the other hand, where goods are delivered to a factor for sale, even though the factor has made no advances and is limited in its duty to sell for cash, the goods are entrusted to the factor with actual . . . authority . . . to sell under subsection (a)(1), and if the factor procures a negotiable document of title it can transfer the owner's interest to a purchaser by due negotiation. Further, where the factor is in the business of selling, goods entrusted to it simply for safekeeping or storage may be entrusted under circumstances which give the factor apparent authority to ship, store or sell under subsection (a)(1), or power of disposition under Section 2-403, 2A-304(2), 2A-305(2), 7-205, 9-320, or 9-321(c) or under a statute such as the earlier Factors Acts, or under a rule of law giving eect to apparent ownership. See Section 1-103. Persons having an interest in goods also frequently deliver or entrust them to agents or servants other than factors for the purpose of shipping or warehousing or under circumstances reasonably contemplating such action. This Act is clear that such persons assume full risk that the agent to whom the goods are so delivered may ship or store in breach of duty, take a document to the agent's own order and then proceed to misappropriate the negotiable document of title that embodies the goods. This Act makes no distinction between 664

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possession or mere custody in such situations and nds no exception in the case of larceny by a bailee or the like. The safeguard in such situations lies in the requirement that a due negotiation can occur only in the regular course of business or nancing and that the purchase be in good faith and without notice. See Section 7-501. Documents of title have no market among the commercially inexperienced and the commercially experienced do not take them without inquiry from persons known to be truck drivers or petty clerks even though such persons purport to be operating in their own names. Again, where the seller allows a buyer to receive goods under a contract for sale, though as a conditional delivery or under cash sale terms and on explicit agreement for immediate payment, the buyer thereby acquires power to defeat the seller's interest by transfer of the goods to certain good faith purchasers. See Section 2-403. Both in policy and under the language of subsection (a)(1) that same power must be extended to accomplish the same result if the buyer procures a negotiable document of title to the goods and duly negotiates it. This comment 1 should be considered in interpreting delivery, entrustment or acquiescence in application of Section 7-209. 2. Under subsection (a) a delivery order issued by a person having no right in or power over the goods is ineective unless the owner acts as provided in subsection (a)(1) or (2). Thus the rights of a transferee of a non-negotiable warehouse receipt can be defeated by a delivery order subsequently issued by the transferor only if the transferee delivers or entrusts to the person procuring the delivery order or acquiesces in that person's procurement. Similarly, a second delivery order issued by the same issuer for the same goods will ordinarily be subject to the rst, both under this section and under Section 7-402. After a delivery order is validly issued but before it is accepted, it may nevertheless be defeated under subsection (b) in much the same way that the rights of a transferee may be defeated under Section 7-504. For example, a buyer in ordinary course from the issuer may defeat the rights of the holder of a prior delivery order if the bailee receives notication of the buyer's rights before notication of the holder's rights. Section 7-504(b)(2). But an accepted delivery order has the same eect as a document issued by the bailee. 3. Under subsection (c) a bill of lading issued to a freight forwarder is subordinated to the freight forwarder's document of title, since the bill on its face gives notice of the fact that a freight forwarder is in the picture and the freight forwarder has in all probability issued a document of title. But the carrier is protected in following the terms of its own bill of lading. Cross References: Point 1: Sections 1-103, 2-403, 2A-304(2), 2A-305(2), 7-205, 7-209, 7-501, 9-320, 9-321(c), and 9-331. Point 2: Sections 7-402 and 7-504. Point 3: Sections 7-402, 7-403 and 7-404. Denitional Cross References: Bill of lading. Section 1-201. Contract for sale. Section 2-106. Delivery. Section 1-201. Delivery order. Section 7-102. Document of title. Section 1-201. Duly negotiate. Section 7-501. Goods. Section 7-102. Person. Section 1-201. Right. Section 1-201. Warehouse receipt. Section 1-201.

7-504. Rights Acquired in Absence of Due Negotiation; Eect of Diversion; Stoppage of Delivery. (a) A transferee of a document of title, whether negotiable or nonnegotiable, to which the document has been delivered but not duly negotiated, acquires the title and rights that its transferor had or had actual authority to convey.
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(b) In the case of a transfer of a nonnegotiable document of title, until but not after the bailee receives notice of the transfer, the rights of the transferee may be defeated: (1) by those creditors of the transferor which could treat the transfer as void under Section 2-402 or 2A-308; (2) by a buyer from the transferor in ordinary course of business if the bailee has delivered the goods to the buyer or received notication of the buyer's rights; (3) by a lessee from the transferor in ordinary course of business if the bailee has delivered the goods to the lessee or received notication of the lessee's rights; or (4) as against the bailee, by good-faith dealings of the bailee with the transferor. (c) A diversion or other change of shipping instructions by the consignor in a nonnegotiable bill of lading which causes the bailee not to deliver the goods to the consignee defeats the consignee's title to the goods if the goods have been delivered to a buyer in ordinary course of business or a lessee in ordinary course of business and, in any event, defeats the consignee's rights against the bailee. (d) Delivery of the goods pursuant to a nonnegotiable document of title may be stopped by a seller under Section 2-705 or a lessor under Section 2A-526, subject to the requirements of due notication in those sections. A bailee that honors the seller's or lessor's instructions is entitled to be indemnied by the seller or lessor against any resulting loss or expense. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-504. Changes: To include cross-references to Article 2A and for style. Purposes: 1. Under the general principles controlling negotiable documents, it is clear that in the absence of due negotiation a transferor cannot convey greater rights than the transferor has, even when the negotiation is formally perfect. This section recognizes the transferor's power to transfer rights which the transferor has or has actual authority to convey. Thus, where a negotiable document of title is being transferred the operation of the principle of estoppel is not recognized, as contrasted with situations involving the transfer of the goods themselves. (Compare Section 2-403 on good faith purchase of goods.) This section applies to both tangible and electronic documents of title. A necessary part of the price for the protection of regular dealings with negotiable documents of title is an insistence that no dealing which is in any way irregular shall be recognized as a good faith purchase of the document or of any rights pertaining to it. So, where the transfer of a negotiable document fails as a negotiation because a requisite indorsement is forged or otherwise missing, the purchaser in good faith and for value may be in the anomalous position of having less rights, in part, than if the purchaser had purchased the goods themselves. True, the purchaser's rights are not subject to defeat by attachment of the goods or surrender of them to the purchaser's transferor (contrast subsection (b)); but on the other hand, the purchaser cannot acquire enforceable rights to control or receive the goods over the bailee's objection merely by giving notice to the bailee. Similarly, a consignee who makes payment to its consignor against a straight bill of lading can thereby acquire the position of a good faith purchaser of goods under provisions of the Article of this Act on Sales (Section 2-403), whereas the same payment made in good faith against an unendorsed order bill would not have such eect. The appropriate remedy of a purchaser in such a situation is to regularize its status by compelling indorsement of the document (see Section 7-506). 2. As in the case of transferas opposed to due negotiationof negotiable documents, 666

Art. 7

Documents of Title

7-505

subsection (a) empowers the transferor of a nonnegotiable document to transfer only such rights as the transferor has or has actual authority to convey. In contrast to situations involving the goods themselves the operation of estoppel or agency principles is not here recognized to enable the transferor to convey greater rights than the transferor actually has. Subsection (b) makes it clear, however, that the transferee of a nonnegotiable document may acquire rights greater in some respects than those of his transferor by giving notice of the transfer to the bailee. New subsection (b)(3) provides for the rights of a lessee in the ordinary course. Subsection (b)(2) & (3) require delivery of the goods. Delivery of the goods means the voluntary transfer of physical possession of the goods. See amended 2-103. 3. Subsection (c) is in part a reiteration of the carrier's immunity from liability if it honors instructions of the consignor to divert, but there is added a provision protecting the title of the substituted consignee if the latter is a buyer in ordinary course of business. A typical situation would be where a manufacturer, having shipped a lot of standardized goods to A on nonnegotiable bill of lading, diverts the goods to customer B who pays for them. Under pre-Code passage-of-title-by-appropriation doctrine A might reclaim the goods from B. However, no consideration of commercial policy supports this involvement of an innocent third party in the default of the manufacturer on his contract to A; and the common commercial practice of diverting goods in transit suggests a trade understanding in accordance with this subsection. The same result should obtain if the substituted consignee is a lessee in ordinary course. The extent of the lessee's interest in the goods is less than a buyer's interest in the goods. However, as against the rst consignee and the lessee in ordinary course as the substituted consignee, the lessee's rights in the goods as granted under the lease are superior to the rst consignee's rights. 4. Subsection (d) gives the carrier an express right to indemnity where the carrier honors a seller's request to stop delivery. 5. Section 1-202 gives the bailee protection, if due diligence is exercised where the bailee's organization has not had time to act on a notication. Cross References: Point 1: Sections 2-403 and 7-506. Point 2: Sections 2-403 and 2A-304. Point 3: Sections 7-303, 7-403(a)(5) and 7-404. Point 4: Sections 2-705 and 7-403(a)(4). Point 5: Section 1-202. Denitional Cross References: Bailee. Section 7-102. Bill of lading. Section 1-201. Buyer in ordinary course of business. Section 1-201. Consignee. Section 7-102. Consignor. Section 7-102. Creditor. Section 1-201. Delivery. Section 1-201. Document of Title. Section 1-201. Duly negotiate. Section 7-501. Good faith. Section 1-201. [7-102]. Goods. Section 7-102. Honor. Section 1-201. Lessee in ordinary course. Section 2A-103. Notication Section 1-202. Purchaser. Section 1-201. Rights. Section 1-201.

7-505. Indorser not Guarantor for Other Parties. The indorsement of a tangible document of title issued by a bailee does not make the indorser liable for any default by the bailee or previous indorsers.
667

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Art. 7

Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-505. Changes: Limited to tangible documents of title. Purposes: This section is limited to tangible documents of title as the concept of indorsement is irrelevant to electronic documents of title. Electronic documents of title will be transferred by delivery of control. Section 7-106. The indorsement of a tangible document of title is generally understood to be directed towards perfecting the transferee's rights rather than towards assuming additional obligations. The language of the present section, however, does not preclude the one case in which an indorsement given for value guarantees future action, namely, that in which the bailee has not yet become liable upon the document at the time of the indorsement. Under such circumstances the indorser, of course, engages that appropriate honor of the document by the bailee will occur. See Section 7-502(a)(4) as to negotiable delivery orders. However, even in such a case, once the bailee attorns to the transferee, the indorser's obligation has been fullled and the policy of this section excludes any continuing obligation on the part of the indorser for the bailee's ultimate actual performance. Cross Reference: Sections 7-106 and 7-502. Denitional Cross References: Bailee. Section 7-102. Document of title. Section 1-201. Party. Section 1-201.

7-506. Delivery Without Indorsement: Right to Compel Indorsement. The transferee of a negotiable tangible document of title has a specically enforceable right to have its transferor supply any necessary indorsement, but the transfer becomes a negotiation only as of the time the indorsement is supplied. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-506. Changes: Limited to tangible documents of title. Purposes: 1. This section is limited to tangible documents of title as the concept of indorsement is irrelevant to electronic documents of title. Electronic documents of title will be transferred by delivery of control. Section 7-106. From a commercial point of view the intention to transfer a tangible negotiable document of title which requires an indorsement for its transfer, is incompatible with an intention to withhold such indorsement and so defeat the eective use of the document. Further, the preceding section and the Comment thereto make it clear that an indorsement generally imposes no responsibility on the indorser. 2. Although this section provides that delivery of a tangible document of title without the necessary indorsement is eective as a transfer, the transferee, of course, has not regularized its position until such indorsement is supplied. Until this is done the transferee cannot claim rights under due negotiation within the requirements of this Article (Section 7-501(a) (5)) on due negotiation. Similarly, despite the transfer to the transferee of the transferor's title, the transferee cannot demand the goods from the bailee until the negotiation has been completed and the document is in proper form for surrender. See Section 7-403(c). Cross References: Point 1: Sections 7-106 and 7-505. Point 2: Sections 7-501(a)(5) and 7-403(c). Denitional Cross References: Document of title. Section 1-201. Rights. Section 1-201. 668

Art. 7

Documents of Title

7-508

7-507. Warranties on Negotiation or Delivery of Document of Title. If a person negotiates or delivers a document of title for value, otherwise than as a mere intermediary under Section 7-508, unless otherwise agreed, the transferor, in addition to any warranty made in selling or leasing the goods, warrants to its immediate purchaser only that: (1) the document is genuine; (2) the transferor does not have knowledge of any fact that would impair the document's validity or worth; and (3) the negotiation or delivery is rightful and fully eective with respect to the title to the document and the goods it represents. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-507. Changes: Substitution of the word delivery for the word transfer, reference leasing transactions and style. Purposes: 1. Delivery of goods by use of a document of title does not limit or displace the ordinary obligations of a seller or lessor as to any warranties regarding the goods that arises under other law. If the transfer of documents attends or follows the making of a contract for the sale or lease of goods, the general obligations on warranties as to the goods (Sections 2-312 through 2-318 and Sections 2A-210 through 2A-316) are brought to bear as well as the special warranties under this section. 2. The limited warranties of a delivering or collecting intermediary, including a collecting bank, are stated in Section 7-508. Cross References: Point 1: Sections 2-312 through 2-318 and 2A-310-through 2A-316. Point 2: Section 7-508. Denitional Cross References: Delivery. Section 1-201. Document of title. Section 1-201. Genuine. Section 1-201. Goods. Section 7-102. Person. Section 1-201. Purchaser. Section 1-201. Value. Section 1-204.

7-508. Warranties of Collecting Bank as to Documents of Title. A collecting bank or other intermediary known to be entrusted with documents of title on behalf of another or with collection of a draft or other claim against delivery of documents warrants by the delivery of the documents only its own good faith and authority even if the collecting bank or other intermediary has purchased or made advances against the claim or draft to be collected. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-508. Changes: Changes for style only. Purposes: 1. To state the limited warranties given with respect to the documents accompanying a documentary draft. 2. In warranting its authority a collecting bank or other intermediary only warrants its authority from its transferor. See Section 4-203. It does not warrant the genuineness or effectiveness of the document. Compare Section 7-507. 669

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Art. 7

3. Other duties and rights of banks handling documentary drafts for collection are stated in Article 4, Part 5. On the meaning of draft, see Section 4-104 and Section 5-102, comment 11. Cross References: Sections 4-104, 4-203, 4-501 through 4-504, 5-102, and 7-507. Denitional Cross References: Collecting bank. Section 4-105. Delivery. Section 1-201. Document of title. Section 1-102. Documentary draft. Section 4-104. Intermediary bank. Section 4-105. Good faith. Section 1-201 [7-102.]

7-509. Adequate Compliance with Commercial Contract. Whether a document of title is adequate to fulll the obligations of a contract for sale, a contract for lease, or the conditions of a letter of credit is determined by Article 2, 2A, or 5. Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-509. Changes: To reference Article 2A. Purposes: To cross-refer to the Articles of this Act which deal with the substantive issues of the type of document of title required under the contract entered into by the parties. Cross References: Articles 2, 2A and 5. Denitional Cross References: Contract for sale. Section 2-106. Document of title. Section 1-201. Lease. Section 2A-103.

PART 6. WAREHOUSE RECEIPTS AND BILLS OF LADING: MISCELLANEOUS PROVISIONS

7-601. Lost, Stolen, or Destroyed Documents of Title. (a) If a document of title is lost, stolen, or destroyed, a court may order delivery of the goods or issuance of a substitute document and the bailee may without liability to any person comply with the order. If the document was negotiable, a court may not order delivery of the goods or issuance of a substitute document without the claimant's posting security unless it nds that any person that may suer loss as a result of nonsurrender of possession or control of the document is adequately protected against the loss. If the document was nonnegotiable, the court may require security. The court may also order payment of the bailee's reasonable costs and attorney's fees in any action under this subsection. (b) A bailee that, without a court order, delivers goods to a person claiming under a missing negotiable document of title is liable to any person injured thereby. If the delivery is not in good faith, the bailee is liable for conversion. Delivery in good faith is not conversion if the claimant posts security with the bailee in an amount at least double the value of the goods at the time of posting to indemnify any person injured by the delivery which les a notice of claim within one year after the delivery.
670

Art. 7

Documents of Title

7-602

Ocial Comment
Prior Uniform Statutory Provision: Former Section 7-601. Changes: To accommodate electronic documents; to provide exibility to courts similar to the exibility in Section 3-309; to update to the modern era of deregulation; and for style. Purposes: 1. Subsection (a) authorizes courts to order compulsory delivery of the goods or compulsory issuance of a substitute document. Compare Section 7-402. Using language similar to that found in Section 3-309, courts are given discretion as to what is adequate protection when the lost, stolen or destroyed document was negotiable or whether security should be required when the lost, stolen or destroyed document was nonnegotiable. In determining whether a party is adequately protected against loss in the case of a negotiable document, the court should consider the likelihood that the party will suer a loss. The court is also given discretion as to the bailee's costs and attorney fees. The rights and obligations of a bailee under this section depend upon whether the document of title is lost, stolen or destroyed and is in addition to the ability of the bailee to bring an action for interpleader. See Section 7-603. 2. Courts have the authority under this section to order a substitute document for either tangible or electronic documents. If the substitute document will be in a dierent medium than the original document, the court should fashion its order in light of the requirements of Section 7-105. 3. Subsection (b) follows prior Section 7-601 in recognizing the legality of the well established commercial practice of bailees making delivery in good faith when they are satised that the claimant is the person entitled under a missing (i.e. lost , stolen, or destroyed) negotiable document. Acting without a court order, the bailee remains liable on the original negotiable document and, to avoid conversion liability, the bailee may insist that the claimant provide an indemnity bond. Cf. Section 7-403. 4. Claimants on non-negotiable instruments are permitted to avail themselves of the subsection (a) procedure because straight (non-negotiable) bills of lading sometimes contain provisions that the goods shall not be delivered except upon production of the bill. If the carrier should choose to insist upon production of the bill, the consignee should have some means of compelling delivery on satisfactory proof of entitlement. Without a court order, a bailee may deliver, subject to Section 7-403, to a person claiming goods under a nonnegotiable document that the same person claims is lost, stolen, or destroyed. 5. The bailee's lien should be protected when a court orders delivery of the goods pursuant to this section. Cross References: Point 1: Sections 3-309, 7-402 and 7-603. Point 2: Section 7-105. Point 3: Section 7-403. Point 4: Section 7-403. Point 5: Sections 7-209 and 7-307. Denitional Cross References: Bailee. Section 7-102. Delivery. Section 1-201. Document of title. Section 1-201. Good faith. Section 1-201 [7-102]. Goods. Section 7-102. Person. Section 1-201.

7-602. Judicial Process Against Goods Covered by Negotiable Document of Title. Unless a document of title was originally issued upon delivery of the goods by a person that did not have power to dispose of them, a lien does not attach by virtue of any judicial process to goods in the possession of a bailee for which a negotiable document of title is outstanding unless possession or control of the document is rst surrendered to the bailee or the
671

 7-602

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Art. 7

document's negotiation is enjoined. The bailee may not be compelled to deliver the goods pursuant to process until possession or control of the document is surrendered to the bailee or to the court. A purchaser of the document for value without notice of the process or injunction takes free of the lien imposed by judicial process. Ocial Comment
Prior Uniform Statutory Provisions: Former Section 7-602. Changes: Changes to accommodate electronic documents of title and for style. Purposes: 1. The purpose of the section is to protect the bailee from conicting claims of the document of title holder and the judgment creditors of the person who deposited the goods. The rights of the former prevail unless, in eect, the judgment creditors immobilize the negotiable document of title through the surrender of possession of a tangible document or control of an electronic document. However, if the document of title was issued upon deposit of the goods by a person who had no power to dispose of the goods so that the document is ineective to pass title, judgment liens are valid to the extent of the debtor's interest in the goods. 2. The last sentence covers the possibility that the holder of a document who has been enjoined from negotiating it will violate the injunction by negotiating to an innocent purchaser for value. In such case the lien will be defeated. Cross Reference: Sections 7-106 and 7-501 through 7-503. Denitional Cross References: Bailee. Section 7-102. Delivery. Section 1-201. Document of title. Section 1-201. Goods. Section 7-102. Notice. Section 1-202. Person. Section 1-201. Purchase. Section 1-201. Value. Section 1-204.

7-603. Conicting Claims; Interpleader. If more than one person claims title to or possession of the goods, the bailee is excused from delivery until the bailee has a reasonable time to ascertain the validity of the adverse claims or to commence an action for interpleader. The bailee may assert an interpleader either in defending an action for nondelivery of the goods or by original action. Ocial Comment
Prior Uniform Statutory Provisions: Former Section 7-603. Changes: Changes for style only. Purposes: 1. The section enables a bailee faced with conicting claims to the goods to compel the claimants to litigate their claims with each other rather than with the bailee. The bailee is protected from legal liability when the bailee complies with court orders from the interpleader. See e.g. Northwestern National Sales, Inc. v. Commercial Cold Storage, Inc., 162 Ga. App. 741, 293 S.E.2d. 30 (1982). 2. This section allows the bailee to bring an interpleader action but does not provide an exclusive basis for allowing interpleader. If either state or federal procedural rules allow an interpleader in other situations, the bailee may commence an interpleader under those rules. Even in an interpleader to which this section applies, the state or federal process of interpleader applies to the bailee's action for interpleader. For example, state or federal interpleader statutes or rules may permit a bailee to protect its lien or to seek attorney's fees and costs in the interpleader action. Cross reference: 672

Art. 7

Documents of Title

7-704

Point 1: Section 7-403. Denitional Cross References: Action. Section 1-201. Bailee. Section 7-102. Delivery. Section 1-201. Goods. Section 7-102. Person. Section 1-201. Reasonable time. Section 1-205.

PART 7. MISCELLANEOUS PROVISIONS

LEGISLATIVE NOTE: The following provisions should be used to apply to both the Article 7 provisions and the conforming amendments to other articles of the Uniform Commercial Code attached as Appendix I.

7-701. Eective Date. This [Act] takes eect on [ ]. 7-702. Repeals. [Existing Article 7] and [Section 10-104 of the Uniform Commercial Code] are repealed. Ocial Comment
A state should repeal its prior version of Uniform Commercial Code Article 7 on documents of title and Uniform Commercial Code section 10-204. The substance of Section 10-104 has been incorporated into Section 7-103(b).

7-703. Applicability. This [Act] applies to a document of title that is issued or a bailment that arises on or after the eective date of this [Act]. This [Act] does not apply to a document of title that is issued or a bailment that arises before the effective date of this [Act] even if the document of title or bailment would be subject to this [Act] if the document of title had been issued or bailment had arisen on or after the eective date of this [Act]. This [Act] does not apply to a right of action that has accrued before the eective date of this [Act]. Ocial Comment
This Act will apply prospectively only to documents of title issued or bailments that arise after the eective date of the Act.

7-704. Savings Clause. A document of title issued or a bailment that arises before the eective date of this [Act] and the rights, obligations, and interests owing from that document or bailment are governed by any statute or other rule amended or repealed by this [Act] as if amendment or repeal had not occurred and may be terminated, completed, consummated, or enforced under that statute or other rule. Ocial Comment
This Act will apply prospectively only to documents of title issued or bailments that arise after the eective date of the Act. To the extent that issues arise based upon documents of title or rights or obligations that arise prior to the eective date of this Act, prior law will apply to resolve those issues. 673

App. I

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APPENDIX I. CONFORMING AMENDMENTS TO OTHER ARTICLES Amendments to Uniform Commercial Code Article 1 ALTERNATIVE A
Legislative Note: These amendments should be adopted in the event a state has not yet adopted Revised Article 1 as approved in 2001.

1-201. General Denitions. Subject to additional denitions contained in the subsequent Articles of this Act which are applicable to specic Articles or Parts thereof, and unless the context otherwise requires, in this Act: * * * (5) Bearer means a person in control of a negotiable electronic document of title or a the person in possession of an instrument, a negotiable tangible document of title, or a certicated security payable to bearer or indorsed in blank. (6) Bill of lading means a document of title evidencing the receipt of goods for shipment issued by a person engaged in the business of directly or indirectly transporting or forwarding goods. The term does not include a warehouse receipt, and includes an airbill. Airbill means a document serving for air transportation as a bill of lading does for marine or rail transportation, and includes an air consignment note or air waybill. * * * (10) Conspicuous: A term or clause is conspicuous when it is so written that a reasonable person against whom it is to operate ought to have noticed it. A printed heading in capitals (as: NON-NEGOTIABLE BILL OF LADING) is conspicuous. Language in the body of a form is conspicuous if it is in larger or other contrasting type or color. But in a telegram any stated term is conspicuous. Whether a term or clause is conspicuous or not is for decision by the court. (10) Conspicuous, with reference to a term, means so written, displayed, or presented that a reasonable person against which it is to operate ought to have noticed it. Whether a term is conspicuous or not is a decision for the court. Conspicuous terms include the following: (A) a heading in capitals equal to or greater in size than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same or lesser size; and (B) language in the body of a record or display in larger type than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same size, or set o from surrounding text of the same size by symbols or other marks that call attention to the language. * * * (14) Delivery with respect to an electronic document of title means voluntary transfer of control and with respect to instruments, tangible documents of title, chattel paper, or certicated securities means voluntary transfer of possession.
674

Art. 7

Documents of Title

App. I
1-201

(15) Document of title includes bill of lading, dock warrant, dock receipt, warehouse receipt or order for the delivery of goods, and also any other means a record (i) that document which in the regular course of business or nancing is treated as adequately evidencing that the person in possession or control of the record it is entitled to receive, control, hold, and dispose of the record document and the goods it the record covers and (ii) that purports to be issued by or addressed to a bailee and to cover goods in the bailee's possession which are either identied or are fungible portions of an identied mass. The term includes a bill of lading, transport document, dock warrant, dock receipt, warehouse receipt, and order for delivery of goods. To be a document of title, a document must purport to be issued by or addressed to a bailee and purport to cover goods in the bailee's possession which are either identied or are fungible portions of an identied mass. An electronic document of title means a document of title evidenced by a record consisting of information stored in an electronic medium. A tangible document of title means a document of title evidenced by a record consisting of information that is inscribed on a tangible medium. * * * (20) Holder, with respect to a negotiable instrument, means the person in possession if the instrument is payable to bearer or, in the case of an instrument payable to an identied person, if the identied person is in possession. Holder with respect to a document of title means the person in possession if the goods are deliverable to bearer or to the order of the person in possession. Holder means: (A) the person in possession of a negotiable instrument that is payable either to bearer or to an identied person that is the person in possession; (B) the person in possession of a negotiable tangible document of title if the goods are deliverable either to bearer or to the order of the person in possession; or (C) the person in control of a negotiable electronic document of title. * * * (25) Subject to subsection (27), a A person has notice of a fact if the person when (a) he has actual knowledge of it; or (b) he has received a notice or notication of it; or (c) from all the facts and circumstances known to him the person at the time in question, he has reason to know that it exists. A person knows or has knowledge of a fact when the person he has actual knowledge of it. Discover or learn or a word or phrase of similar import refers to knowledge rather than to reason to know. The time and circumstances under which a notice or notication may cease to be eective are not determined by this Act. (26) A person noties or gives a notice or notication to another person by taking such steps as may be reasonably required to inform the
675

App. I
1-201

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Art. 7

other person in ordinary course, whether or not such other the other person actually comes to know of it. Subject to subsection (27), a A person receives a notice or notication when (a) it comes to his that person's attention; or (b) it is duly delivered in a form reasonable under the circumstances at the place of business through which the contract was made or at another location any other place held out by that person him as the place for receipt of such communications. (27) Notice, knowledge, or a notice or notication received by an organization is eective for a particular transaction from the time when it is brought to the attention of the individual conducting that transaction, and in any event, from the time when it would have been brought to the individual's his attention if the organization had exercised due diligence. An organization exercises due diligence if it maintains reasonable routines for communicating signicant information to the person conducting the transaction and there is reasonable compliance with the routines. Due diligence does not require an individual acting for the organization to communicate information unless such communication is part of the individual's his regular duties or the individual unless he has reason to know of the transaction and that the transaction would be materially aected by the information. * * * (38) Send in connection with any writing or notice means to deposit in the mail or deliver for transmission by any other usual means of communication with postage or cost of transmission provided for and properly addressed and in the case of an instrument to an address specied thereon or otherwise agreed, or if there be none to any address reasonable under the circumstances. The receipt of any writing or notice within the time at which it would have arrived if properly sent has the eect of a proper signing. (38) Send in connection with a writing, record, or notice means: (A) to deposit in the mail or deliver for transmission by any other usual means of communication with postage or cost of transmission provided for and properly addressed and, in the case of an instrument, to an address specied thereon or otherwise agreed, or if there be none to any address reasonable under the circumstances; or (B) in any other way to cause to be received any record or notice within the time it would have arrived if properly sent. * * * (45) Warehouse receipt means a document of title receipt issued by a person engaged in the business of storing goods for hire. Ocial Comment * * *
5. Bearer. From Section 191, Uniform Negotiable Instruments Law. The prior denition has been broadened. The term bearer applies to negotiable documents of title and has been broadened to include a person in control of an electronic negotiable document of title. Control of an electronic document of title is dened in Article 7 (Section 7-106). 6. Bill of Lading. See similar denitions in Section 1, Uniform Bills of Lading Act. The denition has been enlarged to include freight forwarders' bills and bills issued by contract 676

Art. 7

Documents of Title

App. I
1-201

carriers as well as those issued by common carriers. The denition of airbill is new. A bill of lading is one type of document of title as dened in subsection (15). This denition should be read in conjunction with the denition of carrier in Article 7 (Section 7-102).

* * *
10. Conspicuous. New. This is intended to indicate some of the methods of making a term attention-calling. But the test is whether attention can reasonably be expected to be called to it. This denition states the general standard that to be conspicuous a term ought to be noticed by a reasonable person. Whether a term is conspicuous is an issue for the court. Subparagraphs (A) and (B) set out several methods for making a term conspicuous. Requiring that a term be conspicuous blends a notice function (the term ought to be noticed) and a planning function (giving guidance to the party relying on the term regarding how that result can be achieved). Although these paragraphs indicate some of the methods for making a term attention-calling, the test is whether attention can reasonably be expected to be called to it. The statutory language should not be construed to permit a result that is inconsistent with that test.

* * *
14. Delivery. Section 76, Uniform Sales Act, Section 191, Uniform Negotiable Instruments Law, Section 58, Uniform Warehouse Receipts Act and Section 53, Uniform Bills of Lading Act. The denition has been revised to accommodate electronic documents of title. Control of an electronic document of title is dened in Article 7 (Section 7-106). 15.Document of title. From Section 76, Uniform Sales Act, but rephrased to eliminate certain ambiguities. This denition makes explicit Thus, by making it explicit that the obligation or designation of a third party as bailee is essential to a document, this denition and clearly rejects any such result as obtained in Hixson v. Ward, 254 Ill.App. 505 (1929), which treated a conditional sales contract as a document of title. Also the denition is left open so that new types of documents may be included, including documents which gain commercial recognition in the international arena. See UNCITRAL Draft Instrument on the Carriage of Goods by Sea. It is unforeseeable what documents may one day serve the essential purpose now lled by warehouse receipts and bills of lading. Truck transport has already opened up problems which do not t the patterns of practice resting upon the assumption that a draft can move through banking channels faster than the goods themselves can reach their destination. There lie ahead air transport and such probabilities as teletype transmission of what may some day be regarded commercially as Documents of Title. The denition is stated in terms of the function of the documents with the intention that any document which gains commercial recognition as accomplishing the desired result shall be included within its scope. Fungible goods are adequately identied within the language of the denition by identication of the mass of which they are a part. Dock warrants were within the Sales Act denition of document of title apparently for the purpose of recognizing a valid tender by means of such paper. In current commercial practice a dock warrant or receipt is a kind of interim certicate issued by steamship shipping companies upon delivery of the goods at the dock, entitling a designated person to have issued to him at the company's oce to be issued a bill of lading. The receipt itself is invariably nonnegotiable in form although it may indicate that a negotiable bill is to be forthcoming. Such a document is not within the general compass of the denition, although trade usage may in some cases entitle such paper to be treated as a document of title. If the dock receipt actually represents a storage obligation undertaken by the shipping company, then it is a warehouse receipt within this Section regardless of the name given to the instrument. The goods must be described, but the description may be by marks or labels and may be qualied in such a way as to disclaim personal knowledge of the issuer regarding contents or condition. However, baggage and parcel checks and similar tokens of storage which identify stored goods only as those received in exchange for the token are not covered by this Article. The denition is broad enough to include an airway bill. A document of title may be either tangible or electronic. Tangible documents of title should be construed to mean traditional paper documents. Electronic documents of title are documents that are stored in an electronic medium instead of in tangible form. The concept of an electronic medium should be construed liberally to include electronic, digital, magnetic, optical, electromagnetic, or any other current or similar emerging technologies. As to reissuing a document of title in an alternative medium, see Article 7, Section 7-105. Control for electronic 677

App. I
1-201

Uniform Commercial Code

Art. 7

documents of title is dened in Article 7 (Section 7-106).

* * *
19. Good faith. See Section 76(2), Uniform Sales Act; Section 58(2), Uniform Warehouse Receipts Act; Section 53(2), Uniform Bills of Lading Act; Section 22(2), Uniform Stock Transfer Act. Good faith, whenever it is used in the Code, means at least what is here stated. In certain Articles, by specic provision, additional requirements are made applicable. See, e.g., Secs. 2-103(1)(b), 7-404. To illustrate, in the Article on Sales, Section 2-103, good faith is expressly dened as including in the case of a merchant observance of reasonable commercial standards of fair dealing in the trade, so that throughout that Article wherever a merchant appears in the case an inquiry into his observance of such standards is necessary to determine his good faith. 20. Holder. See similar denitions in Section 191, Uniform Negotiable Instruments Law; Section 58, Uniform Warehouse Receipts Act; Section 53, Uniform Bills of Lading Act. The denition has been amended to provide for electronic negotiable documents of title.

* * *
25. Notice. New. Compare N.I.L. Sec. 56. Under the denition a person has notice when he has received a notication of the fact in question. But by the last sentence the act leaves open the time and circumstances under which notice or notication may cease to be eective. Therefore such cases as Graham v. White-Phillips Co., 296 U.S. 27, 56 S.Ct. 21, 80 L.Ed. 20 (1935), are not overruled. 26. Noties. New. This is the word used when the essential fact is the proper dispatch of the notice, not its receipt. Compare Send. When the essential fact is the other party's receipt of the notice, that is stated. The second sentence states when a notication is received. 27. New. This makes clear that reason to know, knowledge, or a notication, although received for instance by a clerk in Department A of an organization, is eective for a transaction conducted in Department B only from the time when it was or should have been communicated to the individual conducting that transaction. A person has notice of a fact when, inter alia, the person has received a notication of the fact in question. The word noties is used when the essential fact is the proper dispatch of the notice, not its receipt. Compare send. When the essential fact is the other party's receipt of the notice, that is stated. Subsection (26) states when a notication is received. Subsection (27) makes clear that notice, knowledge, or a notication, although received, for instance, by a clerk in Department A of an organization, is eective for a transaction conducted in Department B only from the time when it was or should have been communicated to the individual conducting that transaction.

* * *
38. Send. New. Compare noties. The denition of send has been modied to allow for electronic dispatch.

* * *
45. Warehouse receipt. See Section 76(1), Uniform Sales Act; Section 1, Uniform Warehouse Receipts Act. Receipts issued by a eld warehouse are included, provided the warehouseman and the depositor of the goods are dierent persons. The denition makes clear that the receipt must qualify as a document of title under subsection (15).

ALTERNATIVE B
Legislative Note: These amendments should be used if the jurisdiction has enacted or is enacting at the same time as this Act the provisions of Revised Article 1 as approved in 2001.

1-201. General Denitions. * * * (b) Subject to denitions contained in other articles of [the Uniform Commercial Code] that apply to particular articles or parts thereof: * * *
678

Art. 7

Documents of Title

App. I
1-201

(5) Bearer means a person in control of a negotiable electronic document of title or a person in possession of a negotiable instrument, negotiable tangible document of title, or certicated security that is payable to bearer or indorsed in blank. (6) Bill of lading means a document of title evidencing the receipt of goods for shipment issued by a person engaged in the business of directly or indirectly transporting or forwarding goods. The term does not include a warehouse receipt. * * * (15) Delivery, with respect to an electronic document of title means voluntary transfer of control and with respect to an instrument, a tangible document of title, or chattel paper, means voluntary transfer of possession. (16) Document of title includes bill of lading, dock warrant, dock receipt, warehouse receipt or order for the delivery of goods, and also any other means a record (i) that document which in the regular course of business or nancing is treated as adequately evidencing that the person in possession or control of the record it is entitled to receive, control, hold, and dispose of the record document and the goods it the record covers and (ii) that purports to be issued by or addressed to a bailee and to cover goods in the bailee's possession which are either identied or are fungible portions of an identied mass. The term includes a bill of lading, transport document, dock warrant, dock receipt, warehouse receipt, and order for delivery of goods. To be a document of title, a document must purport to be issued by or addressed to a bailee and purport to cover goods in the bailee's possession which are either identied or are fungible portions of an identied mass. An electronic document of title means a document of title evidenced by a record consisting of information stored in an electronic medium. A tangible document of title means a document of title evidenced by a record consisting of information that is inscribed on a tangible medium. * * * (21) Holder means: (A) the person in possession of a negotiable instrument that is payable either to bearer or to an identied person that is the person in possession; or (B) the person in possession of a negotiable tangible document of title if the goods are deliverable either to bearer or to the order of the person in possession; or (C) the person in control of a negotiable electronic document of title. * * * (42) Warehouse receipt means a document of title receipt issued by a person engaged in the business of storing goods for hire. Ocial Comment
5. Bearer.Unchanged, except in one respect, from former section 1-201, which was derived from Section 191, Uniform Negotiable Instruments Law. The term bearer applies to negotiable documents of title and has been broadened to include a person in control of an electronic negotiable document of title. Control of an electronic document of title is dened in Article 7 (Section 7-106). 679

App. I
1-201

Uniform Commercial Code

Art. 7

6. Bill of Lading. Derived from former Section 1-201. The reference to, and denition of, an airbill has been deleted as no longer necessary. A bill of lading is one type of document of title as dened in subsection (16). This denition should be read in conjunction with the denition of carrier in Article 7 (Section 7-102).

* * *
15. Delivery. Derived from former Section 1-201. The reference to certicated securities has been deleted in light of the more specic treatment of the matter in Section 8-301. The denition has been revised to accommodate electronic documents of title. Control of an electronic document of title is dened in Article 7 (Section 7-106). 16.Document of title. Unchanged Derived from former Section 1-201, which was derived from Section 76, Uniform Sales Act. This denition makes explicit Thus, by making it explicit that the obligation or designation of a third party as bailee is essential to a document of title, this denition and clearly rejects any such result as obtained in Hixson v. Ward, 254 Ill.App. 505 (1929), which treated a conditional sales contract as a document of title. Also the denition is left open so that new types of documents may be included, including documents which gain commercial recognition in the international arena. See UNCITRAL Draft Instrument on the Carriage of Goods By Sea. It is unforeseeable what documents may one day serve the essential purpose now lled by warehouse receipts and bills of lading. Truck transport has already opened up problems which do not t the patterns of practice resting upon the assumption that a draft can move through banking channels faster than the goods themselves can reach their destination. There lie ahead air transport and such probabilities as teletype transmission of what may some day be regarded commercially as Documents of Title. The denition is stated in terms of the function of the documents with the intention that any document which gains commercial recognition as accomplishing the desired result shall be included within its scope. Fungible goods are adequately identied within the language of the denition by identication of the mass of which they are a part. Dock warrants were within the Sales Act denition of document of title apparently for the purpose of recognizing a valid tender by means of such paper. In current commercial practice a dock warrant or receipt is a kind of interim certicate issued by steamship shipping companies upon delivery of the goods at the dock, entitling a designated person to have issued to him at the company's oce to be issued a bill of lading. The receipt itself is invariably nonnegotiable in form although it may indicate that a negotiable bill is to be forthcoming. Such a document is not within the general compass of the denition, although trade usage may in some cases entitle such paper to be treated as a document of title. If the dock receipt actually represents a storage obligation undertaken by the shipping company, then it is a warehouse receipt within this Section regardless of the name given to the instrument. The goods must be described, but the description may be by marks or labels and may be qualied in such a way as to disclaim personal knowledge of the issuer regarding contents or condition. However, baggage and parcel checks and similar tokens of storage which identify stored goods only as those received in exchange for the token are not covered by this Article. The denition is broad enough to include an airway bill. A document of title may be either tangible or electronic. Tangible documents of title should be construed to mean traditional paper documents. Electronic documents of title are documents that are stored in an electronic medium instead of in tangible form. The concept of an electronic medium should be construed liberally to include electronic, digital, magnetic, optical, electromagnetic, or any other current or similar emerging technologies. As to reissuing a document of title in an alternative medium, see Article 7, Section 7-105. Control for electronic documents of title is dened in Article 7 (Section 7-106).

* * *
21. Holder. Derived from former Section 1-201. The denition has been reorganized for clarity and amended to provide for electronic negotiable documents of title.

* * *
42. Warehouse receipt. Unchanged Derived from former Section 1-201, which was derived from Section 76(1), Uniform Sales Act; Section 1, Uniform Warehouse Receipts Act. Receipts issued by a eld warehouse are included, provided the warehouseman and the depositor of the goods are dierent persons. The denition makes clear that the receipt must qualify as a document of title under subsection (16). 680

Art. 7

Documents of Title

App. I
2-308

Amendments to Uniform Commercial Code Article 2

Legislative Note: These amendments should be adopted in the event a state has not yet adopted Amended Article 2 as approved in 2003.

2-103. Denitions and Index of Denitions. * * * (3) Control as provided in Section 7-106 and the following denitions in other Articles apply to this Article: Check. Section 3-104. Consignee. Section 7-102. Consignor. Section 7-102. Consumer Goods. Section 9-102. Dishonor. Section 3-502. Draft. Section 3-104. Ocial Comment * * *
2. Receipt must be distinguished from delivery particularly in regard to the problems arising out of shipment of goods, whether or not the contract calls for making delivery by way of documents of title, since the seller may frequently fulll his obligations to deliver even though the buyer may never receive the goods. Delivery with respect to documents of title is dened in Article 1 and requires transfer of physical delivery of a tangible document of title and transfer of control of an electronic document of title. Otherwise the many divergent incidents of delivery are handled incident by incident.

2-104. Denitions: Merchant; Between Merchants; Financing Agency. * * * (2) Financing agency means a bank, nance company or other person who in the ordinary course of business makes advances against goods or documents of title or who by arrangement with either the seller or the buyer intervenes in ordinary course to make or collect payment due or claimed under the contract for sale, as by purchasing or paying the seller's draft or making advances against it or by merely taking it for collection whether or not documents of title accompany or are associated with the draft. Financing agency includes also a bank or other person who similarly intervenes between persons who are in the position of seller and buyer in respect to the goods (Section 2-707). * * * 2-308. Absence of Specied Place for Delivery. Ocial Comment
3. Where customary banking channels call only for due notication by the banker that the documents are available on hand, leaving the buyer himself to see to the physical receipt of the goods, tender at the buyer's address is not required under paragraph (c). But that paragraph merely eliminates the possibility of a default by the seller if customary banking channels have been properly used in giving notice to the buyer. Where the bank has purchased a draft accompanied by or associated with documents or has undertaken its collection on behalf of the seller, Part 5 of Article 4 spells out its duties and relations to its customer. Where the documents move forward under a letter of credit the Article on Letters of Credit spells out the duties and relations between the bank, the seller and the buyer. Delivery in relationship to either tangible or electronic documents of title is dened in 681

App. I
2-308

Uniform Commercial Code

Art. 7

Article 1, Section 1-201.

2-310. Open Time for Payment or Running of Credit; Authority to Ship Under Reservation. Unless otherwise agreed (a) payment is due at the time and place at which the buyer is to receive the goods even though the place of shipment is the place of delivery; and (b) if the seller is authorized to send the goods he may ship them under reservation, and may tender the documents of title, but the buyer may inspect the goods after their arrival before payment is due unless such inspection is inconsistent with the terms of the contract (Section 2-513); and (c) if delivery is authorized and made by way of documents of title otherwise than by subsection (b) then payment is due regardless of where the goods are to be received (i) at the time and place at which the buyer is to receive delivery of the tangible documents or (ii) at the time the buyer is to receive delivery of the electronic documents and at the seller's place of business or if none, the seller's residence regardless of where the goods are to be received; and (d) where the seller is required or authorized to ship the goods on credit the credit period runs from the time of shipment but post-dating the invoice or delaying its dispatch will correspondingly delay the starting of the credit period. Ocial Comment * * *
2. Paragraph (b) while providing for inspection by the buyer before he pays, protects the seller. He is not required to give up possession of the goods until he has received payment, where no credit has been contemplated by the parties. The seller may collect through a bank by a sight draft against an order bill of lading hold until arrival; inspection allowed. The obligations of the bank under such a provision are set forth in Part 5 of Article 4. Under subsection (c), in the absence of a credit term, the seller is permitted to ship under reservation and if he does payment is then due where and when the buyer is to receive delivery of the tangible documents of title. In the case of an electronic document of title, payment is due when the buyer is to receive delivery of the electronic document and at the seller's place of business, or if none, the seller's residence. Delivery as to documents of title is stated in Article 1, Section 1-201. 3. Unless otherwise agreed, the place for the receipt delivery of the documents and payment is the buyer's city but the time for payment is only after arrival of the goods, since under paragraph (b), and Sections 2-512 and 2-513 the buyer is under no duty to pay prior to inspection. Tender of a document of title requires that the seller be ready, willing and able to transfer possession of a tangible document of title or control of an electronic document of title to the buyer.

* * * 2-320. C.I.F. and C. & F. Terms. Ocial Comment * * *

5. The seller is given the option of paying or providing for the payment of freight. He has no option to ship freight collect unless the agreement so provides. The rule of the common law that the buyer need not pay the freight if the goods do not arrive is preserved. Unless the shipment has been sent freight collect the buyer is entitled to receive 682

Art. 7

Documents of Title

App. I
2-323

documentary evidence that he is not obligated to pay the freight; the seller is therefore required to obtain a receipt showing that the freight has been paid or provided for. The usual notation in the appropriate space on the bill of lading that the freight has been prepaid is a sucient receipt, as at common law. The phrase provided for is intended to cover the frequent situation in which the carrier extends credit to a shipper for the freight on successive shipments and receives periodical payments of the accrued freight charges from him.

* * *
11. The buyer needs all of the documents required under a C.I.F. contract, in due form and , if a tangible document of title, with necessary endorsements, so that before the goods arrive he may deal with them by negotiating the documents or may obtain prompt possession of the goods after their arrival. If the goods are lost or damaged in transit the documents are necessary to enable him promptly to assert his remedy against the carrier or insurer. The seller is therefore obligated to do what is mercantilely reasonable in the circumstances and should make every reasonable exertion to send forward the documents as soon as possible after the shipment. The requirement that the documents be forwarded with commercial promptness expresses a more urgent need for action than that suggested by the phrase reasonable time.

* * * 2-323. Form of Bill of Lading Required in Overseas Shipment; Overseas. (1) Where the contract contemplates overseas shipment and contains a term C.I.F. or C. & F. or F.O.B. vessel, the seller unless otherwise agreed must obtain a negotiable bill of lading stating that the goods have been loaded in board or, in the case of a term C.I.F. or C. & F., received for shipment. (2) Where in a case within subsection (1) a tangible bill of lading has been issued in a set of parts, unless otherwise agreed if the documents are not to be sent from abroad the buyer may demand tender of the full set; otherwise only one part of the bill of lading need be tendered. Even if the agreement expressly requires a full set (a) due tender of a single part is acceptable within the provisions of this Article on cure of improper delivery (subsection (1) of Section 2-508); and (b) even though the full set is demanded, if the documents are sent from abroad the person tendering an incomplete set may nevertheless require payment upon furnishing an indemnity which the buyer in good faith deems adequate. * * * Ocial Comment * * *
2. Subsection (2) deals with the problem of bills of lading covering deep water shipments, issued not as a single bill of lading but in a set of parts, each part referring to the other parts and the entire set constituting in commercial practice and at law a single bill of lading. Commercial practice in international commerce is to accept and pay against presentation of the rst part of a set if the part is sent from overseas even though the contract of the buyer requires presentation of a full set of bills of lading provided adequate indemnity for the missing parts is forthcoming. In accord with the amendment to Section 7-304, bills of lading in a set are limited to tangible bills.

* * *
683

App. I
2-401

Uniform Commercial Code

Art. 7

2-401. Passing of Title; Reservation for Security; Limited Application of This Section. Each provision of this Article with regard to the rights, obligations and remedies of the seller, the buyer, purchasers or other third parties applies irrespective of title to the goods except where the provision refers to such title. Insofar as situations are not covered by the other provisions of this Article and matters concerning title become material the following rules apply: (1) Title to goods cannot pass under a contract for sale prior to their identication to the contract (Section 2-501), and unless otherwise explicitly agreed the buyer acquires by their identication a special property as limited by this Act. Any retention or reservation by the seller of the title (property) in goods shipped or delivered to the buyer is limited in effect to a reservation of a security interest. Subject to these provisions and to the provisions of the Article on Secured Transactions (Article 9), title to goods passes from the seller to the buyer in any manner and on any conditions explicitly agreed on by the parties. (2) Unless otherwise explicitly agreed title passes to the buyer at the time and place at which the seller completes his performance with reference to the physical delivery of the goods, despite any reservation of a security interest and even though a document of title is to be delivered at a dierent time or place; and in particular and despite any reservation of a security interest by the bill of lading (a) if the contract requires or authorizes the seller to send the goods to the buyer but does not require him to deliver them at destination, title passes to the buyer at the time and place of shipment; but (b) if the contract requires delivery at destination, title passes on tender there. (3) Unless otherwise explicitly agreed where delivery is to be made without moving the goods, (a) if the seller is to deliver a tangible document of title, title passes at the time when and the place where he delivers such documents and if the seller is to deliver an electronic document of title, title passes when the seller delivers the document; or (b) if the goods are at the time of contracting already identied and no documents of title are to be delivered, title passes at the time and place of contracting. (4) A rejection or other refusal by the buyer to receive or retain the goods, whether or not justied, or a justied revocation of acceptance revests title to the goods in the seller. Such revesting occurs by operation of law and is not a sale. Ocial Comment * * *
4. The factual situations in subsections (2) and (3) upon which passage of title turn actually base the test upon the time when the seller has nally committed himself in regard to specic goods. Thus in a shipment contract he commits himself by the act of making the shipment. If shipment is not contemplated subsection (3) turns on the seller's nal commitment, i.e. the delivery of documents or the making of the contract. As to delivery of an electronic document of title, see denition of delivery in Article 1, Section 1-201. This Article 684

Art. 7

Documents of Title

App. I
2-503

does not state a rule as to the place of title passage as to goods covered by an electronic document of title.

2-403. Power to Transfer; Good Faith Purchase of Goods; Entrusting. Ocial Comment * * *
2. The many particular situations in which a buyer in ordinary course of business from a dealer has been protected against reservation of property or other hidden interest are gathered by subsections (2)(4) into a single principle protecting persons who buy in ordinary course out of inventory. Consignors have no reason to complain, nor have lenders who hold a security interest in the inventory, since the very purpose of goods in inventory is to be turned into cash by sale. The principle is extended in subsection (3) to t with the abolition of the old law of cash sale by subsection (1)(c). It is also freed from any technicalities depending on the extended law of larceny; such extension of the concept of theft to include trick, particular types of fraud, and the like is for the purpose of helping conviction of the oender; it has no proper application to the long-standing policy of civil protection of buyers from persons guilty of such trick or fraud. Finally, the policy is extended, in the interest of simplicity and sense, to any entrusting by a bailor; this is in consonance with the explicit provisions of Section 7-205 on the powers of a warehouseman who is also in the business of buying and selling fungible goods of the kind he warehouses stores. As to entrusting by a secured party, subsection (2) is limited by the more specic provisions of Section 9-320, which deny protection to a person buying farm products from a person engaged in farming operations.

* * * 2-503. Manner of Seller's Tender of Delivery. * * * (4) Where goods are in the possession of a bailee and are to be delivered without being moved (a) tender requires that the seller either tender a negotiable document of title covering such goods or procure acknowledgment by the bailee of the buyer's right to possession of the goods; but (b) tender to the buyer of a non-negotiable document of title or of a written direction to record directing the bailee to deliver is sucient tender unless the buyer seasonably objects, and except as otherwise provided in Article 9 receipt by the bailee of notication of the buyer's rights xes those rights as against the bailee and all third persons; but risk of loss of the goods and of any failure by the bailee to honor the non-negotiable document of title or to obey the direction remains on the seller until the buyer has had a reasonable time to present the document or direction, and a refusal by the bailee to honor the document or to obey the direction defeats the tender. (5) Where the contract requires the seller to deliver documents (a) he must tender all such documents in correct form, except as provided in this Article with respect to bills of lading in a set (subsection (2) of Section 2-323); and (b) tender through customary banking channels is sucient and dishonor of a draft accompanying or associated with the documents constitutes non-acceptance or rejection. Ocial Comment
1. The major general rules governing the manner of proper or due tender of delivery are gathered in this section. The term tender is used in this Article in two dierent senses. In 685

App. I
2-503

Uniform Commercial Code

Art. 7

one sense it refers to due tender which contemplates an oer coupled with a present ability to fulll all the conditions resting on the tendering party and must be followed by actual performance if the other party shows himself ready to proceed. Unless the context unmistakably indicates otherwise this is the meaning of tender in this Article and the occasional addition of the word due is only for clarity and emphasis. At other times it is used to refer to an oer of goods or documents under a contract as if in fulllment of its conditions even though there is a defect when measured against the contract obligation. Used in either sense, however, tender connotes such performance by the tendering party as puts the other party in default if he fails to proceed in some manner. These concepts of tender would apply to tender of either tangible or electronic documents of title.

* * *
7. Under subsection (5) documents are never required except where there is an express contract term or it is plainly implicit in the peculiar circumstances of the case or in a usage of trade. Documents may, of course, be authorized although not required, but such cases are not within the scope of this subsection. When documents are required, there are three main requirements of this subsection: (1) All: each required document is essential to a proper tender; (2) Such: the documents must be the ones actually required by the contract in terms of source and substance; (3) Correct form: All documents must be in correct form. These requirements apply to both tangible and electronic documents of title. When tender is made through customary banking channels, a draft may accompany or be associated with a document of title. The language has been broadened to allow for drafts to be associated with an electronic document of title. Compare Section 2-104(2) denition of nancing agency. When a prescribed document cannot be procured, a question of fact arises under the provision of this Article on substituted performance as to whether the agreed manner of delivery is actually commercially impracticable and whether the substitute is commercially reasonable.

2-505. Seller's Shipment Under Reservation. (1) Where the seller has identied goods to the contract by or before shipment: (a) his procurement of a negotiable bill of lading to his own order or otherwise reserves in him a security interest in the goods. His procurement of the bill to the order of a nancing agency or of the buyer indicates in addition only the seller's expectation of transferring that interest to the person named. (b) a non-negotiable bill of lading to himself or his nominee reserves possession of the goods as security but except in a case of conditional delivery (subsection (2) of Section 2-507) a non-negotiable bill of lading naming the buyer as consignee reserves no security interest even though the seller retains possession or control of the bill of lading. (2) When shipment by the seller with reservation of a security interest is in violation of the contract for sale it constitutes an improper contract for transportation within the preceding section but impairs neither the rights given to the buyer by shipment and identication of the goods to the contract nor the seller's powers as a holder of a negotiable document of title. Ocial Comment * * *
5. Under subsection (2) an improper reservation by the seller which would constitute a breach in no way impairs such of the buyer's rights as result from identication of the goods. The security title reserved by the seller under subsection (1) does not protect his holding retaining possession or control of the document or the goods for the purpose of exacting more than is due him under the contract. 686

Art. 7

Documents of Title

App. I
2-513

2-506. Rights of Financing Agency. * * * (2) The right to reimbursement of a nancing agency which has in good faith honored or purchased the draft under commitment to or authority from the buyer is not impaired by subsequent discovery of defects with reference to any relevant document which was apparently regular on its face. Ocial Comment * * *
5. The deletion of the language on its face from subsection (2) is designed to accommodate electronic documents of title without changing the requirement of regularity of the document.

2-509. Risk of Loss in The Absence of Breach. * * * (2) Where the goods are held by a bailee to be delivered without being moved, the risk of loss passes to the buyer (a) on his receipt of possession or control of a negotiable document of title covering the goods; or (b) on acknowledgment by the bailee of the buyer's right to possession of the goods; or (c) after his receipt of possession or control of a non-negotiable document of title or other written direction to deliver in a record, as provided in subsection (4)(b) of Section 2-503. * * * Ocial Comment * * *
4. Where the agreement provides for delivery of the goods as between the buyer and seller without removal from the physical possession of a bailee, the provisions on manner of tender of delivery apply on the point of transfer of risk. Due delivery of a negotiable document of title covering the goods or acknowledgment by the bailee that he holds for the buyer completes the delivery and passes the risk. See denition of delivery in Article 1, Section 1-201 and the denition of control in Article 7, Section 7-106.

* * * 2-513. Buyer's Right to Inspection of the Goods. Ocial Comment * * *

5. In the case of payment against documents, subsection (3) requires payment before inspection, since shipping documents against which payment is to be made will commonly arrive and be tendered while the goods are still in transit. This Article recognizes no exception in any peculiar case in which the goods happen to arrive before the documents are tendered. However, where by the agreement payment is to await the arrival of the goods, inspection before payment becomes proper since the goods are then available for inspection. Where by the agreement the documents are to be held to be tendered after until arrival of the goods, the buyer is entitled to inspect before payment since the goods are then available for inspection. Proof of usage is not necessary to establish this right, but if inspection before payment is disputed the contrary must be established by usage or by an explicit contract term to that eect. For the same reason, that the goods are available for inspection, a term calling for payment against storage documents or a delivery order does not normally bar the buyer's right 687

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Art. 7

to inspection before payment under subsection (3)(b). This result is reinforced by the buyer's right under subsection (1) to inspect goods which have been appropriated with notice to him.

* * * 2-605. Waiver of Buyer's Objections by Failure to Particularize. * * * (2) Payment against documents made without reservation of rights precludes recovery of the payment for defects apparent on the face of in the documents. Ocial Comment * * *
4. Subsection (2) applies to the particular case of documents the same principle which the section on eects of acceptance applies to the case of goods. The matter is dealt with in this section in terms of waiver of objections rather than of right to revoke acceptance, partly to avoid any confusion with the problems of acceptance of goods and partly because defects in documents which are not taken as grounds for rejection are generally minor ones. The only defects concerned in the present subsection are defects in the documents which are apparent. on their face. This rule applies to both tangible and electronic documents of title. Where payment is required against the documents they must be inspected before payment, and the payment then constitutes acceptance of the documents. Under the section dealing with this problem, such acceptance of the documents does not constitute an acceptance of the goods or impair any options or remedies of the buyer for their improper delivery. Where the documents are delivered without requiring such contemporary action as payment from the buyer, the reason of the next section on what constitutes acceptance of goods, applies. Their acceptance by non-objection is therefore postponed until after a reasonable time for their inspection. In either situation, however, the buyer waives only what is the defects apparent on the face of in the documents.

2-705. Seller's Stoppage of Delivery in Transit or Otherwise. * * * (2) As against such buyer the seller may stop delivery until (a) receipt of the goods by the buyer; or (b) acknowledgment to the buyer by any bailee of the goods except a carrier that the bailee holds the goods for the buyer; or (c) such acknowledgment to the buyer by a carrier by reshipment or as a warehouseman; or (d) negotiation to the buyer of any negotiable document of title covering the goods. (3) (a) To stop delivery the seller must so notify as to enable the bailee by reasonable diligence to prevent delivery of the goods. (b) After such notication the bailee must hold and deliver the goods according to the directions of the seller but the seller is liable to the bailee for any ensuing charges or damages. (c) If a negotiable document of title has been issued for goods the bailee is not obliged to obey a notication to stop until surrender of possession or control of the document. (d) A carrier who has issued a non-negotiable bill of lading is not obliged to obey a notication to stop received from a person other than the consignor.
688

Art. 7

Documents of Title

App. I
2A-526

Ocial Comment * * *
3. A diversion of a shipment is not a reshipment under subsection (2)(c) when it is merely an incident to the original contract of transportation. Nor is the procurement of exchange bills of lading which change only the name of the consignee to that of the buyer's local agent but do not alter the destination of a reshipment. Acknowledgment by the carrier as a warehouseman within the meaning of this Article requires a contract of a truly dierent character from the original shipment, a contract not in extension of transit but as a warehouseman. 4. Subsection (3)(c) makes the bailee's obedience of a notication to stop conditional upon the surrender of possession or control of any outstanding negotiable document.

* * *

Amendments to Uniform Commercial Code Article 2A

Legislative Note: These amendments should be used if the jurisdiction has not yet adopted Amended Article 2A as approved in 2003.

2A-103. Denitions and Index of Denitions. (1) In this Article unless the context otherwise requires: (a) Buyer in ordinary course of business means a person who in good faith and without knowledge that the sale to him [or her] is in violation of the ownership rights or security interest or leasehold interest of a third party in the goods, buys in ordinary course from a person in the business of selling goods of that kind but does not include a pawnbroker. Buying may be for cash or by exchange of other property or on secured or unsecured credit and includes receiving acquiring goods or documents of title under a pre-existing contract for sale but does not include a transfer in bulk or as security for or in total or partial satisfaction of a money debt. * * * (o) Lessee in ordinary course of business means a person who in good faith and without knowledge that the lease to him [or her] is in violation of the ownership rights or security interest or leasehold interest of a third party in the goods, leases in ordinary course from a person in the business of selling or leasing goods of that kind but does not include a pawnbroker. Leasing may be for cash or by exchange of other property or on secured or unsecured credit and includes receiving acquiring goods or documents of title under a pre-existing lease contract but does not include a transfer in bulk or as security for or in total or partial satisfaction of a money debt. * * * 2A-514. Waiver of Lessee's Objections. * * * (2) A lessee's failure to reserve rights when paying rent or other consideration against documents precludes recovery of the payment for defects apparent on the face of in the documents. 2A-526. Lessor's Stoppage of Delivery in Transit or Otherwise. * * *
689

App. I
2A-526

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Art. 7

(2) In pursuing its remedies under subsection (1), the lessor may stop delivery until (a) receipt of the goods by the lessee; (b) acknowledgment to the lessee by any bailee of the goods, except a carrier, that the bailee holds the goods for the lessee; or (c) such an acknowledgment to the lessee by a carrier via reshipment or as a warehouseman. * * *

Amendments to Uniform Commercial Code Article 4

4-104. Denitions and Index of Denitions. * * * (c) Control as provided in Section 7-106 and the following denitions in other Articles apply to this Article: Acceptance Section 3-409 Alteration Section 3-407 Cashier's check Section 3-104 Certicate of deposit Section 3-104 Certied check Section 3-409 Check Section 3-104 Good faith Section 3-103 Holder in due course Section 3-302 Instrument Section 3-104 Notice of dishonor Section 3-503 Order Section 3-103 Ordinary care Section 3-103 Person entitled to enforce Section 3-301 Presentment Section 3-501 Promise Section 3-103 Prove Section 3-103 Teller's check Section 3-104 Unauthorized signature Section 3-403 Ocial Comment * * *
5. Paragraph (a)(6): Documentary draft applies even though the documents do not accompany the draft but are to be received by the drawee or other payor before acceptance or payment of the draft. Documents may be either in electronic or tangible form. See Article 5, Section 5-102, Comment 2 and Article 1, Section 1-201 (denition of document of title).

* * * 4-210. Security Interest of Collecting Bank in Items, Accompanying Documents and Proceeds. (a) A collecting bank has a security interest in an item and any accompanying documents or the proceeds of either:
690

Art. 7

Documents of Title

App. I
4-503

(1) in case of an item deposited in an account, to the extent to which credit given for the item has been withdrawn or applied; (2) in case of an item for which it has given credit available for withdrawal as of right, to the extent of the credit given, whether or not the credit is drawn upon or there is a right of charge-back; or (3) if it makes an advance on or against the item. (b) If credit given for several items received at one time or pursuant to a single agreement is withdrawn or applied in part, the security interest remains upon all the items, any accompanying documents or the proceeds of either. For the purpose of this section, credits rst given are rst withdrawn. (c) Receipt by a collecting bank of a nal settlement for an item is a realization on its security interest in the item, accompanying documents, and proceeds. So long as the bank does not receive nal settlement for the item or give up possession of the item or possession or control of the accompanying documents for purposes other than collection, the security interest continues to that extent and is subject to Article 9, but: (1) no security agreement is necessary to make the security interest enforceable (Section 9-203(b)(3)(A)); (2) no ling is required to perfect the security interest; and (3) the security interest has priority over conicting perfected security interests in the item, accompanying documents, or proceeds. 4-501. Handling of Documentary Drafts; Duty to Send for Presentment and to Notify Customer of Dishonor. * * * Ocial Comment
This section states the duty of a bank handling a documentary draft for a customer. Documentary draft is dened in Section 4-104. The duty stated exists even if the bank has bought the draft. This is because to the customer the draft normally represents an underlying commercial transaction, and if that is not going through as planned the customer should know it promptly. An electronic document of title may be presented through allowing access to the document or delivery of the document. Article 1, Section 1-201 (denition of delivery).

4-503. Responsibility of Presenting Bank for Documents and Goods; Report of Reasons for Dishonor; Referee in Case of Need. * * * Ocial Comment
1. This section states the rules governing, in the absence of instructions, the duty of the presenting bank in case either of honor or of dishonor of a documentary draft. The section should be read in connection with Section 2-514 on when documents are deliverable on acceptance, when on payment. In the case of a dishonor of the draft, the bank, subject to Section 4-504, must return possession or control of the documents to its principal. 2. If the draft is drawn under a letter of credit, Article 5 controls. See Sections 5-109 through 5-114.

691

App. I
4-503

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Art. 7

Amendments to Uniform Commercial Code Article 5

5-102. Denitions. * * * Ocial Comment * * *
2. The denition of document contemplates and facilitates the growing recognition of electronic and other nonpaper media as documents, however, for the time being, data in those media constitute documents only in certain circumstances. For example, a facsimile received by an issuer would be a document only if the letter of credit explicitly permitted it, if the standard practice authorized it and the letter did not prohibit it, or the agreement of the issuer and beneciary permitted it. The fact that data transmitted in a nonpaper (unwritten) medium can be recorded on paper by a recipient's computer printer, facsimile machine, or the like does not under current practice render the data so transmitted a document. A facsimile or S.W.I.F.T. message received directly by the issuer is in an electronic medium when it crosses the boundary of the issuer's place of business. One wishing to make a presentation by facsimile (an electronic medium) will have to procure the explicit agreement of the issuer (assuming that the standard practice does not authorize it). Article 5 contemplates that electronic documents may be presented under a letter of credit and the provisions of this Article should be read to apply to electronic documents as well as tangible documents. An electronic document of title is delivered through the voluntary transfer of control. Article 1, Section 1-201 (denition of delivery). See Article 7, Section 7-106 on control of an electronic document. Where electronic transmissions are authorized neither by the letter of credit nor by the practice, the beneciary may transmit the data electronically to its agent who may be able to put it in written form and make a conforming presentation. Cf. Article 7, Section 7-105 on reissuing an electronic document in a tangible medium.

* * * 5-108. Issuer's Rights and Obligations. * * * Ocial Comment * * *

2. Section 5-108(a) balances the need of the issuer for time to examine the documents against the possibility that the examiner (at the urging of the applicant or for fear that it will not be reimbursed) will take excessive time to search for defects. What is a reasonable time is not extended to accommodate an issuer's procuring a waiver from the applicant. See Article 14c of the UCP. Under both the UCC and the UCP the issuer has a reasonable time to honor or give notice. The outside limit of that time is measured in business days under the UCC and in banking days under the UCP, a dierence that will rarely be signicant. Neither business nor banking days are dened in Article 5, but a court may nd useful analogies in Regulation CC, 12 CFR 229.2, in state law outside of the Uniform Commercial Code, and in Article 4. Examiners must note that the seven-day period is not a safe harbor. The time within which the issuer must give notice is the lesser of a reasonable time or seven business days. Where there are few documents (as, for example, with the mine run standby letter of credit), the reasonable time would be less than seven days. If more than a reasonable time is consumed in examination, no timely notice is possible. What is a reasonable time is to be determined by examining the behavior of those in the business of examining documents, mostly banks. Absent prior agreement of the issuer, one could not expect a bank issuer to examine documents while the beneciary waited in the lobby if the normal practice was to give the documents to a person who had the opportunity to examine those together with many others in an orderly process. That the applicant has not yet paid the issuer or that the applicant's account with the issuer is insucient to cover the amount of the draft is not a basis for extension of the time period. 692

Art. 7

Documents of Title

App. I
8-103

This section does not preclude the issuer from contacting the applicant during its examination; however, the decision to honor rests with the issuer, and it has no duty to seek a waiver from the applicant or to notify the applicant of receipt of the documents. If the issuer dishonors a conforming presentation, the beneciary will be entitled to the remedies under Section 5-111, irrespective of the applicant's views. Even though the person to whom presentation is made cannot conduct a reasonable examination of documents within the time after presentation and before the expiration date, presentation establishes the parties' rights. The beneciary's right to honor or the issuer's right to dishonor arises upon presentation at the place provided in the letter of credit even though it might take the person to whom presentation has been made several days to determine whether honor or dishonor is the proper course. The issuer's time for honor or giving notice of dishonor may be extended or shortened by a term in the letter of credit. The time for the issuer's performance may be otherwise modied or waived in accordance with Section 5-106. The issuer's time to inspect runs from the time of its receipt of documents. Documents are considered to be received only when they are received at the place specied for presentation by the issuer or other party to whom presentation is made. Receipt of documents when documents of title are presented must be read in light of the denition of delivery in Article 1, Section 1-201 and the denition of presentment in Section 5-102(a)(12). Failure of the issuer to act within the time permitted by subsection (b) constitutes dishonor. Because of the preclusion in subsection (c) and the liability that the issuer may incur under Section 5-111 for wrongful dishonor, the eect of such a silent dishonor may ultimately be the same as though the issuer had honored, i.e., it may owe damages in the amount drawn but unpaid under the letter of credit.

* * *
13. The last clause of Section 5-108(i)(5) deals with a special case in which the fraud is not committed by the beneciary, but is committed by a stranger to the transaction who forges the beneciary's signature. If the issuer pays against documents on which a required signature of the beneciary is forged, it remains liable to the true beneciary. This principle is applicable to both electronic and tangible documents.

* * * 5-113. Transfer by Operation of Law. * * * Ocial Comment

This section arms the result in Pastor v. Nat. Republic Bank of Chicago, 76 Ill.2d 139, 390 N.E.2d 894 (Ill. 1979) and Federal Deposit Insurance Co. v. Bank of Boulder, 911 F.2d 1466 (10th Cir. 1990). Both electronic and tangible documents may be signed. An issuer's requirements for recognition of a successor's status might include presentation of a certicate of merger, a court order appointing a bankruptcy trustee or receiver, a certicate of appointment as bankruptcy trustee, or the like. The issuer is entitled to rely upon such documents which on their face demonstrate that presentation is made by a successor of a beneciary. It is not obliged to make an independent investigation to determine the fact of succession.

Amendments to Uniform Commercial Code Article 8

8-103. Rules for Determining Whether Certain Obligations and Interests are Securities or Financial Assets. * * * (g) A document of title is not a nancial asset unless Section 8-102(a)(9) (iii) applies. Ocial Comment * * *
8. Subsection (g) allows a document of title to be a nancial asset and thus subject to the 693

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Art. 7

indirect holding system rules of Part 5 only to the extent that the intermediary and the person entitled under the document agree to do so. This is to prevent the inadvertent application of the Part 5 rules to intermediaries who may hold either electronic or tangible documents of title.

Amendments to Uniform Commercial Code Article 9

9-102. Denitions and Index of Denitions. (a) [Article 9 denitions.] In this article: * * * (30) Document means a document of title or a receipt of the type described in Section 7-201(2) 7-201(b). * * * (b) [Denitions in other articles.] Control as provided in Section 7-106 and the following denitions in other articles apply to this article: Applicant. Section 5-102. Beneciary. Section 5-102. Broker. Section 8-102. Certicated security. Section 8-102. Check. Section 3-104. Clearing corporation. Section 8-102. Contract for sale. Section 2-106. Customer. Section 4-104. Entitlement holder. Section 8-102. Financial asset. Section 8-102. Holder in due course. Section 3-302. Issuer (with respect to a letter of credit or letter-of-credit right). Section 5-102. Issuer (with respect to a security). Section 8-201. Issuer (with respect to documents of title). Section 7-102. Lease. Section 2A-103. Lease agreement. Section 2A-103. Lease contract. Section 2A-103. Leasehold interest. Section 2A-103. Lessee. Section 2A-103. Lessee in ordinary course of business. Section 2A-103. Lessor. Section 2A-103. Lessor's residual interest. Section 2A-103. Letter of credit. Section 5-102. Merchant. Section 2-104. Negotiable instrument. Section 3-104. Nominated person. Section 5-102. Note. Section 3-104. Proceeds of a letter of credit. Section 5-114. Prove. Section 3-103.
694

Art. 7

Documents of Title

App. I
9-203

Sale. Section 2-106. Securities account. Section 8-501. Securities intermediary. Section 8-102. Security. Section 8-102. Security certicate. Section 8-102. Security entitlement. Section 8-102. Uncerticated security. Section 8-102. Ocial Comment * * *
16. Document. The denition of document is unchanged in substance from the corresponding denitions in former Section 9-105. incorporates both tangible and electronic documents of title. See Section 1-201(15)[1-201(b)16] and Comment 15 [16]. Legislative Note: Former Article 1 dened document of title in section 1-201(15) and accompanying comment 15. Revised Article 1 denes document of title in Section 1-201(b)(16) and accompanying comment 16. Cross references should be adapted depending upon which version of Article 1 is in force in the jurisdiction.

9-203. Attachment and Enforceability of Security Interest; Proceeds; Supporting Obligations; Formal Requisites. * * * (b) [Enforceability.] Except as otherwise provided in subsections (c) through (i), a security interest is enforceable against the debtor and third parties with respect to the collateral only if : (1) value has been given; (2) the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party; and (3) one of the following conditions is met: (A) the debtor has authenticated a security agreement that provides a description of the collateral and, if the security interest covers timber to be cut, a description of the land concerned; (B) the collateral is not a certicated security and is in the possession of the secured party under Section 9-313 pursuant to the debtor's security agreement; (C) the collateral is a certicated security in registered form and the security certicate has been delivered to the secured party under Section 8-301 pursuant to the debtor's security agreement; or (D) the collateral is deposit accounts, electronic chattel paper, investment property, or letter-of-credit rights, or electronic documents, and the secured party has control under Section 7-106, 9-104, 9-105, 9-106, or 9-107 pursuant to the debtor's security agreement. * * * Ocial Comment * * *
4. Possession, Delivery, or Control Pursuant to Security Agreement. The other alternatives in subsection (b)(3) dispense with the requirement of an authenticated security agreement and provide alternative evidentiary tests. Under paragraph (3)(B), the secured party's possession substitutes for the debtor's authentication under paragraph (3)(A) if the secured party's possession is pursuant to the debtor's security agreement. That phrase refers to the debtor's agreement to the secured party's possession for the purpose of creat695

App. I
9-203

Uniform Commercial Code

Art. 7

ing a security interest. The phrase should not be confused with the phrase debtor has authenticated a security agreement, used in paragraph (3)(A), which contemplates the debtor's authentication of a record. In the unlikely event that possession is obtained without the debtor's agreement, possession would not suce as a substitute for an authenticated security agreement. However, once the security interest has become enforceable and has attached, it is not impaired by the fact that the secured party's possession is maintained without the agreement of a subsequent debtor (e.g., a transferee). Possession as contemplated by Section 9-313 is possession for purposes of subsection (b)(3)(B), even though it may not constitute possession pursuant to the debtor's agreement and consequently might not serve as a substitute for an authenticated security agreement under subsection (b)(3)(A). Subsection (b)(3)(C) provides that delivery of a certicated security to the secured party under Section 8-301 pursuant to the debtor's security agreement is sucient as a substitute for an authenticated security agreement. Similarly, under subsection (b)(3)(D), control of investment property, a deposit account, electronic chattel paper, or a letter-of-credit right, or electronic documents satises the evidentiary test if control is pursuant to the debtor's security agreement.

* * * 9-207. Rights and Duties of Secured Party Having Possession or Control of Collateral. * * * (c) [Duties and rights when secured party in possession or control.] Except as otherwise provided in subsection (d), a secured party having possession of collateral or control of collateral under Section 7-106, 9-104, 9-105, 9-106, or 9-107: (1) may hold as additional security any proceeds, except money or funds, received from the collateral; (2) shall apply money or funds received from the collateral to reduce the secured obligation, unless remitted to the debtor; and (3) may create a security interest in the collateral. * * * 9-208. Additional Duties of Secured Party Having Control of Collateral. (a) [Applicability of section.] This section applies to cases in which there is no outstanding secured obligation and the secured party is not committed to make advances, incur obligations, or otherwise give value. (b) [Duties of secured party after receiving demand from debtor.] Within 10 days after receiving an authenticated demand by the debtor: (1) a secured party having control of a deposit account under Section 9-104(a)(2) shall send to the bank with which the deposit account is maintained an authenticated statement that releases the bank from any further obligation to comply with instructions originated by the secured party; (2) a secured party having control of a deposit account under Section 9-104(a)(3) shall: (A) pay the debtor the balance on deposit in the deposit account; or (B) transfer the balance on deposit into a deposit account in the debtor's name; (3) a secured party, other than a buyer, having control of electronic chattel paper under Section 9-105 shall:
696

Art. 7

Documents of Title

App. I
9-208

(A) communicate the authoritative copy of the electronic chattel paper to the debtor or its designated custodian; (B) if the debtor designates a custodian that is the designated custodian with which the authoritative copy of the electronic chattel paper is maintained for the secured party, communicate to the custodian an authenticated record releasing the designated custodian from any further obligation to comply with instructions originated by the secured party and instructing the custodian to comply with instructions originated by the debtor; and (C) take appropriate action to enable the debtor or its designated custodian to make copies of or revisions to the authoritative copy which add or change an identied assignee of the authoritative copy without the consent of the secured party; (4) a secured party having control of investment property under Section 8-106(d)(2) or 9-106(b) shall send to the securities intermediary or commodity intermediary with which the security entitlement or commodity contract is maintained an authenticated record that releases the securities intermediary or commodity intermediary from any further obligation to comply with entitlement orders or directions originated by the secured party; and (5) a secured party having control of a letter-of-credit right under Section 9-107 shall send to each person having an unfullled obligation to pay or deliver proceeds of the letter of credit to the secured party an authenticated release from any further obligation to pay or deliver proceeds of the letter of credit to the secured party; and (6) a secured party having control of an electronic document shall: (A) give control of the electronic document to the debtor or its designated custodian; (B) if the debtor designates a custodian that is the designated custodian with which the authoritative copy of the electronic document is maintained for the secured party, communicate to the custodian an authenticated record releasing the designated custodian from any further obligation to comply with instructions originated by the secured party and instructing the custodian to comply with instructions originated by the debtor; and (C) take appropriate action to enable the debtor or its designated custodian to make copies of or revisions to the authoritative copy which add or change an identied assignee of the authoritative copy without the consent of the secured party. Ocial Comment * * *
2. Scope and Purpose. This section imposes duties on a secured party who has control of a deposit account, electronic chattel paper, investment property, or a letter-of-credit right, or electronic documents of title. The duty to terminate the secured party's control is analogous to the duty to le a termination statement, imposed by Section 9-513. Under subsection (a), it applies only when there is no outstanding secured obligation and the secured party is not committed to give value. The requirements of this section can be varied by agreement under Section 1-102(3). For example, a debtor could by contract agree that the secured party may comply with subsection (b) by releasing control more than 10 days after demand. Also, duties under this section should not be read to conict with the 697

App. I
9-208

Uniform Commercial Code

Art. 7

terms of the collateral itself. For example, if the collateral is a time deposit account, subsection (b)(2) should not require a secured party with control to make an early withdrawal of the funds (assuming that were possible) in order to pay them over to the debtor or put them in an account in the debtor's name.

* * * 9-301. Law Governing Perfection and Priority of Security Interests. Except as otherwise provided in Sections 9-303 through 9-306, the following rules determine the law governing perfection, the eect of perfection or nonperfection, and the priority of a security interest in collateral: (1) Except as otherwise provided in this section, while a debtor is located in a jurisdiction, the local law of that jurisdiction governs perfection, the eect of perfection or nonperfection, and the priority of a security interest in collateral. (2) While collateral is located in a jurisdiction, the local law of that jurisdiction governs perfection, the eect of perfection or nonperfection, and the priority of a possessory security interest in that collateral. (3) Except as otherwise provided in paragraph (4), while tangible negotiable documents, goods, instruments, money, or tangible chattel paper is located in a jurisdiction, the local law of that jurisdiction governs: (A) perfection of a security interest in the goods by ling a xture ling; (B) perfection of a security interest in timber to be cut; and (C) the eect of perfection or nonperfection and the priority of a nonpossessory security interest in the collateral. (4) The local law of the jurisdiction in which the wellhead or minehead is located governs perfection, the eect of perfection or nonperfection, and the priority of a security interest in as-extracted collateral. Ocial Comment * * *
5. Law Governing Perfection: Exceptions. The general rule is subject to several exceptions. It does not apply to goods covered by a certicate of title (see Section 9-303), deposit accounts (see Section 9-304), investment property (see Section 9-305), or letter-ofcredit rights (see Section 9-306). Nor does it apply to possessory security interests, i.e., security interests that the secured party has perfected by taking possession of the collateral (see paragraph (2)), security interests perfected by ling a xture ling (see subparagraph (3)(A)), security interests in timber to be cut (subparagraph (3)(B)), or security interests in as-extracted collateral (see paragraph (4)). a. Possessory Security Interests. Paragraph (2) applies to possessory security interests and provides that perfection is governed by the local law of the jurisdiction in which the collateral is located. This is the rule of former Section 9-103(1)(b), except paragraph (2) eliminates the troublesome last event test of former law. The distinction between nonpossessory and possessory security interests creates the potential for the same jurisdiction to apply two dierent choice-of-law rules to determine perfection in the same collateral. For example, were a secured party in possession of an instrument or a tangible document to relinquish possession in reliance on temporary perfection, the applicable law immediately would change from that of the location of the collateral to that of the location of the debtor. The applicability of two dierent choice-oflaw rules for perfection is unlikely to lead to any material practical problems. The perfection rules of one Article 9 jurisdiction are likely to be identical to those of another. Moreover, under paragraph (3), the relative priority of competing security interests in tangible 698

Art. 7

Documents of Title

App. I
9-308

collateral is resolved by reference to the law of the jurisdiction in which the collateral is located, regardless of how the security interests are perfected.

* * *
7. Law Governing Eect of Perfection and Priority: Goods, Documents, Instruments, Money, Negotiable Documents, and Tangible Chattel Paper. Under former Section 9-103, the law of a single jurisdiction governed both questions of perfection and those of priority. This Article generally adopts that approach. See paragraph (1). But the approach may create problems if the debtor and collateral are located in dierent jurisdictions. For example, assume a security interest in equipment located in Pennsylvania is perfected by ling in Illinois, where the debtor is located. If the law of the jurisdiction in which the debtor is located were to govern priority, then the priority of an execution lien on goods located in Pennsylvania would be governed by rules enacted by the Illinois legislature. To address this problem, paragraph (3)(C) divorces questions of perfection from questions of the eect of perfection or nonperfection and the priority of a security interest. Under paragraph (3)(C), the rights of competing claimants to tangible collateral are resolved by reference to the law of the jurisdiction in which the collateral is located. A similar bifurcation applied to security interests in investment property under former Section 9-103(6). See Section 9-305. Paragraph (3)(C) applies the law of the situs to determine priority only with respect to goods (including xtures), instruments, money, tangible negotiable documents, and tangible chattel paper. Compare former Section 9-103(1), which applied the law of the location of the collateral to documents, instruments, and ordinary (as opposed to mobile) goods. This Article does not distinguish among types of goods. The ordinary/mobile goods distinction appears to address concerns about where to le and search, rather than concerns about priority. There is no reason to preserve this distinction under the bifurcated approach. Particularly serious confusion may arise when the choice-of-law rules of a given jurisdiction result in each of two competing security interests in the same collateral being governed by a dierent priority rule. The potential for this confusion existed under former Section 9-103(4) with respect to chattel paper: Perfection by possession was governed by the law of the location of the paper, whereas perfection by ling was governed by the law of the location of the debtor. Consider the mess that would have been created if the language or interpretation of former Section 9-308 were to dier in the two relevant States, or if one of the relevant jurisdictions (e.g., a foreign country) had not adopted Article 9. The potential for confusion could have been exacerbated when a secured party perfected both by taking possession in the State where the collateral is located (State A) and by ling in the State where the debtor is located (State B)a common practice for some chattel paper nancers. By providing that the law of the jurisdiction in which the collateral is located governs priority, paragraph (3) substantially diminishes this problem.

* * * 9-308. When Security Interest or Agricultural Lien Is Perfected; Continuity of Perfection. Ocial Comment * * *
4. Continuous Perfection. The following example illustrates the operation of subsection (c): Example 1: Debtor, an importer, creates a security interest in goods that it imports and the documents of title that cover the goods. The secured party, Bank, takes possession of a tangible negotiable bill of lading covering certain imported goods and thereby perfects its security interest in the bill of lading and the goods. See Sections 9-313(a), 9-312(c)(1). Bank releases the bill of lading to the debtor for the purpose of procuring the goods from the carrier and selling them. Under Section 9-312(f), Bank continues to have a perfected security interest in the document and goods for 20 days. Bank les a nancing statement covering the collateral before the expiration of the 20-day period. Its security interest now continues perfected for as long as the ling is good. If the successive stages of Bank's security interest succeed each other without an intervening gap, the security interest is perfected continuously, and the date of perfection is when the security interest rst became perfected (i.e., when Bank received possession of 699

App. I
9-308

Uniform Commercial Code

Art. 7

the tangible bill of lading). If, however, there is a gap between stagesfor example, if Bank does not le until after the expiration of the 20-day period specied in Section 9-312(f) and leaves the collateral in the debtor's possessionthen, the chain being broken, the perfection is no longer continuous. The date of perfection would now be the date of ling (after expiration of the 20-day period). Bank's security interest would be vulnerable to any interests arising during the gap period which under Section 9-317 take priority over an unperfected security interest.

* * * 9-310. When Filing Required to Perfect Security Interest or Agricultural Lien; Security Interests and Agricultural Liens to Which Filing Provisions Do Not Apply. * * * (b) [Exceptions: ling not necessary.] The ling of a nancing statement is not necessary to perfect a security interest: (1) that is perfected under Section 9-308(d), (e), (f), or (g); (2) that is perfected under Section 9-309 when it attaches; (3) in property subject to a statute, regulation, or treaty described in Section 9-311(a); (4) in goods in possession of a bailee which is perfected under Section 9-312(d)(1) or (2); (5) in certicated securities, documents, goods, or instruments which is perfected without ling, control, or possession under Section 9-312(e), (f), or (g); (6) in collateral in the secured party's possession under Section 9-313; (7) in a certicated security which is perfected by delivery of the security certicate to the secured party under Section 9-313; (8) in deposit accounts, electronic chattel paper, electronic documents, investment property, or letter-of-credit rights which is perfected by control under Section 9-314; (9) in proceeds which is perfected under Section 9-315; or (10) that is perfected under Section 9-316. * * * 9-312. Perfection of Security Interests in Chattel Paper, Deposit Accounts, Documents, Goods Covered by Documents, Instruments, Investment Property, Letter-of-Credit Rights, and Money; Perfection by Permissive Filing; Temporary Perfection Without Filing or Transfer of Possession. * * * (e) [Temporary perfection: new value.] A security interest in certicated securities, negotiable documents, or instruments is perfected without ling or the taking of possession or control for a period of 20 days from the time it attaches to the extent that it arises for new value given under an authenticated security agreement. * * * Ocial Comment * * *
3. Chattel Paper; Negotiable Documents. Subsection (a) further provides that ling 700

Art. 7

Documents of Title

App. I
9-312

is available as a method of perfection for security interests in chattel paper and negotiable documents. Tangible chattel paper is sometimes delivered to the assignee, and sometimes left in the hands of the assignor for collection. Subsection (a) allows the assignee to perfect its security interest by ling in the latter case. Alternatively, the assignee may perfect by taking possession. See Section 9-313(a). An assignee of electronic chattel paper may perfect by taking control. See Sections 9-314(a), 9-105. The security interest of an assignee who takes possession or control may qualify for priority over a competing security interest perfected by ling. See Section 9-330. Negotiable documents may be, and usually are, delivered to the secured party. See Article 1, Section 1-201 (denition of delivery). The secured party's taking possession of a tangible document or control of an electronic document will suce as a perfection step. See Sections 9-313(a), 9-314 and 7-106. However, as is the case with chattel paper, a security interest in a negotiable document may be perfected by ling.

* * *
7. Goods Covered by Document of Title. Subsection (c) applies to goods in the possession of a bailee who has issued a negotiable document covering the goods. Subsection (d) applies to goods in the possession of a bailee who has issued a nonnegotiable document of title, including a document of title that is non-negotiable under Section 7-104. Section 9-313 governs perfection of a security interest in goods in the possession of a bailee who has not issued a document of title. Subsection (c) claries the perfection and priority rules in former Section 9-304(2). Consistently with the provisions of Article 7, subsection (c) takes the position that, as long as a negotiable document covering goods is outstanding, title to the goods is, so to say, locked up in the document. Accordingly, a security interest in goods covered by a negotiable document may be perfected by perfecting a security interest in the document. The security interest also may be perfected by another method, e.g., by ling. The priority rule in subsection (c) governs only priority between (i) a security interest in goods which is perfected by perfecting in the document and (ii) a security interest in the goods which becomes perfected by another method while the goods are covered by the document. Example 1: While wheat is in a grain elevator and covered by a negotiable warehouse receipt, Debtor creates a security interest in the wheat in favor of SP-1 and SP-2. SP-1 perfects by ling a nancing statement covering wheat. Thereafter, SP-2 perfects by ling a nancing statement describing the warehouse receipt. Subsection (c)(1) provides that SP-2's security interest is perfected. Subsection (c)(2) provides that SP-2's security interest is senior to SP-1's. Example 2: The facts are as in Example 1, but SP-1's security interest attached and was perfected before the goods were delivered to the grain elevator. Subsection (c)(2) does not apply, because SP-1's security interest did not become perfected during the time that the wheat was in the possession of a bailee. Rather, the rst-to-le-or-perfect priority rule applies. See Sections 9-322 and 7-503. A secured party may become a holder to whom a negotiable document of title has been duly negotiated under Section 7-501. If so, the secured party acquires the rights specied by Article 7. Article 9 does not limit those rights, which may include the right to priority over an earlier-perfected security interest. See Section 9-331(a). Subsection (d) takes a dierent approach to the problem of goods covered by a nonnegotiable document. Here, title to the goods is not looked on as being locked up in the document, and the secured party may perfect its security interest directly in the goods by ling as to them. The subsection provides two other methods of perfection: issuance of the document in the secured party's name (as consignee of a straight bill of lading or the person to whom delivery would be made under a non-negotiable warehouse receipt) and receipt of notication of the secured party's interest by the bailee. Perfection under subsection (d) occurs when the bailee receives notication of the secured party's interest in the goods, regardless of who sends the notication. Receipt of notication is eective to perfect, regardless of whether the bailee responds. Unlike former Section 9-304(3), from which it derives, subsection (d) does not apply to goods in the possession of a bailee who has not issued a document of title. Section 9-313(c) covers that case and provides that perfection by possession as to goods not covered by a document requires the bailee's acknowledgment. 8. Temporary Perfection Without Having First Otherwise Perfected. Subsection (e) follows former Section 9-304(4) in giving perfected status to security interests in 701

App. I
9-312

Uniform Commercial Code

Art. 7

certicated securities, instruments, and negotiable documents for a short period (reduced from 21 to 20 days, which is the time period generally applicable in this Article), although there has been no ling and the collateral is in the debtor's possession or control. The 20day temporary perfection runs from the date of attachment. There is no limitation on the purpose for which the debtor is in possession, but the secured party must have given new value (dened in Section 9-102) under an authenticated security agreement. 9. Maintaining Perfection After Surrendering Possession. There are a variety of legitimate reasonsmany of them are described in subsections (f) and (g)why certain types of collateral must be released temporarily to a debtor. No useful purpose would be served by cluttering the les with records of such exceedingly short term transactions. Subsection (f) aords the possibility of 20-day perfection in negotiable documents and goods in the possession of a bailee but not covered by a negotiable document. Subsection (g) provides for 20-day perfection in certicated securities and instruments. These subsections derive from former Section 9-305(5). However, the period of temporary perfection has been reduced from 21 to 20 days, which is the time period generally applicable in this Article, and enforcement has been added in subsection (g) as one of the special and limited purposes for which a secured party can release an instrument or certicated security to the debtor and still remain perfected. The period of temporary perfection runs from the date a secured party who already has a perfected security interest turns over the collateral to the debtor. There is no new value requirement, but the turnover must be for one or more of the purposes stated in subsection (f) or (g). The 20-day period may be extended by perfecting as to the collateral by another method before the period expires. However, if the security interest is not perfected by another method until after the 20-day period expires, there will be a gap during which the security interest is unperfected. Temporary perfection extends only to the negotiable document or goods under subsection (f) and only to the certicated security or instrument under subsection (g). It does not extend to proceeds. If the collateral is sold, the security interest will continue in the proceeds for the period specied in Section 9-315. Subsections (f) and (g) deal only with perfection. Other sections of this Article govern the priority of a security interest in goods after surrender of possession or control of the document covering them. In the case of a purchase-money security interest in inventory, priority may be conditioned upon giving notication to a prior inventory nancer. See Section 9-324.

9-313. When Possession by or Delivery to Secured Party Perfects Security Interest Without Filing. (a) [Perfection by possession or delivery.] Except as otherwise provided in subsection (b), a secured party may perfect a security interest in tangible negotiable documents, goods, instruments, money, or tangible chattel paper by taking possession of the collateral. A secured party may perfect a security interest in certicated securities by taking delivery of the certicated securities under Section 8-301. * * * Ocial Comment * * *
2. Perfection by Possession. As under the common law of pledge, no ling is required by this Article to perfect a security interest if the secured party takes possession of the collateral. See Section 9-310(b)(6). This section permits a security interest to be perfected by the taking of possession only when the collateral is goods, instruments, tangible negotiable documents, money, or tangible chattel paper. Accounts, commercial tort claims, deposit accounts, investment property, letter-of-credit rights, letters of credit, and oil, gas, or other minerals before extraction are excluded. (But see Comment 6, below, regarding certicated securities.) A security interest in accounts and payment intangiblesproperty not ordinarily represented by any writing whose delivery operates to transfer the right to paymentmay under this Article be perfected only by ling. This rule would not be aected by the fact that a security 702

Art. 7

Documents of Title

App. I
9-317

agreement or other record described the assignment of such collateral as a pledge. Section 9-309(2) exempts from ling certain assignments of accounts or payment intangibles which are out of the ordinary course of nancing. These exempted assignments are perfected when they attach. Similarly, under Section 9-309(3), sales of payment intangibles are automatically perfected.

9-314. Perfection by Control. (a) [Perfection by control.] A security interest in investment property, deposit accounts, letter-of-credit rights, or electronic chattel paper, or electronic documents may be perfected by control of the collateral under Section 7-106, 9-104, 9-105, 9-106, or 9-107. (b) [Specied collateral: time of perfection by control; continuation of perfection.] A security interest in deposit accounts, electronic chattel paper, or letter-of-credit rights, or electronic documents is perfected by control under Section 7-106, 9-104, 9-105, or 9-107 when the secured party obtains control and remains perfected by control only while the secured party retains control. (c) [Investment property: time of perfection by control; continuation of perfection.] A security interest in investment property is perfected by control under Section 9-106 from the time the secured party obtains control and remains perfected by control until: (1) the secured party does not have control; and (2) one of the following occurs: (A) if the collateral is a certicated security, the debtor has or acquires possession of the security certicate; (B) if the collateral is an uncerticated security, the issuer has registered or registers the debtor as the registered owner; or (C) if the collateral is a security entitlement, the debtor is or becomes the entitlement holder. Ocial Comment * * *
2. Control. This section provides for perfection by control with respect to investment property, deposit accounts, letter-of-credit rights, and electronic chattel paper, and electronic documents. For explanations of how a secured party takes control of these types of collateral, see Sections 9-104 through 9-107 and Section 7-106. Subsection (b) explains when a security interest is perfected by control and how long a security interest remains perfected by control. Like Section 9-313(d) and for the same reasons, subsection (b) makes no reference to the doctrine of relation back. See Section 9-313, Comment 5. As to an electronic document that is reissued in a tangible medium, Section 7-105, a secured party that is perfected by control in the electronic document should le as to the document before relinquishing control in order to maintain continuous perfection in the document. See Section 9-308.

9-317. Interests That Take Priority Over or Take Free of Security Interest or Agricultural Lien. * * * (b) [Buyers that receive delivery.] Except as otherwise provided in subsection (e), a buyer, other than a secured party, of tangible chattel paper, tangible documents, goods, instruments, or a security certicate takes free of a security interest or agricultural lien if the buyer gives value and receives delivery of the collateral without knowledge of the security interest or agricultural lien and before it is perfected.
703

App. I
9-317

Uniform Commercial Code

Art. 7

(c) [Lessees that receive delivery.] Except as otherwise provided in subsection (e), a lessee of goods takes free of a security interest or agricultural lien if the lessee gives value and receives delivery of the collateral without knowledge of the security interest or agricultural lien and before it is perfected. (d) [Licensees and buyers of certain collateral.] A licensee of a general intangible or a buyer, other than a secured party, of accounts, electronic chattel paper, electronic documents , general intangibles, or investment property other than a certicated security takes free of a security interest if the licensee or buyer gives value without knowledge of the security interest and before it is perfected. * * * Ocial Comment * * *
6. Purchasers Other Than Secured Parties. Subsections (b), (c), and (d) aord priority over an unperfected security interest to certain purchasers (other than secured parties) of collateral. They derive from former Sections 9-301(1)(c), 2A-307(2), and 9-301(d). Former Section 9-301(1)(c) and (1)(d) provided that unperfected security interests are subordinate to the rights of certain purchasers. But, as former Comment 9 suggested, the practical effect of subordination in this context is that the purchaser takes free of the security interest. To avoid any possible misinterpretation, subsections (b) and (d) of this section use the phrase takes free. Subsection (b) governs goods, as well as intangibles of the type whose transfer is eected by physical delivery of the representative piece of paper (tangible chattel paper, tangible documents, instruments, and security certicates). To obtain priority, a buyer must both give value and receive delivery of the collateral without knowledge of the existing security interest and before perfection. Even if the buyer gave value without knowledge and before perfection, the buyer would take subject to the security interest if perfection occurred before physical delivery of the collateral to the buyer. Subsection (c) contains a similar rule with respect to lessees of goods. Note that a lessee of goods in ordinary course of business takes free of all security interests created by the lessor, even if perfected. See Section 9-321. Normally, there will be no question when a buyer of tangible chattel paper, tangible documents, instruments, or security certicates receives delivery of the property. See Section 1-201 (dening delivery). However, sometimes a buyer or lessee of goods, such as complex machinery, takes delivery of the goods in stages and completes assembly at its own location. Under those circumstances, the buyer or lessee receives delivery within the meaning of subsections (b) and (c) when, after an inspection of the portion of the goods remaining with the seller or lessor, it would be apparent to a potential lender to the seller or lessor that another person might have an interest in the goods. The rule of subsection (b) obviously is not appropriate where the collateral consists of intangibles and there is no representative piece of paper whose physical delivery is the only or the customary method of transfer. Therefore, with respect to such intangibles (accounts, electronic chattel paper, electronic documents, general intangibles, and investment property other than certicated securities), subsection (d) gives priority to any buyer who gives value without knowledge, and before perfection, of the security interest. A licensee of a general intangible takes free of an unperfected security interest in the general intangible under the same circumstances. Note that a licensee of a general intangible in ordinary course of business takes rights under a nonexclusive license free of security interests created by the licensor, even if perfected. See Section 9-321. Unless Section 9-109 excludes the transaction from this Article, a buyer of accounts, chattel paper, payment intangibles, or promissory notes is a secured party (dened in Section 9-102), and subsections (b) and (d) do not determine priority of the security interest created by the sale. Rather, the priority rules generally applicable to competing security interests apply. See Section 9-322.

* * *
704

Art. 7

Documents of Title

App. I
9-338

9-322. Priorities Among Conicting Security Interests in and Agricultural Liens on Same Collateral. Ocial Comment
* * * Example 3: On October 1, A acquires a temporarily perfected (20-day) security interest, unled, in a tangible negotiable document in the debtor's possession under Section 9-312(e). On October 5, B les and thereby perfects a security interest that previously had attached to the same document. On October 10, A les. A has priority, even after the 20-day period expires, regardless of whether A knows of B's security interest when A les. A was the rst to perfect and maintained continuous perfection or ling since the start of the 20-day period. However, the perfection of A's security interest extends only to the extent it arises for new value given. To the extent A's security interest secures advances made by A beyond the 20-day period, its security interest would be subordinate to B's, inasmuch as B was the rst to le.

* * *
8. Proceeds of Non-Filing Collateral: Non-Temporal Priority. Subsection (c)(2) provides a baseline priority rule for proceeds of non-ling collateral which applies if the secured party has taken the steps required for non-temporal priority over a conicting security interest in non-ling collateral (e.g., control, in the case of deposit accounts, letter-ofcredit rights, and investment property, and in some cases, electronic negotiable documents, section 9-331). This rule determines priority in proceeds of non-ling collateral whether or not there exists an actual conicting security interest in the original non-ling collateral. Under subsection (c)(2), the priority in the original collateral continues in proceeds if the security interest in proceeds is perfected and the proceeds are cash proceeds or non-ling proceeds of the same type as the original collateral. As used in subsection (c)(2), type means a type of collateral dened in the Uniform Commercial Code and should be read broadly. For example, a security is of the same type as a security entitlement (i.e., investment property), and a promissory note is of the same type as a draft (i.e., an instrument).

* * * 9-323. Future Advances. Ocial Comment

* * * Example 2: On October 1, A acquires a temporarily perfected (20-day) security interest, unled, in a tangible negotiable document in the debtor's possession under Section 9-312(e) or (f). The security interest secures an advance made on that day as well as future advances. On October 5, B les and thereby perfects a security interest that previously had attached to the same document. On October 8, A makes an additional advance. On October 10, A les. Under Section 9-322(a)(1), because A was the rst to perfect and maintained continuous perfection or ling since the start of the 20-day period, A has priority, even after the 20-day period expires. See Section 9-322, Comment 4, Example 3. However, under this section, for purposes of Section 9-322(a)(1), to the extent A's security interest secures the October 8 advance, the security interest was perfected on October 8. Inasmuch as B perfected on October 5, B has priority over the October 8 advance.

* * * 9-338. Priority of Security Interest or Agricultural Lien Perfected by Filed Financing Statement Providing Certain Incorrect Information. If a security interest or agricultural lien is perfected by a led nancing statement providing information described in Section 9-516(b)(5) which is incorrect at the time the nancing statement is led: (1) the security interest or agricultural lien is subordinate to a conicting perfected security interest in the collateral to the extent that the
705

App. I
9-338

Uniform Commercial Code

Art. 7

holder of the conicting security interest gives value in reasonable reliance upon the incorrect information; and (2) a purchaser, other than a secured party, of the collateral takes free of the security interest or agricultural lien to the extent that, in reasonable reliance upon the incorrect information, the purchaser gives value and, in the case of tangible chattel paper, tangible documents, goods, instruments, or a security certicate, receives delivery of the collateral. 9-601. Rights After Default; Judicial Enforcement; Consignor or Buyer of Accounts, Chattel Paper, Payment Intangibles, or Promissory Notes. * * * (b) [Rights and duties of secured party in possession or control.] A secured party in possession of collateral or control of collateral under Section 7-106, 9-104, 9-105, 9-106, or 9-107 has the rights and duties provided in Section 9-207. * * *

706

ARTICLE 8. INVESTMENT SECURITIES*

PART 1. SHORT TITLE AND GENERAL MATTERS
8-101. Short Title. 8-102. Denitions. 8-103. Rules for Determining Whether Certain Obligations and Interests are Securities or Financial Assets. 8-104. Acquisition of Security or Financial Asset or Interest Therein. 8-105. Notice of Adverse Claim. 8-106. Control. 8-107. Whether Indorsement, Instruction, or Entitlement Order is Eective. 8-108. Warranties in Direct Holding. 8-109. Warranties in Indirect Holding. 8-110. Applicability; Choice of Law. 8-111. Clearing Corporation Rules. 8-112. Creditor's Legal Process. 8-113. Statute of Frauds Inapplicable. 8-114. Evidentiary Rules Concerning Certicated Securities. 8-115. Securities Intermediary and Others Not Liable to Adverse Claimant. 8-116. Securities Intermediary as Purchaser For Value.

PART 2. ISSUE AND ISSUER

Issuer. Issuer's Responsibility and Defenses; Notice of Defect or Defense. Staleness as Notice of Defect or Defense. Eect of Issuer's Restriction on Transfer. Eect of Unauthorized Signature on Security Certicate. Completion of Alteration of Security Certicate. Rights and Duties of Issuer with Respect to Registered Owners. Eect of Signature of Authenticating Trustee, Registrar, or Transfer Agent. 8-209. Issuer's Lien. 8-210. Overissue. 8-201. 8-202. 8-203. 8-204. 8-205. 8-206. 8-207. 8-208.

PART 3. TRANSFER OF CERTIFICATED AND UNCERTIFICATED SECURITIES

8-301. Delivery. 8-302. Rights of Purchaser. 8-303. Protected Purchaser.
*Article 8 was revised in 1994. Prerevision Article 8 may be found in Appendix L. Conforming amendments to other articles may be found in Appendix K. See Appendix K for text of conforming amendments to other articles of the Code and Ocial Comments thereto. 707

Uniform Commercial Code 8-304. 8-305. 8-306. 8-307. Indorsement. Instruction. Eect of Guaranteeing Signature, Indorsement, or Instruction. Purchaser's Right to Requisites for Registration of Transfer.

Art. 8

PART 4. REGISTRATION
Duty of Issuer to Register Transfer. Assurance that Indorsement or Instruction is Eective. Demand that Issuer Not Register Transfer. Wrongful Registration. Replacement of Lost, Destroyed, or Wrongfully Taken Security Certicate. 8-406. Obligation to Notify Issuer of Lost, Destroyed, or Wrongfully Taken Security Certicate. 8-407. Authenticating Trustee, Transfer Agent, and Registrar. 8-401. 8-402. 8-403. 8-404. 8-405.

PART 5. SECURITY ENTITLEMENTS

8-501. Securities Account; Acquisition of Security Entitlement from Securities Intermediary. 8-502. Assertion of Adverse Claim Against Entitlement Holder. 8-503. Property Interest of Entitlement Holder in Financial Asset Held By Securities Intermediary. 8-504. Duty of Securities Intermediary to Maintain Financial Asset. 8-505. Duty of Securities Intermediary with Respect to Payments and Distributions. 8-506. Duty of Securities Intermediary to Exercise Rights as Directed by Entitlement Holder. 8-507. Duty of Securities Intermediary to Comply With Entitlement Order. 8-508. Duty of Securities Intermediary to Change Entitlement Holder's Position to Other Form of Security Holding. 8-509. Specication of Duties of Securities Intermediary by Other Statute or Regulation; Manner of Performance of Duties of Securities Intermediary and Exercise of Rights of Entitlement Holder. 8-510. Rights of Purchaser of Security Entitlement from Entitlement Holder. 8-511. Priority Among Security Interests and Entitlement Holders.

PART 6. TRANSITION PROVISIONS FOR REVISED ARTICLE 8

8-601. Eective Date. 8-602. Repeals. 8-603. Savings Clause.

708

NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS

REPORTER James Steven Rogers, Newton, Massachusetts DRAFTING COMMITTEE CHAIRMAN Curtis R. Reitz, Philadelphia, Pennsylvania MEMBERS Ann E. Conaway Anker, Wilmington, Delaware John Fox Arnold, St. Louis, Missouri Robert J. Desiderio, Albuquerque, New Mexico Egon Guttman, Washington, District of Columbia, The American Law Institute Representative Howard T. Rosen, Millburn, New Jersey Richard B. Smith, New York, New York, The American Law Institute Representative and American Bar Association Advisor Howard J. Swibel, Chicago, Illinois Justin L. Vigdor, Rochester, New York Richard C. Hite, Wichita, Kansas, President (Member Ex Ocio) K. King Burnett, Salisbury, Maryland, Chairman, Division A (Member Ex Ocio) REVIEW COMMITTEE CHAIRMAN Michael P. Sullivan, Minneapolis, Minnesota MEMBERS Gerald L. Bepko, Indianapolis, Indiana Reed L. Martineau, Salt Lake City, Utah ADVISORS Charles W. Mooney, Jr., American Bar Association, Section of Business Law Thomas J. Greco, American Bankers Association CONSULTANTS Jonathan Kallman, United States Securities and Exchange Commission Calvin Ninomiya and Cynthia E. Reese, United States Department of the Treasury Lawranne Stewart, Board of Governors, Federal Reserve System Debra W. Cook and MarySue Fisher, Federal Reserve Bank of New York PREFATORY NOTE The present version of Article 8 is the product of a major revision made necessary by the fact that the prior version of Article 8 did not adequately deal with the system of securities holding through securities intermediaries that has developed in the past few decades. Although the prior version of Article 8 did contain some provisions dealing with securities holding through securities intermediaries, these were engrafted onto a structure designed for securities practices of earlier times. The resulting legal uncertainties adversely aected all participants. The revision is intended to eliminate these uncertainties by providing a modern legal structure for current securities holding practices. 709

Uniform Commercial Code

I. EVOLUTION OF SECURITIES HOLDING SYSTEMS

Art. 8

A. The Traditional Securities Holding System The original version of Article 8, drafted in the 1940s and 1950s, was based on the assumption that possession and delivery of physical certicates are the key elements in the securities holding system. Ownership of securities was traditionally evidenced by possession of the certicates, and changes were accomplished by delivery of the certicates. Transfer of securities in the traditional certicate-based system was a complicated, laborintensive process. Each time securities were traded, the physical certicates had to be delivered from the seller to the buyer, and in the case of registered securities the certicates had to be surrendered to the issuer or its transfer agent for registration of transfer. As is well known, the mechanical problems of processing the paperwork for securities transfers reached crisis proportions in the late 1960s, leading to calls for the elimination of the physical certicate and development of modern electronic systems for recording ownership of securities and transfers of ownership. That was the focus of the revision eort that led to the promulgation of the 1978 amendments to Article 8 concerning uncerticated securities. B. The Uncerticated Securities System Envisioned by the 1978 Amendments In 1978, amendments to Article 8 were approved to establish the commercial law rules that were thought necessary to permit the evolution of a system in which issuers would no longer issue certicates. The Drafting Committee that produced the 1978 amendments was given a fairly limited charge. It was to draft the revisions that would be needed for uncerticated securities, but otherwise leave the Article 8 rules unchanged. Accordingly, the 1978 amendments primarily took the form of adding parallel provisions dealing with uncerticated securities to the existing rules of Article 8 on certicated securities. The system of securities holding contemplated by the 1978 amendments diered from the traditional system only in that ownership of securities would not be evidenced by physical certicates. It was contemplated that changes in ownership would continue to be reected by changes in the records of the issuer. The main dierence would be that instead of surrendering an indorsed certicate for registration of transfer, an instruction would be sent to the issuer directing it to register the transfer. Although a system of the sort contemplated by the 1978 amendments may well develop in the coming decades, this has not yet happened for most categories of securities. Mutual funds shares have long been issued in uncerticated form, but virtually all other forms of publicly traded corporate securities are still issued in certicated form. Individual investors who wish to be recorded as registered owners on the issuers' books still obtain and hold physical certicates. The certicates representing the largest portion of the shares of publicly traded companies, however, are not held by the benecial owners, but by clearing corporations. Settlement of securities trading occurs not by delivery of certicates or by registration of transfer on the records of the issuers or their transfer agents, but by computer entries in the records of clearing corporations and securities intermediaries. That is quite dierent from the system envisioned by the 1978 amendments. C. Evolution of the Indirect Holding System At the time of the paperwork crunch in the late 1960s, the trading volume on the New York Stock Exchange that so seriously strained the capacities of the clearance and settlement system was in the range of 10 million shares per day. Today, the system can easily handle trading volume on routine days of hundreds of millions of shares. This processing capacity could have been achieved only by the application of modern electronic information processing systems. Yet the legal rules under which the system operates are not the uncerticated securities provisions of Article 8. To understand why this is so, one must delve at least a bit deeper into the operations of the current system. If one examines the shareholder records of large corporations whose shares are publicly traded on the exchanges or in the over the counter market, one would nd that one entity Cede & Co.is listed as the shareholder of record of somewhere in the range of sixty to eighty per cent of the outstanding shares of all publicly traded companies. Cede & Co. is the nominee name used by The Depository Trust Company (DTC), a limited purpose trust company organized under New York law for the purpose of acting as a depository to hold securities for the benet of its participants, some 600 or so broker-dealers and banks. Essentially all of the trading in publicly held companies is executed through the broker710

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dealers who are participants in DTC, and the great bulk of public securitiesthe sixty to eighty per cent gure noted aboveare held by these broker-dealers and banks on behalf of their customers. If all of these broker-dealers and banks held physical certicates, then as trades were executed each day it would be necessary to deliver the certicates back and forth among these broker-dealers and banks. By handing all of their securities over to a common depository all of these deliveries can be eliminated. Transfers can be accomplished by adjustments to the participants' DTC accounts. Although the use of a common depository eliminates the needs for physical deliveries, an enormous number of entries would still have to be made on DTC's books if each transaction between its participants were recorded one by one on DTC's books. Any two major brokerdealers may have executed numerous trades with each other in a given security on a single day. Signicant processing eciency has been achieved by netting all of the transactions among the participants that occur each day, so that entries need be made on the depository's books only for the net changes in the positions of each participant at the end of each day. This clearance and netting function might well be performed by the securities exchanges or by the same institution that acts as the depository, as is the case in many other securities markets around the world. In the United States, however, this clearance and netting function is carried out by a separate corporation, National Securities Clearing Corporation (NSCC). All that needs to be done to settle each day's trading is for NSCC to compute the net receive and deliver obligations and to instruct DTC to make the corresponding adjustments in the participants' accounts. The broker-dealers and banks who are participants in the DTC-NSCC system in turn provide analogous clearance and settlement functions to their own customers. If Customer A buys 100 shares of XYZ Co. through Broker, and Customer B sells 100 shares of XYZ Co. through the same Broker, the trade can be settled by entries on Broker's books. Neither DTC's books showing Broker's total position in XYZ Co., nor XYZ Co.'s books showing DTC's total position in XYZ Co., need be changed to reect the settlement of this trade. One can readily appreciate the signicance of the settlement function performed at this level if one considers that a single major bank may be acting as securities custodian for hundreds or thousands of mutual funds, pension funds, and other institutional investors. On any given day, the customers of that bank may have entered into an enormous number of trades, yet it is possible that relatively little of this trading activity will result in any net change in the custodian bank's positions on the books of DTC. Settlement of market trading in most of the major U.S. securities markets is now eected primarily through some form of netted clearance and depository system. Virtually all publicly traded corporate equity securities, corporate debt securities, and municipal debt securities are now eligible for deposit in the DTC system. Recently, DTC has implemented a similar depository settlement system for the commercial paper market, and could, but for limitations in present Article 8, handle other forms of short-term money market securities such as bankers' acceptances. For trading in mortgage-backed securities, such as Ginnie Mae's, a similar depository settlement system has been developed by Participants Trust Company. For trading in U.S. Treasury securities, a somewhat analogous book-entry system is operated under Treasury rules by the Federal Reserve System. D. Need for Dierent Legal Rules for the Direct and Indirect Holding Systems Both the traditional paper-based system, and the uncerticated system contemplated by the 1978 amendments, can be described as direct securities holding systems; that is, the benecial owners of securities have a direct relationship with the issuer of the securities. For securities in bearer form, whoever has possession of the certicate thereby has a direct claim against the issuer. For registered securities, the registered owner, whether of certicated or uncerticated securities, has a direct relationship with the issuer by virtue of being recorded as the owner on the records maintained by the issuer or its transfer agent. By contrast, the DTC depository system for corporate equity and debt securities can be described as an indirect holding system, that is, the issuer's records do not show the identity of all of the benecial owners. Instead, a large portion of the outstanding securities of any given issue are recorded on the issuer's records as belonging to a depository. The depository's records in turn show the identity of the banks or brokers who are its members, and the records of those securities intermediaries show the identity of their customers. Even after the 1978 amendments, the rules of Article 8 did not deal eectively with the indirect holding system. The rules of the 1978 version of Article 8 were based on the as711

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sumption that changes in ownership of securities would still be eected either by delivery of physical certicates or by registration of transfer on the books of the issuer. Yet in the indirect holding system, settlement of the vast majority of securities trades does not involve either of these events. For most, if not all, of the securities held through DTC, physical certicates representing DTC's total position do exist. These jumbo certicates, however, are never delivered from person to person. Just as nothing ever happens to these certicates, virtually nothing happens to the ocial registry of stockholders maintained by the issuers or their transfer agents to reect the great bulk of the changes in ownership of shares that occur each day. The principal mechanism through which securities trades are settled today is not delivery of certicates or registration of transfers on the issuer's books, but netted settlement arrangements and accounting entries on the books of a multi-tiered pyramid of securities intermediaries. Herein is the basic problem. Virtually all of the rules of the prior version of Article 8 specifying how changes in ownership of securities are eected, and what happens if something goes awry in the process, were keyed to the concepts of a transfer of physical certicates or registration of transfers on the books of the issuers, yet that is not how changes in ownership are actually reected in the modern securities holding system. II. BRIEF OVERVIEW OF REVISED ARTICLE 8 A. Drafting ApproachNeutrality Principle One of the objectives of the revision of Article 8 is to devise a structure of commercial law rules for investment securities that will be suciently exible to respond to changes in practice over the next few decades. If it were possible to predict with condence how the securities holding and trading system would develop, one could produce a statute designed specically for the system envisioned. Recent experience, however, shows the danger of that approach. The 1978 amendments to Article 8 were based on the assumption that the solution to the problems that plagued the paper-based securities trading system of the 1960s would be the development of uncerticated securities. Instead, the solution thus far has been the development of the indirect holding system. If one thought that the indirect holding system would come to dominate securities holding, one might draft Article 8 rules designed primarily for the indirect holding system, giving limited attention to the traditional direct holding system of security certicates or any uncerticated version of a direct holding system that might develop in the future. It is, however, by no means clear whether the long-term evolution will be toward decreased or increased use of direct holdings. At present, investors in most equity securities can either hold their securities through brokers or request that certicates be issued in their own name. For the immediate future it seems likely that that situation will continue. One can imagine many plausible scenarios for future evolution. Direct holding might become less and less common as investors become more familiar and comfortable with book-entry systems and/or as market or regulatory pressures develop that discourage direct holding. One might note, for example, that major brokerage rms are beginning to impose fees for having certicates issued and that some observers have suggested that acceleration of the cycle for settlement of securities trades might be facilitated by discouraging customers from obtaining certicates. On the other hand, other observers feel that it is important for investors to retain the option of holding securities in certicated form, or at least in some form that gives them a direct relationship with the issuer and does not require them to hold through brokers or other securities intermediaries. Some groups within the securities industry are beginning to work on development of uncerticated systems that would preserve this option. Revised Article 8 takes a neutral position on the evolution of securities holding practices. The revision was based on the assumption that the path of development will be determined by market and regulatory forces and that the Article 8 rules should not seek to inuence that development in any specic direction. Although various drafting approaches were considered, it became apparent early in the revision process that the dierences between the direct holding system and the indirect holding system are suciently signicant that it is best to treat them as separate systems requiring dierent legal concepts. Accordingly, while the rules of the prior version of Article 8 have, in large measure, been retained for the direct holding system, a new Part 5 has been added, setting out the commercial law rules for the indirect securities holding system. The principle of neutrality does carry some implications for the design of specic Article 8 rules. At the very least, the Article 8 rules 712

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for all securities holding systems should be suciently clear and predictable that uncertainty about the governing law does not itself operate as a constraint on market developments. In addition, an eort has been made to identify and eliminate any Article 8 rules that might act as impediments to any of the foreseeable paths of development. B. Direct Holding System With respect to securities held directly, Revised Article 8 retains the basic conceptual structure and rules of present law. Part 2, which is largely unchanged from former law, deals with certain aspects of the obligations of issuers. The primary purpose of the rules of Part 2 is to apply to investment securities the principles of negotiable instruments law that preclude the issuers of negotiable instruments from asserting defenses against subsequent purchasers. Part 3 deals with transfer for securities held directly. One of its principal purposes is to apply to investment securities the principles of negotiable instruments law that protect purchasers of negotiable instruments against adverse claims. Part 4 deals with the process of registration of transfer by the issuer or transfer agent. Although the basic concepts of the direct holding system rules have been retained, there are signicant changes in terminology, organization, and statement of the rules. Some of the major changes are as follows: Simplication of Part 3. The addition of the new Part 5 on the indirect holding system makes unnecessary the rather elaborate provisions of former law, such as those in Section 8-313, that sought to t the indirect holding system into the conceptual structure of the direct holding system. Thus, Part 3 of Revised Article 8 is, in many respects, more similar to the original version of Article 8 than to the 1978 version. Protected purchaser. The prior version of Article 8 used the term bona de purchaser to refer to those purchasers who took free from adverse claims, and it used the phrase good faith in stating the requirements for such status. In order to promote clarity, Revised Article 8 states the rules that protect purchasers against adverse claims without using the phrase good faith and uses the new term protected purchaser to refer to purchasers in the direct holding system who are protected against adverse claims. See Sections 8-105 and 8-303. Certicated versus uncerticated securities. The rules of the 1978 version of Article 8 concerning uncerticated securities have been simplied considerably. The 1978 version added provisions on uncerticated securities parallel to the provisions of the original version of Article 8 dealing with securities represented by certicates. Thus, virtually every section had one set of rules on certicated securities and another on uncerticated securities. The constant juxtaposition of certicated securities and uncerticated securities has probably led readers to overemphasize the dierences. Revised Article 8 has a unitary denition of security in Section 8-102(a)(15) which refers to the underlying intangible interest or obligation. In Revised Article 8, the dierence between certicated and uncerticated is treated not as an inherent attribute of the security but as a dierence in the means by which ownership is evidenced. The terms certicated and uncerticated security are used in those sections where it is important to distinguish between these two means of evidencing ownership. Revised Article 8 also deletes the provisions of the 1978 version concerning transaction statements and registered pledges. These changes are explained in the Revision Notes 3, 4, and 5, below. Scope of Parts 2, 3, and 4. The rules of Parts 2, 3, and 4 deal only with the rights of persons who hold securities directly. In typical securities holding arrangements in the modern depository system, only the clearing corporation would be a direct holder of the securities. Thus, while the rules of Parts 2, 3, and 4 would apply to the relationship between the issuer and the clearing corporation, they have no application to relationships below the clearing corporation level. Under Revised Article 8, a person who holds a security through a broker or securities custodian has a security entitlement governed by the Part 5 rules but is not the direct holder of the security. Thus, the rules of Revised Section 8-303 on the rights of protected purchasers, which are the analog of the bona de purchaser rules of former Article 8, do not apply to persons who hold securities through brokers or securities custodians. Instead, Part 5 contains its own rules to protect investors in the indirect holding system against adverse claims. See Revised Section 8-502. C. Indirect Holding System Although the Revised Article 8 provisions for the indirect holding system are somewhat complex, the basic approach taken can be summarized rather briey. Revised Article 8 713

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abandons the attempt to describe all of the complex relationships in the indirect holding system using the simple concepts of the traditional direct holding system. Instead, new rules specically designed for the indirect holding system are added as Part 5 of Article 8. In a nutshell, the approach is to describe the core of the package of rights of a person who holds a security through a securities intermediary and then give that package of rights a name. The starting point of Revised Article 8's treatment of the indirect holding system is the concept of security entitlement. The term is dened in Section 8-102(a)(17) as the rights and property interest of an entitlement holder with respect to a nancial asset specied in Part 5. Like many legal concepts, however, the meaning of security entitlement is to be found less in any specic denition than in the matrix of rules that use the term. In a sense, then, the entirety of Part 5 is the denition of security entitlement because the Part 5 rules specify the rights and property interest that comprise a security entitlement. Part 5 begins by specifying, in Section 8-501, when an entitlement holder acquires a security entitlement. The basic rule is very simple. A person acquires a security entitlement when the securities intermediary credits the nancial asset to the person's account. The remaining sections of Part 5 specify the content of the security entitlement concept. Section 8-504 provides that a securities intermediary must maintain a sucient quantity of nancial assets to satisfy the claims of all of its entitlement holders. Section 8-503 provides that these nancial assets are held by the intermediary for the entitlement holders, are not the property of the securities intermediary, and are not subject to claims of the intermediary's general creditors. Thus, a security entitlement is itself a form of property interest not merely an in personam claim against the intermediary. The concept of a security entitlement does, however, include a package of in personam rights against the intermediary. Other Part 5 rules identify the core of this package of rights, subject to specication by agreement and regulatory law. See Sections 8-505 through 8-509. To illustrate the basic features of the new rules, consider a simple example of two investors, John and Mary, each of whom owns 1000 shares of Acme, Inc., a publicly traded company. John has a certicate representing his 1000 shares and is registered on the books maintained by Acme's transfer agent as the holder of record of those 1000 shares. Accordingly, he has a direct claim against the issuer, he receives dividends and distributions directly from the issuer, and he receives proxies directly from the issuer for purposes of voting his shares. Mary has chosen to hold her securities through her broker. She does not have a certicate and is not registered on Acme's stock books as a holder of record. She enjoys the economic and corporate benets of ownership but does so through her broker and any other intermediaries in the chain back to the issuer. John's interest in Acme common stock would be described under Revised Article 8 as a direct interest in a security. Thus, if John grants a security interest in his investment position, the collateral would be described as a security. Mary's interest in Acme common stock would be described under Revised Article 8 as a security entitlement. Thus, if Mary grants a security interest in her investment position, the collateral would be described as a security entitlement. For many purposes, there is no need to dierentiate among the various ways that an investor might hold securities. For example, for purposes of nancial accounting, John and Mary would each be described as the owner of 1000 shares of Acme common stock. For those purposes it is irrelevant that John is the registered owner and has physical possession of a certicate, while Mary holds her position through an intermediary. Revised Article 8 recognizes this point in Section 8-104 which provides that acquiring a security entitlement and acquiring a security certicate are dierent ways of acquiring an interest in the underlying security. D. Security Interests Along with the revision of Article 8, signicant changes have been made in the rules concerning security interests in securities. The revision returns to the pre-1978 structure in which the rules on security interests in investment securities are set out in Article 9, rather than in Article 8. The changes in Article 9 are, in part, conforming changes to adapt Article 9 to the new concept of a security entitlement. The Article 9 changes, however, go beyond that to establish a simplied structure for the creation and perfection of security interests in investment securities, whether held directly or indirectly. The Revised Article 9 rules continue the long-established principle that a security interest in a security represented by a certicate can be perfected by a possessory pledge. The 714

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revised rules, however, do not require that all security interests in investment securities be implemented by procedures based on the conceptual structure of the common law pledge. Under the revised Article 9 rules, a security interest in securities can be created pursuant to Section 9-203 in the same fashion as a security interest in any other form of property, that is, by agreement between the debtor and secured party. There is no requirement of a transfer, delivery, or any similar action, physical or metaphysical, for the creation of an eective security interest. A security interest in securities is, of course, a form of property interest, but the only requirements for creation of this form of property interest are those set out in Section 9-203. The perfection methods for security interests in investment securities are set out in Sections 9-309, 9-312, 9-313, and 9-314. The basic rule is that a security interest may be perfected by control. The concept of control, dened in Section 8-106, plays an important role in both Article 8 and Article 9. In general, obtaining control means taking the steps necessary to place the lender in a position where it can have the collateral sold o without the further cooperation of the debtor. Thus, for certicated securities, a lender obtains control by taking possession of the certicate with any necessary indorsement. For securities held through a securities intermediary, the lender can obtain control in two ways. First, the lender obtains control if it becomes the entitlement holder; that is, has the securities positions transferred to an account in its own name. Second, the lender obtains control if the securities intermediary agrees to act on instructions from the secured party to dispose of the positions, even though the debtor remains the entitlement holder. Such an arrangement suces to give the lender control even though the debtor retains the right to trade and exercise other ordinary rights of an entitlement holder. Except where the debtor is itself a securities rm, ling of an ordinary Article 9 nancing statement is also a permissible alternative method of perfection. However, ling with respect to investment property does not assure the lender the same protections as for other forms of collateral, since the priority rules provide that a secured party who obtains control has priority over a secured party who does not obtain control. The details of the new rules on security interests, as applied both to the retail level and to arrangements for secured nancing of securities dealers, are explained in the Ocial Comments to Sections 9-309, 9-312, 9-313, and 9-314. III. SCOPE AND APPLICATION OF ARTICLE 8

A. Terminology To understand the scope and application of the rules of Revised Article 8, and the related security interest rules of Article 9, it is necessary to understand some of the key dened terms: Security, dened in Section 8-102(a)(15), has essentially the same meaning as under the prior version of Article 8. The dierence in Revised Article 8 is that the denition of security does not determine the coverage of all of Article 8. Although the direct holding system rules in Parts 2, 3, and 4 apply only to securities, the indirect holding system rules of Part 5 apply to the broader category of nancial assets. Financial asset, dened in Section 8-103(a)(9), is the term used to describe the forms of property to which the indirect holding system rules of Part 5 apply. The term includes not only securities, but also other interests, obligations, or property that are held through securities accounts. The best illustration of the broader scope of the term nancial asset is the treatment of money market instruments, discussed below. Security entitlement, dened in Section 8-103(a)(17), is the term used to describe the property interest of a person who holds a security or other nancial asset through a securities intermediary. Securities intermediary, dened in Section 8-103(a)(14), is the term used for those who hold securities for others in the indirect holding system. It covers clearing corporations, banks acting as securities custodians, and brokers holding securities for their customers. Entitlement holder, dened in Section 8-103(a)(7), is the term used for those who hold securities through intermediaries. Securities account, dened in Section 8-501(a), describes the form of arrangement between a securities intermediary and an entitlement holder that gives rise to a security entitlement. As explained below, the denition of securities account plays a key role in set715

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ting the scope of the indirect holding system rules of Part 5. Investment property, dened in Section 9-102(a)(49), determines the application of the new Article 9 rules for secured transactions. In addition to securities and security entitlements, the Article 9 term investment property is dened to include securities account in order to simplify the drafting of the Article 9 rules that permit debtors to grant security interests either in specic security entitlements or in an entire securities account. The other dierence between the coverage of the Article 8 and Article 9 terms is that commodity futures contracts are excluded from Article 8, but are included within the Article 9 denition of investment property. Thus, the new Article 9 rules apply to security interests in commodity futures positions as well as security interests in securities positions. B. Notes on Scope of Article 8 Article 8 is in no sense a comprehensive codication of the law governing securities or transactions in securities. Although Article 8 deals with some aspects of the rights of securities holders against issuers, most of that relationship is governed not by Article 8, but by corporation, securities, and contract law. Although Article 8 deals with some aspects of the rights and duties of parties who transfer securities, it is not a codication of the law of contracts for the purchase or sale of securities. (The prior version of Article 8 did include a few miscellaneous rules on contracts for the sale of securities, but these have not been included in Revised Article 8). Although the new indirect holding system rules of Part 5 deal with some aspects of the relationship between brokers or other securities professionals and their customers, Article 8 is still not in any sense a comprehensive code of the law governing the relationship between broker-dealers or other securities intermediaries and their customers. Most of the law governing that relationship is the common law of contract and agency, supplemented or supplanted by regulatory law. The distinction between the aspects of the broker-customer relationship that are and are not dealt with in this Article may be illuminated by considering the diering roles of the broker in a typical securities transaction, in which the broker acts as agent for the customer. When a customer directs a broker to buy or sell securities for the customer, and the broker executes that trade on a securities exchange or in the over the counter market, the broker is entering into a contract for the purchase or sale of the securities as agent of the customer. The rules of the exchange, practices of the market, or regulatory law will specify when and how that contract is to be performed. For example, today the terms of the standard contract for trades in most corporate securities require the seller to deliver the securities, and the buyer to pay for them, ve business days after the date that the contract was made, although the SEC has recently promulgated a rule that will accelerate the cycle to require settlement in three business days. In the common speech of the industry, the transaction in which the broker enters into a contract for the purchase or sale of the securities is referred to as executing the trade, and the transaction in which the securities are delivered and paid for is referred to as settlement. Thus, the current settlement cycle is known as T+5, that is, settlement is required on the fth business day after the date of the trade, and the new SEC rule will change it to T+3. One must be careful in moving from the jargon of the securities industry to the jargon of the legal profession. For most practical economic purposes, the trade date is the date that counts, because that is the time at which the price is set, the risk of price changes shifts, and the parties become bound to perform. For purposes of precise legal analysis, however, the securities phrase trade or execute a trade means enter into a contract for the purchase or sale of the securities. The transfer of property interests occurs not at the time the contract is made but at the time it is performed, that is, at settlement. The distinction between trade and settlement is important in understanding the scope of Article 8. Article 8 deals with the settlement phase of securities transactions. It deals with the mechanisms by which interests in securities are transferred, and the rights and duties of those who are involved in the transfer process. It does not deal with the process of entering into contracts for the transfer of securities or regulate the rights and duties of those involved in the contracting process. To use securities parlance, Article 8 deals not with the trade, but with settlement of the trade. Indeed, Article 8 does not even deal with all aspects of settlement. In a netted clearance and settlement system such as the NSCC-DTC system, individual trades are not settled one-by-one by corresponding entries on the books of any depository. Rather, settlement of the individual trades occurs through the clearing arrangements, in accordance with the rules and agreements that govern those arrangements. 716

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In the rules dealing with the indirect holding system, one must be particularly careful to bear in mind the distinction between trade and settlement. Under Revised Article 8, the property interest of a person who holds securities through an intermediary is described as a security entitlement, which is dened in Revised Section 8-102(a)(17) as the package of rights and property interest of an entitlement holder specied in Part 5. Saying that the security entitlement is a package of rights against the broker does not mean that all of the customer's rights against the broker are part of the security entitlement and hence part of the subject matter of Article 8. The distinction between trade and settlement remains fundamental. The rules of this Article on the indirect holding system deal with brokers and other intermediaries as media through which investors hold their nancial assets. Brokers are also media through which investors buy and sell their nancial assets, but that aspect of their role is not the subject of this Article. The principal goal of the Article 8 revision project is to provide a satisfactory framework for analysis of the indirect holding system. The technique used in Revised Article 8 is to acknowledge explicitly that the relationship between a securities intermediary and its entitlement holders is sui generis, and to state the applicable commercial law rules directly, rather than by inference from a categorization of the relationship based on legal concepts of a dierent era. One of the consequences of this drafting technique is that in order to provide content to the concept of security entitlement it becomes necessary to identify the core of the package of rights that make up a security entitlement. Sections 8-504 through 8-508 cover such basic matters as the duty of the securities intermediary to maintain a sufcient quantity of securities to satisfy all of its entitlement holders, the duty of the securities intermediary to pass through to entitlement holder the economic and corporate law rights of ownership of the security, and the duty of the securities intermediary to comply with authorized entitlement orders originated by the entitlement holder. These sections are best thought of as denitional; that is, a relationship which does not include these rights is not the kind of relationship that Revised Article 8 deals with. Because these sections take the form of statements of the duties of an intermediary toward its entitlement holders, one must be careful to avoid a distorted perspective on what Revised Article 8 is and is not designed to do. Revised Article 8 is not, and should not be, a comprehensive body of private law governing the relationship between brokers and their customers, nor a body of regulatory law to police against improper conduct by brokers or other intermediaries. Many, if not most, aspects of the relationship between brokers and customers are governed by the common law of contract and agency, supplemented or supplanted by federal and state regulatory law. Revised Article 8 does not take the place of this body of private and regulatory law. If there are gaps in the regulatory law, they should be dealt with as such; Article 8 is not the place to address them. Article 8 deals with how interests in securities are evidenced and how they are transferred. By way of a rough analogy, one might think of Article 8 as playing the role for the securities markets that real estate recording acts play for the real estate markets. Real estate recording acts do not regulate the conduct of parties to real estate transactions; Article 8 does not regulate the conduct of parties to securities transactions. Application of Revised Articles 8 and 9 to Common Investments and Investment Arrangements It may aid understanding to sketch briey the treatment under Revised Articles 8 and 9 of a variety of relatively common products and arrangements. 1. Publicly traded stocks and bonds. Security is dened in Revised Section 8-102(a)(15) in substantially the same terms as in the prior version of Article 8. It covers the ordinary publicly traded investment securities, such as corporate stocks and bonds. Parts 2, 3, and 4 govern the interests of persons who hold securities directly, and Part 5 governs the interest of those who hold securities indirectly. Ordinary publicly traded securities provide a good illustration of the relationship between the direct and indirect holding system rules. The distinction between the direct and indirect holding systems is not an attribute of the securities themselves but of the way in which a particular person holds the securities. Thus, whether one looks to the direct holding system rules of Parts 2, 3, and 4 or the indirect holding system rules of Part 5 will depend on the level in the securities holding system being analyzed. Consider, for example, corporate stock which is held through a depository, such as DTC. 717 C.

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The clearing corporation, or its nominee, is the registered owner of all of the securities it holds on behalf of all of its participants. Thus the rules of Parts 2, 3, and 4 of Revised Article 8 apply to the relationship between the issuer and the clearing corporation. If, as is typically the case today, the securities are still represented by certicates, the clearing corporation will be the holder of the security certicate or certicates representing its total holdings. So far as Article 8 is concerned, the relationship between the issuer and the clearing corporation is no dierent from the relationship between the issuer and any other registered owner. The relationship between the clearing corporation and its participants is governed by the indirect holding system rules of Part 5. At that level, the clearing corporation is the securities intermediary and the participant is the entitlement holder. If the participant is itself a securities intermediary, such as a broker holding for its customers or a bank acting as a securities custodian, the Part 5 rules apply to its relationship to its own customers. At that level the broker or bank custodian is the securities intermediary and the customer is the entitlement holder. Note that the broker or bank custodian is both an entitlement holder and a securities intermediarybut is so with respect to dierent security entitlements. For purposes of Article 8 analysis, the customer's security entitlement against the broker or bank custodian is a dierent item of property from the security entitlement of the broker or bank custodian against the clearing corporation. For investors who hold their securities directly, it makes no dierence that some other investors hold their interests indirectly. Many investors today choose to hold their securities directly, becoming the registered owners on the books of the issuer and obtaining certicates registered in their names. For such investors, the addition of the new indirect holding system rules to Article 8 is entirely irrelevant. They will continue to deal directly with the issuers, or their transfer agents, under essentially the same rules as in the prior version of Article 8. The securities holding options available to investors in a particular form of security may depend on the terms of the security. For example, direct holding is frequently not available for new issues of state and local government bonds. At one time, state and local government bonds were commonly issued in bearer form. Today, however, new issues of state and local government bonds must be in registered form and most are issued in what is known as book-entry only form; that is, the issuer species that the only person it will directly register as the registered owner is a clearing corporation. Thus, one of the inherent terms of the security is that investors can hold only in the indirect holding system. 2. Treasury securities. U.S. government securities fall within the denition of security in Article 8 and therefore are governed by Article 8 in the same fashion as any other publicly held debt security, except insofar as Article 8 is preempted by applicable federal law or regulation. New Treasury securities are no longer issued in certicated form; they can be held only through the book-entry systems established by the Treasury and Federal Reserve Banks. The Treasury oers a book-entry system, known as Treasury Direct which enables individual investors to have their positions recorded directly on the books of a Federal Reserve Bank, in a fashion somewhat similar to the uncerticated direct holding system contemplated by the 1978 version of Article 8. The governing law for the Treasury Direct system, however, is set out in the applicable Treasury regulations. The Treasury Direct system is not designed for active trading. The great bulk of Treasury securities are held not through the Treasury Direct system but through a multi-tiered indirect holding system. The Federal Reserve Banks, acting as scal agent for the Treasury, maintain records of the holdings of member banks of the Federal Reserve System, and those banks in turn maintain records showing the extent to which they are holding for themselves or their own customers, including government securities dealers, institutional investors, or smaller banks who in turn may act as custodians for investors. The indirect holding system for Treasury securities was established under federal regulations promulgated in the 1970s. In the 1980s, Treasury released the proposed TRADES regulations that would have established a more comprehensive body of federal commercial law for the Treasury holding system. During the Article 8 revision process, Treasury withdrew these regulations, anticipating that once Revised Article 8 is enacted, it will be possible to base the law for the Treasury system on the new Article 8 rules. 3. Broker-customer relationships. 718

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Whether the relationship between a broker and its customer is governed by the Article 8 Part 5 rules depends on the nature of the services that the broker performs for the customer. Some investors use brokers only to purchase and sell securities. These customers take delivery of certicates representing the securities they purchase and hold them in their own names. When they wish to sell, they deliver the certicates to the brokers. The Article 8 Part 5 rules would not aect such customers, because the Part 5 rules deal with arrangements in which investors hold securities through securities intermediaries. The transaction between the customer and broker might be the traditional agency arrangement in which the broker buys or sells on behalf of the customer as agent for an undisclosed principal, or it might be a dealer transaction in which the broker as principal buys from or sells to the customer. In either case, if the customer takes delivery and holds the securities directly, she will become the purchaser of a security whose interest therein is governed by the rules of Parts 2, 3, and 4 of Article 8. If the customer meets the other requirements of Section 8-303(a), the customer who takes delivery can qualify as a protected purchaser who takes free from any adverse claims under Section 8-303(b). The broker's role in such transactions is primarily governed by non-Article 8 law. There are only a few provisions of Article 8 that aect the relationship between the customer and broker in such cases. See Section 8-108 (broker makes to the customer the warranties of a transferor) and 8-115 (broker not liable in conversion if customer was acting wrongfully against a third party in selling securities). Many investors use brokers not only to purchase and sell securities, but also as the custodians through whom they hold their securities. The indirect holding system rules of Part 5 apply to the custodial aspect of this relationship. If a customer purchases a security through a broker and directs the broker to hold the security in an account for the customer, the customer will never become a purchaser of a security whose interest therein is governed by the rules of Parts 2, 3, and 4 of Article 8. Accordingly, the customer does not become a protected purchaser under Section 8-303. Rather, the customer becomes an entitlement holder who has a security entitlement to the security against the broker as securities intermediary. See Section 8-501. It would make no sense to say that the customer in such a case takes an interest in the security free from all other claims, since the nature of the relationship is that the customer has an interest in common with other customers who hold positions in the same security through the same broker. Section 8-502, however, does protect an entitlement holder against adverse claims, in the sense that once the entitlement holder has acquired the package of rights that comprise a security entitlement no one else can take that package of rights away by arguing that the transaction that resulted in the customer's acquisition of the security entitlement was the traceable product of a transfer or transaction that was wrongful as against the claimant. 4. Bank deposit accounts; brokerage asset management accounts. An ordinary bank deposit account would not fall within the denition of security in Section 8-102(a)(15), so the rules of Parts 2, 3, and 4 of Article 8 do not apply to deposit accounts. Nor would the relationship between a bank and its depositors be governed by the rules of Part 5 of Article 8. The Part 5 rules apply to security entitlements. Section 8-501(b) provides that a person has a security entitlement when a securities intermediary credits a nancial asset to the person's securities account. Securities account is dened in Section 8-501(a) as an account to which a nancial asset is or may be credited in accordance with an agreement under which the person maintaining the account undertakes to treat the person for whom the account is maintained as entitled to exercise the rights that comprise the nancial asset. The denition of securities account plays a key role in setting the scope of Part 5 of Article 8. A person has a security entitlement governed by Part 5 only if the relationship in question falls within the denition of securities account. The denition of securities account in Section 8-501(a) excludes deposit accounts from the Part 5 rules of Article 8. One of the basic elements of the relationship between a securities intermediary and an entitlement holder is that the securities intermediary has the duty to hold exactly the quantity of securities that it carries for the account of its customers. See Section 8-504. The assets that a securities intermediary holds for its entitlement holder are not assets that the securities intermediary can use in its own proprietary business. See Section 8-503. A deposit account is an entirely dierent arrangement. A bank is not required to hold in its vaults or in deposit accounts with other banks a sum of money equal to the claims of all of its depositors. Banks are permitted to use depositors' funds in their ordinary lending business; indeed, that is a primary function of banks. A deposit account, unlike a 719

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securities account, is simply a debtor-creditor relationship. Thus a bank or other nancial institution maintaining deposit accounts is not covered by Part 5 of Article 8. Today, it is common for brokers to maintain securities accounts for their customers which include arrangements for the customers to hold liquid cash assets in the form of money market mutual fund shares. Insofar as the broker is holding money market mutual fund shares for its customer, the customer has a security entitlement to the money market mutual fund shares. It is also common for brokers to oer their customers an arrangement in which the customer has access to those liquid assets via a deposit account with a bank, whereby shares of the money market fund are redeemed to cover checks drawn on the account. Article 8 applies only to the securities account; the linked bank account remains an account covered by other law. Thus the rights and duties of the customer and the bank are governed not by Article 8, but by the relevant payment system law, such as Article 4 or Article 4A. 5. Trusts. The indirect holding system rules of Part 5 of Article 8 are not intended to govern all relationships in which one person holds securities on behalf of another. Rather, the Part 5 rules come into play only if the relationship in question falls within the denition of securities account in Section 8-501(a). The denition of securities account serves the important function of ensuring that ordinary trust arrangements are not inadvertently swept into Part 5 of Article 8. Suppose that Bank serves as trustee of a trust for the benet of Beneciary. The corpus of the trust is invested in securities and other nancial assets. Although Bank is, in some senses, holding securities for Beneciary, the arrangement would not fall within the denition of securities account. Bank, as trustee, has not undertaken to treat Beneciary as entitled to exercise all of the rights that comprise the portfolio securities. For instance, although Beneciary receives the economic benet of the portfolio securities, Beneciary does not have the right to direct dispositions of individual trust assets or to exercise voting or other corporate law rights with respect to the individual securities. Thus Bank's obligations to Beneciary as trustee are governed by ordinary trust law, not by Part 5 of Article 8. Of course, if Bank, as trustee, holds the securities through an intermediary, Part 5 of Revised Article 8 would govern the relationship between Bank, as entitlement holder, and the intermediary through which Bank holds the securities. It is also possible that a dierent department of Bank acts as the intermediary through which Bank, as trustee, holds the securities. Bank, qua securities custodian, might be holding securities for a large number of customers, including Bank's own trust department. Insofar as Bank may be regarded as acting in dierent capacities, Part 5 of Article 8 may be relevant to the relationship between the two sides of Bank's business. However, the relationship between Bank as trustee and the beneciaries of the trust would remain governed by trust law, not Article 8. 6. Mutual fund shares. Shares of mutual funds are Article 8 securities, whether the fund is organized as a corporation, business trust, or other form of entity. See Sections 8-102(a)(15) and 8-103(b). Mutual funds commonly do not issue certicates. Thus, mutual fund shares are typically uncerticated securities under Article 8. Although a mutual fund is, in a colloquial sense, holding the portfolio securities on behalf of the fund's shareholders, the indirect holding system rules of Part 5 do not apply to the relationship between the fund and its shareholders. The Part 5 rules apply to security entitlements. Section 8-501(e) provides that issuance of a security is not establishment of a security entitlement. Thus, because mutual funds shares do t within the Article 8 denition of security, the relationship between the fund and its shareholders is automatically excluded from the Part 5 rules. Of course, a person might hold shares in a mutual fund through a brokerage account. Because mutual fund shares are securities, they automatically fall within the broader term nancial asset, so the Part 5 indirect holding system rules apply to mutual fund shares that are held through securities accounts. That is, a person who holds mutual fund shares through a brokerage account could have a security entitlement to the mutual fund shares, just as the person would have a security entitlement to any other security carried in the brokerage account. 7. Stock of closely held corporations. Ordinary corporate stock falls within the Article 8 denition of security, whether or not it 720

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Investment Securities

is publicly traded. See Sections 8-102(a)(15) and 8-103(a). There is nothing in the new indirect holding system rules of Article 8 that would preclude their application to shares of companies that are not publicly traded. The indirect holding system rules, however, would come into play only if the shares were in fact held through a securities account with a securities intermediary. Since that is typically not the case with respect to shares of closely held corporations, transactions involving those shares will continue to be governed by the traditional rules, as amended, that are set out in Parts 2, 3, and 4 of Article 8, and the corresponding provisions of Article 9. The simplication of the Article 8 rules on uncerticated securities may, however, make the alternative of dispensing with certicates more attractive for closely held corporations. 8. Partnership interests and limited liability company shares. Interests in partnerships or shares of limited liability companies are not Article 8 securities unless they are in fact dealt in or traded on securities exchanges or in securities markets. See Section 8-103(c). The issuers, however, may if they wish explicitly opt-in by specifying that the interests or shares are securities governed by Article 8. Even though interests in partnerships or shares of limited liability companies do not generally fall within the category of security in Article 8, they would fall within the broader term nancial asset. Accordingly, if such interests are held through a securities account with a securities intermediary, the indirect holding system rules of Part 5 apply, and the interest of a person who holds them through such an account is a security entitlement. 9. Bankers' acceptances, commercial paper, and other money market instruments. Money market instruments, such as commercial paper, bankers' acceptances, and certicates of deposit, are good examples of a form of property that may fall within the denition of nancial asset, even though they may not fall within the denition of security. Section 8-103(d) provides that a writing that meets the denition of security certicate under Section 8-102(a)(15) is governed by Article 8, even though it also ts within the denition of negotiable instrument in Article 3. Some forms of short term money market instruments may meet the requirements of an Article 8 security, while others may not. For example, the Article 8 denition of security requires that the obligation be in registered or bearer form. Bankers' acceptances are typically payable to order, and thus do not qualify as Article 8 securities. Thus, the obligations of the immediate parties to a bankers' acceptance are governed by Article 3, rather than Article 8. That is an entirely appropriate classication, even for those bankers' acceptance that are handled as investment media in the securities markets, because Article 8, unlike Article 3, does not contain rules specifying the standardized obligations of parties to instruments. For example, the Article 3 rules on the obligations of acceptors and drawers of drafts are necessary to specify the obligations represented by bankers' acceptances, but Article 8 contains no provisions dealing with these issues. Immobilization through a depository system is, however, just as important for money market instruments as for traditional securities. Under the prior version of Article 8, the rules on the depository system, set out in Section 8-320, applied only to Article 8 securities. Although some forms of money market instruments could be tted within the language of the Article 8 denition of security, this is not true for bankers' acceptances. Accordingly, it was not thought feasible to make bankers' acceptances eligible for deposit in clearing corporations under the prior version of Article 8. Revised Article 8 solves this problem by separating the coverage of the Part 5 rules from the denition of security. Even though a bankers' acceptance or other money market instrument is an Article 3 negotiable instrument rather than an Article 8 security, it would still fall within the denition of nancial asset in Section 8-102(a)(9). Accordingly, if the instrument is held through a clearing corporation or other securities intermediary, the rules of Part 5 of Article 8 apply. 10. Repurchase agreement transactions. Repurchase agreements are an important form of transaction in the securities business, particularly in connection with government securities. Repos and reverse repos can be used for a variety of purposes. The one that is of particular concern for purposes of commercial law rules is the use of repurchase agreements as a form of nancing transaction for government securities dealers. Government securities dealers typically obtain intra-day nancing from their clearing banks, and then at the end of the trading day seek overnight nancing from other sources to repay that day's advances from the clearing bank. Repos are the principal source of this nancing. The dealer (repo seller) sells securities to the nancing 721

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source (repo buyer) for cash, and at the same time agrees to repurchase the same or like securities the following day, or at some other brief interval. The sources of the nancing include a variety of entities seeking short term investments for surplus cash, such as pension funds, business corporations, money market funds, and banks. The pricing may be computed in various ways, but in essence the price at which the dealer agrees to repurchase the securities exceeds the price paid to the dealer by an amount equivalent to interest on the funds. The transfer of the securities from a securities dealer as repo seller to a provider of funds as repo buyer can be eected in a variety of ways. The repo buyer might be willing to allow the repo seller to keep the securities in its hands, relying on the dealer's representation that it will hold them on behalf of the repo buyer. In the jargon of the trade, these are known as hold-in-custody repos or HIC repos. At the other extreme, the repo buyer might insist that the dealer hand over the securities so that in the event that the dealer fails and is unable to perform its obligation to repurchase them, the repo buyer will have the securities in its hands. The jargon for these is delivered-out repos. A wide variety of arrangements between these two extremes might be devised, in which the securities are handed over to a third party with powers concerning their disposition allocated between the repo seller and repo buyer in a variety of ways. Specication of the rights of repo buyers is complicated by the fact that the transfer of the interest in securities from the repo seller to the repo buyer might be characterized as an outright sale or as the creation of a security interest. Article 8 does not attempt to specify any categorical rules on that issue. Article 8 sets out rules on the rights of parties who have implemented securities transactions in certain ways. It does not, however, deal with the legal characterization of the transactions that are implemented through the Article 8 mechanisms. Rather, the Article 8 rules apply without regard to the characterization of transactions for other purposes. For example, the Article 8 rules for the direct holding system provide that a person who takes delivery of a duly indorsed security certicate for value and without notice of adverse claims takes free from any adverse claims. That rule applies without regard to the character of the transaction in which the security certicate was delivered. It applies both to delivery upon original issue and to delivery upon transfer. It applies to transfers in settlement of sales and to transfers in pledge. Similarly, the Article 8 indirect holding system rules, such as the adverse claim cut-o rules in Sections 8-502 and 8-510, apply to the transactions that fall within their terms, whether those transactions were sales, secured transactions, or something else. Repos involve transfers of interests in securities. The Article 8 rules apply to transfers of securities in repos, just as they apply to transfers of securities in any other form of transaction. The transfer of the interest in securities from the repo seller to the repo buyer might be characterized as an outright sale or as the creation of a security interest. Article 8 does not determine that question. The rules of Revised Article 8 have, however, been drafted to minimize the possibility that disputes over the characterization of the transfer in a repo would aect substantive questions that are governed by Article 8. See, e.g., Section 8-510 and Comment 4 thereto. 11. Securities lending transactions. In a typical securities lending transaction, the owner of securities lends them to another person who needs the securities to satisfy a delivery obligation. For example, when a customer of a broker sells a security short, the broker executes an ordinary trade as seller and so must deliver the securities at settlement. The customer is short against the broker because the customer has an open obligation to deliver the securities to the broker, which the customer hopes to be able to satisfy by buying in the securities at a lower price. If the short seller's broker does not have the securities in its own inventory, the broker will borrow them from someone else. The securities lender delivers the securities to the borrowing broker, and the borrowing broker becomes contractually obligated to redeliver a like quantity of the same security. Securities borrowers are required to provide collateral, usually government securities, to assure performance of their redelivery obligation. The securities lender does not retain any property interest in the securities that are delivered to the borrower. The transaction is an outright transfer in which the borrower obtains full title. The whole point of securities lending is that the borrower needs the securities to transfer them to someone else. It would make no sense to say that the lender 722

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retains any property interest in the securities it has lent. Accordingly, even if the securities borrower defaults on its redelivery obligation, the securities lender has no property interest in the original securities that could be asserted against any person to whom the securities borrower may have transferred them. One need not look to adverse claim cut-o rules to reach that result; the securities lender never had an adverse claim. The securities borrower's default is no dierent from any other breach of contract. The securities lender's protection is its right to foreclose on the collateral given to secure the borrower's redelivery obligation. Perhaps the best way to understand securities lending is to note that the word loan in securities lending transactions is used in the sense it carries in loans of money, as distinguished from loans of specic identiable chattels. Someone who lends money does not retain any property interest in the money that is handed over to the borrower. To use civil law terminology, securities lending is mutuum, rather than commodatum. See Story on Bailments, 6 and 47. 12. Traded stock options. Stock options issued and cleared through the Options Clearing Corporation (OCC) are a good example of a form of investment vehicle that is treated as a nancial asset to which the Part 5 rules apply, but not as an Article 8 security to which Parts 2, 3, and 4 apply. OCC carries on its books the options positions of the brokerage rms which are clearing members of OCC. The clearing members in turn carry on their books the options positions of their customers. The arrangements are structurally similar to the securities depository system. In the options structure, however, there is no issuer separate from the clearing corporation. The nancial assets held through the system are standardized contracts entitling the holder to purchase or sell a certain security at a set price. Rather than being an interest in or obligation of a separate issuer, an option is a contractual right against the counter-party. In order to assure performance of the options, OCC interposes itself as counter-party to each options trade. The rules of Parts 2, 3, and 4 of this Article, however, do not well describe the obligations and rights of OCC. On the other hand, the rules of Part 5, and the related Article 9 rules on security interests and priorities, do provide a workable legal framework for the commercial law analysis of the rights of the participants in the options market. Accordingly, publicly traded securities options are included within the denition of nancial asset, but not security. See Section 8-103(e). Thus, although OCC would not be an issuer of a security for purposes of this Article, it would be a clearing corporation, against whom its clearing members have security entitlements to the options positions. Similarly, the clearing members' customers have security entitlements against the clearing members. Traded stock options are also a good illustration of the point that the classication issues under Article 8 are very dierent from classication under other law, such as the federal securities laws. See Section 8-102(d). Stock options are treated as securities for purposes of federal securities laws, but not for purposes of Article 8. 13. Commodity futures. Section 8-103(f) provides that a commodity contract is not a security or a nancial asset. Section 9-102(a)(15) denes commodity contract to include commodity futures contracts, commodity options, and options on commodity futures contracts that are traded on or subject to the rules of a board of trade that has been designated as a contract market for that contract pursuant to the federal commodities laws. Thus, commodity contracts themselves are not Article 8 securities to which the rules of Parts 2, 3, and 4 apply, nor is the relationship between a customer and a commodity futures commission merchant governed by the Part 5 rules of Article 8. Commodity contracts, however, are included within the Article 9 denition of investment property. Thus security interests in commodity positions are governed by essentially the same set of rules as security interests in security entitlements. 14. Whatever else they have or may devise. The classication question posed by the above-captioned category of investment products and arrangements is among the most dicultand importantissue raised by the Article 8 revision process. Rapid innovation is perhaps the only constant characteristic of the securities and nancial markets. The rules of Revised Article 8 are intended to be suciently exible to accommodate new developments. A common mechanism by which new nancial instruments are devised is that a nancial institution that holds some security, nancial instrument, or pool thereof, creates interests in that asset or pool which are sold to others. It is not possible to answer in the abstract 723

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the question of how such interests are treated under Article 8, because the variety of such products is limited only by human imagination and current regulatory structures. At this general level, however, one can note that there are at least three possible treatments under Article 8 of the relationship between the institution which creates the interests and the persons who hold them. (Again, it must be borne in mind that the Article 8 classication issue may be dierent from the classication question posed by federal securities law or other regulation.) First, creation of the new interests in the underlying assets may constitute issuance of a new Article 8 security. In that case the relationship between the institution that created the interest and the persons who hold them is not governed by the Part 5 rules, but by the rules of Parts 2, 3, and 4. See Section 8-501(e). That, for example, is the structure of issuance of mutual fund shares. Second, the relationship between the entity creating the interests and those holding them may t within the Part 5 rules, so that the persons are treating as having security entitlements against the institution with respect to the underlying assets. That, for example, is the structure used for stock options. Third, it may be that the creation of the new interests in the underlying assets does not constitute issuance of a new Article 8 security, nor does the relationship between the entity creating the interests and those holding them t within the Part 5 rules. In that case, the relationship is governed by other law, as in the case of ordinary trusts. The rst of these three possibilitiesthat the creation of the new interest is issuance of a new security for Article 8 purposesis a fairly common pattern. For example, an American depositary receipt facility does not maintain securities accounts but issues securities called ADRs in respect of foreign securities deposited in such facility. Similarly, custodians of government securities which issue receipts, certicates, or the like representing direct interests in those securities (sometimes interests split between principal and income) do not maintain securities accounts but issue securities representing those interests. Trusts holding assets, in a variety of structured and securitized transactions, which issue certicates or the like representing pass-through or undivided benecial interests in the trust assets, do not maintain securities accounts but issue securities representing those interests. In analyzing these classication questions, courts should take care to avoid mechanical jurisprudence based solely upon exegesis of the wording of denitions in Article 8. The result of classication questions is that dierent sets of rules come into play. In order to decide the classication question it is necessary to understand fully the commercial setting and consider which set of rules best ts the transaction. Rather than letting the choice of rules turn on interpretation of the words of the denitions, the interpretation of the words of the denitions should turn on the suitability of the application of the substantive rules. IV. CHANGES FROM PRIOR (1978) VERSION OF ARTICLE 8 A. Table of Disposition of Sections in Prior Version Revised Articles 8 and 9 8-101 8-102(a)(4) & (15) 8-102(a)(15) & (18) 8-102(a)(15) 8-102(a)(13) 8-102(a)(2) 8-202(b)(1) 8-102(a)(5) omitted, see Revision Note 1 8-102(b) 8-102(c) 8-209 8-210 omitted, see Revision Note 8 omitted, see Revision Note 4

Article 8 (1978) 8-101 8-102(1)(a) 8-102(1)(b) 8-102(1)(c) 8-102(1)(d) 8-102(1)(e) 8-102(2) 8-102(3) 8-102(4) 8-102(5) 8-102(6) 8-103 8-104 8-105(1) 8-105(2) 724

Art. 8
Article 8 (1978) 8-105(3) 8-106 8-107 8-108 8-201 8-202 8-203 8-204 8-205 8-206 8-207 8-208 8-301 8-302(1) 8-302(2) 8-302(3) 8-302(4) 8-303 8-304(1) 8-304(2) 8-304(3) 8-305 8-306(1) 8-306(2) 8-306(3) 8-306(4) 8-306(5) 8-306(6) 8-306(7) 8-306(8) 8-306(9) 8-306(10) 8-307 8-308(1) 8-308(2) 8-308(3) 8-308(4) 8-308(5) 8-308(6) 8-308(7) 8-308(8) 8-308(9) 8-308(10)

Investment Securities
Revised Articles 8 and 9 8-114 8-110 omitted, see Revision Note 8 omitted, see Revision Note 5 8-201 8-202; transaction statement provisions omitted, see Revision Note 4 8-203 8-204; transaction statement provisions omitted, see Revision Note 4 8-205; transaction statement provisions omitted, see Revision Note 4 8-206; transaction statement provisions omitted, see Revision Note 4 8-207; registered pledge provisions omitted, see Revision Note 5 8-208; transaction statement provisions omitted, see Revision Note 4 8-302(a) & (b) 8-303(a) 8-102(a)(1) 8-303(b) 8-302(c) 8-102(a)(3) 8-105(d) omitted, see Revision Note 4 8-105(b) 8-105(c) 8-108(f) 8-108(a) 8-108(g) 8-108(h) 8-108(e) 8-306(h) 8-108(b), 8-306(h) omitted, see Revision Note 5 8-108(c) 8-108(i) 8-304(d) 8-102(a)(11), 8-107 8-304(a) 8-304(b) 8-102(a)(12) 8-107 & 8-305(a) 8-107 8-107 8-107 8-304(f) & 8-305(b) 8-107 725

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Article 8 (1978) 8-308(11) 8-309 8-310 8-311(a) 8-311(b) 8-312 8-313(1)(a) 8-313(1)(b) 8-313(1)(c) 8-313(1)(d) 8-313(1)(e) 8-313(1)(f) 8-313(1)(g) 8-313(1)(h) (j) 8-313(2) 8-313(3) 8-313(4) 8-314 8-315 8-316 8-317 8-318 8-319 8-320 8-321 8-401 8-402 8-403 8-404 8-405(1) 8-405(2) 8-405(3) 8-406 8-407 8-408

Art. 8

Revised Articles 8 and 9 8-107 8-304(c) 8-304(e) omitted, see 8-106(b)(2), 8-301(b)(1), 8-303 8-404 8-306 omitted, see Revision Note 2; see also 8-301(a)(1) & (2) omitted, see Revision Note 2; see also 8-301(b)(1) & (2) omitted, see Revision Note 2; see also 8-301(a)(3) omitted, see Revision Note 2; see also 8-501(b) omitted, see Revision Note 2; see also 8-301(a)(2) omitted, see Revision Note 2; see also 8-301(b)(2) omitted, see Revision Notes 1 & 2; see also 8-501(b), 8-111 omitted, see Revision Note 2; see also 9-203 omitted, see Revision Note 2; see also 8-503 omitted, see Revision Note 2 8-102(a)(14) omitted, see Revision Note 8 omitted, see Revision Note 8 8-307 8-112 8-115 omitted, see 8-113 and Revision Note 7 omitted, see Revision Note 1 omitted, see 9-203, 9-309, 9-312, 9-314 8-401 8-402, see Revision Note 6 8-403, see Revision Note 6 8-404 8-406 8-405(a) 8-405(b) 8-407 omitted, see Revision Note 8 omitted, see Revision Note 4

B. Revision Notes 1. Provisions of former Article 8 on clearing corporations. The keystone of the treatment of the indirect holding system in the prior version of Article 8 was the special provision on clearing corporations in Section 8-320. Section 8-320 was added to Article 8 in 1962, at the very end of the process that culminated in promulgation and enactment of the original version of the Code. The key concepts of the original version of Article 8 were bona de purchaser and delivery. Under Section 8-302 (1962) one could qualify as a bona de purchaser only if one had taken delivery of a security, and Section 8-313 (1962) specied what counted as a delivery. Section 8-320 was added to take account of the development of the system in which trades can be settled by netted book-entry movements at a depository without physical deliveries of certicates. Rather than reworking the basic concepts, however, Section 8-320 brought the depository system within Article 8 by denitional at. Subsection (a) of Section 726

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8-320 (1962) stated that a transfer or pledge could be eected by entries on the books of a central depository, and subsection (b) stated that such an entry has the eect of a delivery of a security in bearer form or duly indorsed in blank. In 1978, 1978, Section 8-320 was revised to conform it to the general substitution of the concept of transfer for delivery, but the basic structure remained the same. Under the 1978 version of Article 8, the only book-entry transfers that qualied the transferee for bona de purchaser rights were those made on the books of a clearing corporation. See Sections 8-302(1)(c), 8-313(1)(g), and 8-320. Thus, for practical purposes, the indirect holding system rules of the prior version of Article 8 required that the securities be held by a clearing corporation in accordance with the central depository rules of Section 8-320. Some of the denitional provisions concerning clearing corporation in the prior version of Article 8 seem to have conated the commercial law rules on the eect of book-entry transactions with issues about the regulation of entities that are acting as clearing corporations. For example, the Section 8-320 rules that gave eect to book-entry transfers applied only if the security was in the custody of the clearing corporation, another clearing corporation, [or] a custodian bank. Custodian bank was dened in Section 8-102(4) as a bank or trust company that is supervised and examined by state or federal authority having supervision over banks and is acting as custodian for a clearing corporation. Although this was probably inadvertent, these denitional provisions have operated as an obstacle to the development of clearing arrangements for global trading, since they eectively precluded clearing corporations from using foreign banks as custodians. Revised Article 8 is based on the view that Article 8 is not the proper place for regulatory decisions about whether certain sorts of nancial institutions should or should not be permitted to engage in a particular aspect of the securities business, such as acting as a clearing corporation, or how they should be permitted to conduct that business. Rather, Article 8 should deal only with the commercial law questions of what duties and rights ow from doing business as a clearing corporation, leaving it to other regulatory law to decide which entities should be permitted to act as clearing corporations, and to regulate their activities. Federal securities laws now establish a detailed regulatory structure for clearing corporations; there is no need for Article 8 to duplicate parts of that structure. Revised Article 8 deletes all provision of the prior version which had the eect of specifying how clearing corporations should conduct their operations. For example, Revised Article 8 deletes the denition of custodian bank, which operated in the prior version only as a regulatory restriction on how clearing corporations could hold securities. In general, the structure of Revised Article 8 is such that there is relatively little need for special provisions on clearing corporations. Book-entry transactions eected through clearing corporations are treated under the same rules in Part 5 as book-entry transactions effected through any other securities intermediary. Accordingly, Revised Article 8 has no direct analog of the special provisions in Section 8-320 on transfers on the books of clearing corporations. 2. Former Section 8-313Transfer. Section 8-313 of the 1978 version of Article was extremely complicated, because it attempted to cover many dierent issues. The following account of the evolution of Section 8-313 may assist in understanding why a dierent approach is taken in Revised Article 8. This explanation is, however, intended not as an actual account of historical events, but as a conceptual reconstruction, devised from the perspective of, and with the benet of, hindsight. The original objective of Article 8 was to ensure that certicates representing investment securities would be negotiable in the sense that purchasers would be protected by the bona de purchaser rules. The requirements for bona de purchaser status were that the purchaser had to (i) take delivery of the security and (ii) give value in good faith and without notice of adverse claims. Section 8-313 specied what counted as a delivery, and Section 8-302 specied the other requirements. The 1978 amendments added provisions on uncerticated securities, but the basic organizational pattern was retained. Section 8-302 continued to state the requirements of value, good faith, and lack of notice for good faith purchase, and Section 8-313 stated the mechanism by which the purchase had to be implemented. Delivery as dened in the original version of Section 8-313 had a meaning similar to the concept known in colloquial securities jargon as good delivery; that is, physical delivery with any necessary indorsement. 727

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Although the word delivery has now come to be used in securities parlance in a broader sense than physical delivery, when the provisions for uncerticated securities were added it was thought preferable to use another word. Thus, the word transfer was substituted for delivery in Section 8-313. The 1978 amendments also moved the rules governing security interests in securities from Article 9 to Article 8, though the basic conceptual structure of the common law of pledge was retained. Since a pledge required a delivery, and since the term transfer had been substituted for delivery, the 1978 amendments provided that in order to create a security interest there must be a transfer, in the dened Article 8 sense, from the debtor to the secured party. Accordingly, provisions had to be added to Section 8-313 so that any of the steps that should suce to create a perfected security interest would be deemed to constitute a transfer within the meaning of Section 8-313. Thus, the Section 8-313 rules on transfer, which had in the previous version dealt only with what counted as a delivery that qualied one for bona de purchaser status, became the statutory locus for all of the rules on creation and perfection of security interests in securities. Accordingly the rather elaborate rules of subsections (1)(h), (1)(i), and (1)(j) were added. Having expanded Section 8-313 to the point that it served as the rule specifying the formal requirements for transfer of all signicant forms of interests in securities, it must have seemed only logical to take the next step and make the Section 8-313 rules the exclusive means of transferring interests in securities. Thus, while the prior version had stated that Delivery to a purchaser occurs when . . . , the 1978 version stated that Transfer of a security or a limited interest (including a security interest) therein to a purchaser occurs only . . .. Having taken that step, however, it then became necessary to ensure that anyone who should be regarded as having an interest in a security would be covered by some provision of Section 8-313. Thus, the provisions of subsection (1)(d)(ii) and (iii) were added to make it possible to say that the customers of a securities intermediary who hold interests in securities held by the intermediary in fungible bulk received transfers. Section 8-313(1)(d) was the key provision in the 1978 version dealing with the indirect holding system at the level below securities depositories. It operated in essentially the same fashion as Section 8-320; that is, it stated that when a broker or bank holding securities in fungible bulk makes entries on its books identifying a quantity of the fungible bulk as belonging to the customer, that action is treated as a transferin the special Section 8-313 senseof an interest in the security from the intermediary to the customer. Revised Article 8 has no direct analog of the 1978 version of Section 8-313. The rules on secured transactions have been returned to Article 9, so subsections of Section 8-313 (1978) dealing with security interests are deleted from Article 8. Insofar as portions of Section 8-313 (1978) were designed to specify the formal requirements for transferees to qualify for protection against adverse claims, their place is taken by Revised Section 8-301, which denes delivery, in a fashion somewhat akin to the pre-1978 version of Section 8-313. The descendant of the provisions of Section 8-313 (1978) dealing with the indirect holding system is Revised Section 8-501 which species when a person acquires a security entitlement. Section 8-501, however, is based on a dierent analysis of the transaction in which a customer acquires a position in the indirect holding system. The transaction is not described as a transfer of an interest in some portion of a fungible bulk of securities held by the securities intermediary but as the creation of a security entitlement. Accordingly, just as Revised Article 8 has no direct analog of the Section 8-320 rules on clearing corporation transfers, it has no direct analog of the Section 8-313(1) rules on transfers of interests in securities held in fungible bulk. 3. Uncerticated securities provisions. Given the way that securities holding practices have evolved, the sharp distinction that the 1978 version of Article 8 drew between certicated securities and uncerticated securities has become somewhat misleading. Since many provisions of the 1978 version had separate subsections dealing rst with certicated securities and then with uncerticated securities, and since people intuitively realize that the volume of trading in the modern securities markets could not possibly be handled by pushing around certicates, it was only natural for a reader of the statute to conclude that the uncerticated securities provisions of Article 8 were the basis of the book-entry system. That, however, is not the case. Although physical delivery of certicates plays little role in the settlement system, most publicly traded securities are still, in legal theory, certicated securities. To use clearance 728

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and settlement jargon, the book-entry securities holding system has used immobilization rather than dematerialization. The important legal and practical dierence is between the direct holding system, in which the benecial owners have a direct relationship with the issuer, and the indirect holding system, in which securities are held through tiers of securities intermediaries. Accordingly, in Revised Article 8 the contrast between certicated securities and uncerticated securities has been minimized or eliminated as much as possible in stating the substantive provisions. 4. Transaction statements. Although the 1978 provisions on uncerticated securities contemplated a system in which there would be no denitive certicates as reications of the underlying interests or obligations, the 1978 amendments did not really dispense with all requirements of paper evidence of securities holding. The 1978 amendments required issuers of uncerticated securities to send paper transaction statements upon registration of transfer. Section 8-408 regulated the content and format of these transaction statements in considerable detail. The statements had to be in writing, include specic information, and contain a conspicuous legend stating that This statement is merely a record of the rights of the addressee as of the time of its issuance. Delivery of this statement, of itself, confers no rights on the recipient. This statement is neither a negotiable instrument nor a security. Issuers were required to send statements when any transfer was registered (known as initial transaction statements) and also were required to send periodic statements at least annually and also upon any security holder's reasonable request. Fees were regulated to some extent, in that Section 8-408(8) specied that if periodic statements were sent at least quarterly, the issuer could charge for statements requested by security holders at other times. The detailed specication of reporting requirements for issuers of uncerticated securities was quite dierent from the treatment of securities intermediaries. Though the prior version of Article 8 did require non-clearing corporation securities intermediaries to send conrmations of transfersa requirement deleted in Revised Article 8it did not regulate their content or format. Article 8 has never imposed periodic reporting requirements on securities intermediaries. Thus, reporting requirements for the indirect holding system were left to agreements and regulatory authorities, while reporting requirements for a bookentry direct holding system were imposed by statute. Securities holding systems based on transaction statements of the sort contemplated by the 1978 amendments have not yet evolved to any major extentindeed, the statutory specication of the details of the information system may itself have acted as an impediment to the evolution of a book-entry direct system. Accordingly, Revised Article 8 drops the statutory requirements concerning transaction statements. The record keeping and reporting obligations of issuers of uncerticated securities would be left to agreement and other law, as is the case today for securities intermediaries. In the 1978 version, the Part 2 rules concerning transfer restrictions, issuers' defenses, and the like were based on the assumption that transaction statements would be used in a fashion analogous to traditional security certicates. For example, Sections 8-202 and 8-204 specied that the terms of a security, or any restrictions on transfer imposed by the issuer, had to be noted on the transaction statement. Revised Article 8 deletes all such references to transaction statements. The terms of securities, or of restrictions of transfer, would be governed by whatever law or agreement species these matters, just as is the case for various other forms of business entities, such as partnerships, that have never issued certicates representing interests. Other Part 2 rules, such as Sections 8-205, 8-206, and 8-208, attempted to state rules on forgery and related matters for transactions statements. Since Revised Article 8 does not specify the format for information systems for uncerticated securities, there is no point in attempting to state rules on the consequences of wrongful information transmission in the particular format of written statements authenticated by signatures. 5. Deletion of provisions on registered pledges. The 1978 version of Article 8 also added detailed provisions concerning registered pledges of uncerticated securities. Revised Article 8 adopts a new system of rules for security interests in securities, for both the direct and indirect holding systems that make it unnecessary to have special statutory provisions for registered pledges of uncerticated securities. 729

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The reason that the 1978 version of Article 8 created this concept was that if the only means of creating security interests was the pledge, it seemed necessary to provide some substitute for the pledge in the absence of a certicate. The point of the registered pledge was, presumably, that it permitted a debtor to grant a perfected security interest in securities, yet still keep the securities in the debtor's own name for purposes of dividends, voting, and the like. The concept of registered pledge has, however, been thought troublesome by many legal commentators and securities industry participants. For example, in Massachusetts where many mutual funds have their headquarters, a non-uniform amendment was enacted to permit the issuer of an uncerticated security to refuse to register a pledge and instead issue a certicate to the owner that the owner could then pledge by ordinary means. Under the 1978 version of Article 8, if an issuer chose to issue securities in uncerticated form, it was also required by statute to oer a registered pledge program. Revised Articles 8 and 9 take a dierent approach. All of the provisions dealing with registered pledges have been deleted. This does not mean, however, that issuers cannot oer such a service. The control rules of Revised Section 8-106 and the related priority provisions in Article 9 establish a structure that permits issuers to develop systems akin to the registered pledge device, without mandating that they do so, or legislating the details of the system. In essence, the registered pledge or control device amounts to a record keeping service. A debtor can always transfer securities to its lender. In a registered pledge or control agreement arrangement, the issuer keeps track of which securities the secured party holds for its own account outright, and which securities it holds in pledge from its debtors. Under the rules of Revised Articles 8 and 9, the registered pledge issue can easily be left to resolution by the market. The concept of control is dened in such fashion that if an issuer or securities intermediary wishes to oer a service akin to the registered pledge device it can do so. The issuer or securities intermediary would oer to enter into agreements with the debtor and secured party under which it would hold the securities for the account of the debtor, but subject to instructions from the secured party. The secured party would thereby obtain control assuring perfection and priority of its lien. Even if such arrangements are not oered by issuers, persons who hold uncerticated securities will have several options for using them as collateral for secured loans. Under the new rules, ling is a permissible method of perfection, for debtors other than securities rms. A secured party who relies on ling is, of course, exposed to the risk that the debtor will double nance and grant a later secured lender a security interest under circumstances that give that lender control and hence priority. If the lender is unwilling to run that risk, the debtor can transfer the securities outright to the lender on the books of the issuer, though between the parties the debtor would be the owner and the lender only a secured party. That, of course, requires that the debtor trust the secured party not to dispose of the collateral wrongfully, and the debtor may also need to make arrangements with the secured party to exercise benets of ownership such as voting and receiving distributions. It may well be that both lenders and borrowers would prefer to have some arrangement, such as the registered pledge device of current law, that permits the debtor to remain as the registered owner entitled to vote and receive dividends but gives the lender exclusive power to order their disposition. The approach taken in this revision is that if there is a genuine demand for such arrangements, it can be met by the market. The diculty with the approach of present Article 8 is that it mandates that any issuer that wishes to issue securities in uncerticated form must also oer this record keeping service. That obligation may well have acted as a disincentive to the development of uncerticated securities. Thus, the deletion of the mandated registered pledge provisions is consistent with the principle of neutrality toward the evolution of securities holding practices. 6. Former Section 8-403Issuer's Duty as to Adverse Claims. Section 8-403 of the prior version of Article 8 dealt with the obligations of issuers to adverse claimants. The starting point of American law on issuers' liability in such circumstances is the old case of Lowry v. Commercial & Farmers' Bank, 15 F.Cas. 1040 (C.C.D.Md.1848) (No. 8551), under which issuers could be held liable for registering a transfer at the direction of a registered owner who was acting wrongfully as against a third person in making the transfer. The Lowry principle imposed onerous liability on issuers, particularly in the case of transfers by duciaries, such as executors and trustees. To protect against risk of such liability, issuers developed the practice of requiring extensive 730

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documentation for duciary stock transfers to assure themselves that the duciaries were acting rightfully. As a result, duciary stock transfers were cumbersome and time consuming. In the present century, American law has gradually moved away from the Lowry principle. Statutes such as the Uniform Fiduciaries Act, the Model Fiduciary Stock Transfer Act, and the Uniform Act for the Simplication of Fiduciary Security Transfers sought to avoid the delays in stock transfers that could result from issuers' demands for documentation by limiting the issuer's responsibility for transfers in breach of the registered owner's duty to others. Although these statutes provided that issuers had no duty of inquiry to determine whether a duciary was acting rightfully, they all provided that an issuer could be liable if the issuer acted with notice of third party claims. The prior version of Article 8 followed the same approach as the various duciary transfer statutes. Issuers were not required to seek out information from which they could determine whether a duciary was acting properly, but they were liable if they registered a transfer with notice that the duciary was acting improperly. Former Section 8-308(11) said that the failure of a duciary to comply with a controlling instrument or failure to obtain a court approval required under local law did not render the indorsement or instruction unauthorized. However, if a duciary was in fact acting improperly, then the beneciary would be treated as an adverse claimant. See Section 8-302(2) (1978) and Comment 4. Former Section 8-403 specied that if written notice of an adverse claim had been sent to the issuer, the issuer shall inquire into the adverse claim before registering a transfer on the indorsement or instruction of the registered owner. The issuer could discharge any duty of inquiry by any reasonable means, including by notifying the adverse claimant that the transfer would be registered unless the adverse claimant obtained a court order or gave an indemnity bond. Revised Article 8 rejects the Lowry principle altogether. It provides that an issuer is not liable for wrongful registration if it acts on an eective indorsement or instruction, even though the issuer may have notice of adverse claims, so long as the issuer has not been served with legal process and is not acting in collusion with the wrongdoer in registering the transfer. See Revised Section 8-404 and Comments thereto. The provisions of prior Section 8-403 specifying that issuers had a duty to investigate adverse claims of which they had notice are deleted. Revised Article 8 also deletes the provisions set out in Section 8-403(3) of prior law specifying that issuers did not have a duty to inquire into the rightfulness of transfers by duciaries. The omission of the rules formerly in Section 8-403(3) does not, of course, mean that issuers would be liable for acting on the instruction of duciaries in the circumstances covered by former Section 8-403(3). Former Section 8-403(3) assumed that issuers would be liable if they registered a transfer with notice of an adverse claim. Former Section 8-403(3) was necessary only to negate any inference that knowledge that a transfer was initiated by a duciary might give constructive notice of adverse claims. Under Section 8-404 of Revised Article 8, mere notice of adverse claims does not impose duties on the issuer. Accordingly the provisions included in former Section 8-403(3) are unnecessary. Although the prior version of Article 8 included provisions similar or identical to those set out in the Uniform Act for the Simplication of Fiduciary Security Transfers and similar statutes, most states retained these statutes at the time the Uniform Commercial Code was adopted. These statutes are based on a premise dierent from Revised Article 8. The duciary simplication acts are predicated on the assumption that an issuer would be liable to an adverse claimant if the issuer had notice. These statutes seek only to preclude any inference that issuers have such notice when they register transfers on the instructions of a duciary. Revised Article 8 is based on the view that a third party should not be able to interfere with the relationship between an issuer and its registered shareholders unless the claimant obtains legal process. Since notice of an adverse claim does not impose duties on an issuer under Revised Article 8, the Uniform Act for the Simplication of Fiduciary Security Transfers, or similar statutes, should be repealed upon enactment of Revised Article 8. 7. Former Section 8-319Statute of Frauds. Revised Article 8 deletes the special statute of frauds provision for securities contracts that was set out in former Section 8-319. See Revised Section 8-113. Most of the litigation involving the statute of frauds rule of the prior version of Article 8 involved informal 731

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transactions, rather than transactions on the organized securities markets. Typical cases were those in which an employee or former employee of a small enterprise sued to enforce an alleged promise that he or she would receive an equity interest in the business. The usual commercial policies relating to writings in contracts for the sale of personal property are at most tangentially implicated in such cases. There was a rather large and complex body of case law dealing with the applicability of Section 8-319 to cases of this sort. It seems doubtful that the cost of litigating these issues was warranted by whatever protections the statute of frauds oered against fraudulent claims. Subsection (c) of former Section 8-319 provided that the statute of frauds bar did not apply if a written conrmation was sent and the recipient did not seasonably send an objection. That provision, however, presumably would not have had the eect of binding a broker's customer to the terms of a trade for which conrmation had been sent though the customer had not objected within 10 days. In the rst place, the relationship between a broker and customer is ordinarily that of agent and principal; thus the broker is not seeking to enforce a contract for sale of a security, but to bind its principal for action taken by the broker as agent. Former Section 8-319 did not by its terms apply to the agency relationship. Moreover, even if former Section 8-319(c) applied, it is doubtful that it, of its own force, had the eect of precluding the customer from disputing whether there was a contract or what the terms of the contract were. Former Section 8-319(c) only removed the statute of frauds as a bar to enforcement; it did not say that there was a contract or that the conrmation had the eect of excluding other evidence of its terms. Thus, deletion of former Section 8-319 does not change the law one way or the other on whether a customer who fails to object to a written conrmation is precluded from denying the trade described in the conrmation, because that issue was never governed by former Section 8-319(c). 8. Miscellaneous. Prior Section 8-105. Revised Article 8 deletes the statement found in Section 8-105(1) of the prior version that certicated securities are negotiable instruments. This provision was added very late in the drafting process of the original Uniform Commercial Code. Apparently the thought was that it might be useful in dealing with potential transition problems arising out of the fact that bonds were then treated as negotiable instruments under the Uniform Negotiable Instruments Law. During that era, many other statutes, such as those specifying permissible categories of investments for regulated entities, might have used such phrases as negotiable securities or negotiable instruments. Section 8-105 seems to have been included in the original version of Article 8 to avoid unfortunate interpretations of those other statutes once securities were moved from the Uniform Negotiable Instruments Law to UCC Article 8. Whether or not Section 8-105 was necessary at that time, it has surely outlived its purpose. The statement that securities are negotiable instruments is very confusing. As used in the Uniform Commercial Code, the term negotiable instrument means an instrument that is governed by Article 3; yet Article 8 securities are not governed by Article 3. Courts have occasionally cited Section 8-105(1) of prior law for the proposition that the rules that are generally thought of as characteristic of negotiability, such as the rule that bona de purchasers take free from adverse claims, apply to certicated securities. Section 8-105(1), however, is unnecessary for that purpose, since the relevant rules are set out in specic provisions of Article 8. Prior Sections 8-107 and 8-314. Article 8 has never been, and should not be, a comprehensive codication of the law of contracts for the purchase and sale of securities. The prior version of Article 8 did contain, however, a number of provisions dealing with miscellaneous aspects of the law of contracts as applied to contracts for the sale of securities. Section 8-107 dealt with one remedy for breach, and Section 8-314 dealt with certain aspects of performance. Revised Article 8 deletes these on the theory that inclusion of a few sections on issues of contract law is likely to cause more harm than good since inferences might be drawn from the failure to cover related issues. The deletion of these sections is not, however, intended as a rejection of the rules of contract law and interpretation that they expressed. Prior Section 8-315. It is not entirely clear what the function of Section 8-315 of prior law was. The section specied that the owner of a security could recover it from a person to whom it had been transferred, if the transferee did not qualify as a bona de purchaser. It seems to have been intended only to recognize that securities, like any other form of personal property, are governed by the general principle of property law that an owner can recover property from a person to whom it has been transferred under circumstances that 732

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did not cut o the owner's claim. Although many other Articles of the UCC deal with cut-o rules, Article 8 was the only one that included an armative statement of the rights of an owner to recover her property. It seems wiser to adopt the same approach as in Articles 2, 3, 7, and 9, and leave this point to other law. Accordingly, Section 8-315 is deleted in Revised Article 8, without, of course, implying rejection of the nearly self-evident rule that it sought to express. Prior Section 8-407. This section, entitled Exchangeability of Securities, seemed to say that holders of securities had the right to cause issuers to convert them back and forth from certicated to uncerticated form. The provision, however, applied only if the issuer regularly maintains a system for issuing the class of securities involved under which both certicated and uncerticated securities are regularly issued to the category of owners, which includes the person in whose name the new security is to be registered. The provision seems unnecessary, since it applied only if the issuer decided that it should. The matter can be covered by agreement or corporate charter or by-laws. V. ACKNOWLEDGMENTS On behalf of the National Conference of Commissioners on Uniform State Laws and the American Law Institute, the Drafting Committee and the Reporter acknowledge with deep appreciation the dedicated and helpful assistance of a great many individuals and organizations. Among the large number of individuals who participated in the development of Revised Article 8, special mention should be made of a few whose contributions were extraordinary. Preceding the preparation of Revised Article 8, the topic was carefully studied by the Advisory Committee on Settlement of Market Transactions of the American Bar Association Section of Business Law, under the chairmanship of Robert Haydock, Jr., of Boston, MA. Martin Aronstein, of Philadelphia, PA, reporter for the 1977 revision of Article 8, served on the Haydock Committee and continued to advise the Drafting Committee. Robert C. Mendelson, New York, NY, who also served on the Haydock Committee, is chair of the Market Transactions Advisory Committee set up by the Securities and Exchange Commission; Bob Mendelson's considerable contribution to the preparation of Revised Article 8 was most important. Other members of the Haydock Committee had continuing roles either as members of the Drafting Committee or as sources of valuable advice to that committee. The revision of Article 8 is the culmination of a successful federal-state collaboration among the American Law Institute and the National Conference of Commissioners on Uniform State Laws, sponsors of the Uniform Commercial Code, and representatives of the United States Department of the Treasury, the Securities and Exchange Commission, the Federal Reserve System, and other federal bodies. The product reects the assistance of many people, and particularly of Jonathan Kallman and Ari Burstein on behalf of the SEC, Calvin Ninomiya, Cynthia E. Reese, and Virginia S. Rutledge of Treasury, Lawranne Stewart of the Board of Governors of the Federal Reserve System, Debra W. Cook and MarySue Fisher of the Federal Reserve Bank of New York, and George Wilder and Carla Behnfeldt of the Commodity Futures Trading Commission. Representatives of organizations in the securities and banking industry and their counsel gave generously of their time and knowledge. Special mention should be made of Norman R. Nelson, New York Clearing House, R. May Lee, Public Securities Association, Robert J. Woldow and Karen Saperstein, National Securities Clearing Corporation, Leopold S. Rassnick, Participants Trust Company, Robert Wittie and Patricia Louie, Investment Company Institute, Thomas A. Williams, Richard B. Nesson and Carl Urist, Depository Trust Company, Dennis A. Dutterer, Board of Trade Clearing Corporation, Evalyn Lipton Fishbein, State Street Bank and Trust Company, Robert P. DeGregorie, Chemical Bank, Gail M. Inaba, Morgan Guaranty Trust Company of New York, Anthony J. Leitner, Goldman, Sachs & Company, Robert M. MacAllister, The Chase Manhattan Bank, N.A., Kevin J. Moynihan, Merrill Lynch, Pierce, Fenner & Smith Inc., Lois J. Radisch, J.P. Morgan & Co., James J. Volpe, First Chicago Trust Company of New York, and Richard E. Smith, Securities Transfer Association. Many lawyers and law professors contributed to the work of the Drafting Committee. Special appreciation is due to Sandra M. Rocks, New York, NY, who participated on behalf of the ABA UCC Investment Securities Subcommittee and ABA Task Force on TRADES Regulations. Others who participated included Steven Harris and James R. McDaniel, Chicago, IL, Kenneth B. Davis, Jr., Madison, WI, David M. Huggins and Bradley Y. Smith, 733

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New York, NY, David J. Schraa, Brussels, Belgium, and Randall D. Guynn, London, England. The Reporter and Drafting Committee also received assistance from the dedicated work of lawyers, not themselves experts in securities law, who reviewed and commented upon drafts and participated in the revision process through meetings of the Members Consultative Group of the American Law Institute and at various national, state, and local bar association programs.

PART 1. SHORT TITLE AND GENERAL MATTERS

8-101. Short Title. This Article may be cited as Uniform Commercial CodeInvestment Securities. 8-102. Denitions. (a) In this Article: (1) Adverse claim means a claim that a claimant has a property interest in a nancial asset and that it is a violation of the rights of the claimant for another person to hold, transfer, or deal with the nancial asset. (2) Bearer form, as applied to a certicated security, means a form in which the security is payable to the bearer of the security certicate according to its terms but not by reason of an indorsement. (3) Broker means a person dened as a broker or dealer under the federal securities laws, but without excluding a bank acting in that capacity. (4) Certicated security means a security that is represented by a certicate. (5) Clearing corporation means: (i) a person that is registered as a clearing agency under the federal securities laws; (ii) a federal reserve bank; or (iii) any other person that provides clearance or settlement services with respect to nancial assets that would require it to register as a clearing agency under the federal securities laws but for an exclusion or exemption from the registration requirement, if its activities as a clearing corporation, including promulgation of rules, are subject to regulation by a federal or state governmental authority. (6) Communicate means to: (i) send a signed writing; or (ii) transmit information by any mechanism agreed upon by the persons transmitting and receiving the information. (7) Entitlement holder means a person identied in the records of a securities intermediary as the person having a security entitlement against the securities intermediary. If a person acquires a security entitlement by virtue of Section 8-501(b)(2) or (3), that person is the entitlement holder. (8) Entitlement order means a notication communicated to a securities intermediary directing transfer or redemption of a nancial asset to which the entitlement holder has a security entitlement.
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8-102

(9) Financial asset, except as otherwise provided in Section 8-103, means: (i) a security; (ii) an obligation of a person or a share, participation, or other interest in a person or in property or an enterprise of a person, which is, or is of a type, dealt in or traded on nancial markets, or which is recognized in any area in which it is issued or dealt in as a medium for investment; or (iii) any property that is held by a securities intermediary for another person in a securities account if the securities intermediary has expressly agreed with the other person that the property is to be treated as a nancial asset under this Article. As context requires, the term means either the interest itself or the means by which a person's claim to it is evidenced, including a certicated or uncerticated security, a security certicate, or a security entitlement. (10) [reserved] (11) Indorsement means a signature that alone or accompanied by other words is made on a security certicate in registered form or on a separate document for the purpose of assigning, transferring, or redeeming the security or granting a power to assign, transfer, or redeem it. (12) Instruction means a notication communicated to the issuer of an uncerticated security which directs that the transfer of the security be registered or that the security be redeemed. (13) Registered form, as applied to a certicated security, means a form in which: (i) the security certicate species a person entitled to the security; and (ii) a transfer of the security may be registered upon books maintained for that purpose by or on behalf of the issuer, or the security certicate so states. (14) Securities intermediary means: (i) a clearing corporation; or (ii) a person, including a bank or broker, that in the ordinary course of its business maintains securities accounts for others and is acting in that capacity. (15) Security, except as otherwise provided in Section 8-103, means an obligation of an issuer or a share, participation, or other interest in an issuer or in property or an enterprise of an issuer: (i) which is represented by a security certicate in bearer or registered form, or the transfer of which may be registered upon books maintained for that purpose by or on behalf of the issuer; (ii) which is one of a class or series or by its terms is divisible into a class or series of shares, participations, interests, or obligations; and (iii) which: (A) is, or is of a type, dealt in or traded on securities exchanges or securities markets; or
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(B) is a medium for investment and by its terms expressly provides that it is a security governed by this Article. (16) Security certicate means a certicate representing a security. (17) Security entitlement means the rights and property interest of an entitlement holder with respect to a nancial asset specied in Part 5. (18) Uncerticated security means a security that is not represented by a certicate. (b) Other denitions applying to this Article and the sections in which they appear are: Appropriate person Control Delivery Investment company security Issuer Overissue Protected purchaser Securities account Section Section Section Section Section Section Section Section 8-107 8-106 8-301 8-103 8-201 8-210 8-303 8-501

(c) In addition, Article 1 contains general denitions and principles of construction and interpretation applicable throughout this Article. (d) The characterization of a person, business, or transaction for purposes of this Article does not determine the characterization of the person, business, or transaction for purposes of any other law, regulation, or rule. As amended in 2001.
See Appendix I contained within revised Article 1 for material relating to changes made in text in 2001.

Ocial Comment
1. Adverse claim. The denition of the term adverse claim has two components. First, the term refers only to property interests. Second, the term means not merely that a person has a property interest in a nancial asset but that it is a violation of the claimant's property interest for the other person to hold or transfer the security or other nancial asset. The term adverse claim is not, of course, limited to ownership rights, but extends to other property interests established by other law. A security interest, for example, would be an adverse claim with respect to a transferee from the debtor since any eort by the secured party to enforce the security interest against the property would be an interference with the transferee's interest. The denition of adverse claim in the prior version of Article 8 might have been read to suggest that any wrongful action concerning a security, even a simple breach of contract, gave rise to an adverse claim. Insofar as such cases as Fallon v. Wall Street Clearing Corp., 586 N.Y.S.2d 953, 182 A.D.2d 245, (1992) and Pentech Intl. v. Wall St. Clearing Co., 983 F.2d 441 (2d Cir.1993), were based on that view, they are rejected by the new denition which explicitly limits the term adverse claim to property interests. Suppose, for example, that A contracts to sell or deliver securities to B, but fails to do so and instead sells or pledges the securities to C. B, the promisee, has an action against A for breach of contract, but absent unusual circumstances the action for breach would not give rise to a property interest in the securities. Accordingly, B does not have an adverse claim. An adverse claim might, however, be based upon principles of equitable remedies that give rise to property claims. It would, for example, cover a right established by other law to rescind a transac736

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tion in which securities were transferred. Suppose, for example, that A holds securities and is induced by B's fraud to transfer them to B. Under the law of contract or restitution, A may have a right to rescind the transfer, which gives A a property claim to the securities. If so, A has an adverse claim to the securities in B's hands. By contrast, if B had committed no fraud, but had merely committed a breach of contract in connection with the transfer from A to B, A may have only a right to damages for breach, not a right to rescind. In that case, A would not have an adverse claim to the securities in B's hands. 2. Bearer form. The denition of bearer form has remained substantially unchanged since the early drafts of the original version of Article 8. The requirement that the certicate be payable to bearer by its terms rather than by an indorsement has the eect of preventing instruments governed by other law, such as chattel paper or Article 3 negotiable instruments, from being inadvertently swept into the Article 8 denition of security merely by virtue of blank indorsements. Although the other elements of the denition of security in Section 8-102(a)(14) probably suce for that purpose in any event, the language used in the prior version of Article 8 has been retained. 3. Broker. Broker is dened by reference to the denitions of broker and dealer in the federal securities laws. The only dierence is that banks, which are excluded from the federal securities law denition, are included in the Article 8 denition when they perform functions that would bring them within the federal securities law denition if it did not have the clause excluding banks. The denition covers both those who act as agents (brokers in securities parlance) and those who act as principals (dealers in securities parlance). Since the denition refers to persons dened as brokers or dealers under the federal securities law, rather than to persons required to register as brokers or dealers under the federal securities law, it covers not only registered brokers and dealers but also those exempt from the registration requirement, such as purely intrastate brokers. The only substantive rules that turn on the dened term broker are one provision of the section on warranties, Section 8-108(i), and the special perfection rule in Article 9 for security interests granted by brokers or securities intermediaries, Section 9-309(10). 4. Certicated security. The term certicated security means a security that is represented by a security certicate. 5. Clearing corporation. The denition of clearing corporation limits its application to entities that are subject to a rigorous regulatory framework. Accordingly, the denition includes only federal reserve banks, persons who are registered as clearing agencies under the federal securities laws (which impose a comprehensive system of regulation of the activities and rules of clearing agencies), and other entities subject to a comparable system of regulatory oversight. 6. Communicate. The term communicate assures that the Article 8 rules will be sufciently exible to adapt to changes in information technology. Sending a signed writing always suces as a communication, but the parties can agree that a dierent means of transmitting information is to be used. Agreement is dened in Section 1-201(3) as the bargain of the parties in fact as found in their language or by implication from other circumstances including course of dealing or usage of trade or course of performance. Thus, use of an information transmission method might be found to be authorized by agreement, even though the parties have not explicitly so specied in a formal agreement. The term communicate is used in Sections 8-102(a)(7) (denition of entitlement order), 8-102(a)(11) (denition of instruction), and 8-403 (demand that issuer not register transfer). 7. Entitlement holder. This term designates those who hold nancial assets through intermediaries in the indirect holding system. Because many of the rules of Part 5 impose duties on securities intermediaries in favor of entitlement holders, the denition of entitlement holder is, in most cases, limited to the person specically designated as such on the records of the intermediary. The last sentence of the denition covers the relatively unusual cases where a person may acquire a security entitlement under Section 8-501 even though the person may not be specically designated as an entitlement holder on the records of the securities intermediary. A person may have an interest in a security entitlement, and may even have the right to give entitlement orders to the securities intermediary with respect to it, even though the person is not the entitlement holder. For example, a person who holds securities through a securities account in its own name may have given discretionary trading authority to another person, such as an investment adviser. Similarly, the control provisions in Section 737

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8-106 and the related provisions in Article 9 are designed to facilitate transactions in which a person who holds securities through a securities account uses them as collateral in an arrangement where the securities intermediary has agreed that if the secured party so directs the intermediary will dispose of the positions. In such arrangements, the debtor remains the entitlement holder but has agreed that the secured party can initiate entitlement orders. Moreover, an entitlement holder may be acting for another person as a nominee, agent, trustee, or in another capacity. Unless the entitlement holder is itself acting as a securities intermediary for the other person, in which case the other person would be an entitlement holder with respect to the securities entitlement, the relationship between an entitlement holder and another person for whose benet the entitlement holder holds a securities entitlement is governed by other law. 8. Entitlement order. This term is dened as a notication communicated to a securities intermediary directing transfer or redemption of the nancial asset to which an entitlement holder has a security entitlement. The term is used in the rules for the indirect holding system in a fashion analogous to the use of the terms indorsement and instruction in the rules for the direct holding system. If a person directly holds a certicated security in registered form and wishes to transfer it, the means of transfer is an indorsement. If a person directly holds an uncerticated security and wishes to transfer it, the means of transfer is an instruction. If a person holds a security entitlement, the means of disposition is an entitlement order. An entitlement order includes a direction under Section 8-508 to the securities intermediary to transfer a nancial asset to the account of the entitlement holder at another nancial intermediary or to cause the nancial asset to be transferred to the entitlement holder in the direct holding system (e.g., the delivery of a securities certicate registered in the name of the former entitlement holder). As noted in Comment 7, an entitlement order need not be initiated by the entitlement holder in order to be eective, so long as the entitlement holder has authorized the other party to initiate entitlement orders. See Section 8-107(b). 9. Financial asset. The denition of nancial asset, in conjunction with the denition of securities account in Section 8-501, sets the scope of the indirect holding system rules of Part 5 of Revised Article 8. The Part 5 rules apply not only to securities held through intermediaries, but also to other nancial assets held through intermediaries. The term nancial asset is dened to include not only securities but also a broader category of obligations, shares, participations, and interests. Having separate denitions of security and nancial asset makes it possible to separate the question of the proper scope of the traditional Article 8 rules from the question of the proper scope of the new indirect holding system rules. Some forms of nancial assets should be covered by the indirect holding system rules of Part 5, but not by the rules of Parts 2, 3, and 4. The term nancial asset is used to cover such property. Because the term security entitlement is dened in terms of nancial assets rather than securities, the rules concerning security entitlements set out in Part 5 of Article 8 and in Revised Article 9 apply to the broader class of nancial assets. The fact that something does or could fall within the denition of nancial asset does not, without more, trigger Article 8 coverage. The indirect holding system rules of Revised Article 8 apply only if the nancial asset is in fact held in a securities account, so that the interest of the person who holds the nancial asset through the securities account is a security entitlement. Thus, questions of the scope of the indirect holding system rules cannot be framed as Is such-and-such a nancial asset under Article 8? Rather, one must analyze whether the relationship between an institution and a person on whose behalf the institution holds an asset falls within the scope of the term securities account as dened in Section 8-501. That question turns in large measure on whether it makes sense to apply the Part 5 rules to the relationship. The term nancial asset is used to refer both to the underlying asset and the particular means by which ownership of that asset is evidenced. Thus, with respect to a certicated security, the term nancial asset may, as context requires, refer either to the interest or obligation of the issuer or to the security certicate representing that interest or obligation. Similarly, if a person holds a security or other nancial asset through a securities account, the term nancial asset may, as context requires, refer either to the underlying asset or to the person's security entitlement. 10. Good faith. Section 1-203 provides that Every contract or duty within [the Uniform Commercial Code] imposes an obligation of good faith in its performance or enforcement. 738

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Section 1-201(b)(20) denes good faith as honesty in fact and the observance of reasonable commercial standards of fair dealing. The reference to commercial standards makes clear that assessments of conduct are to be made in light of the commercial setting. The substantive rules of Article 8 have been drafted to take account of the commercial circumstances of the securities holding and processing system. For example, Section 8-115 provides that a securities intermediary acting on an eective entitlement order, or a broker or other agent acting as a conduit in a securities transaction, is not liable to an adverse claimant, unless the claimant obtained legal process or the intermediary acted in collusion with the wrongdoer. This, and other similar provisions, see Sections 8-404 and 8-503(e), do not depend on notice of adverse claims, because it would impair rather than advance the interest of investors in having a sound and ecient securities clearance and settlement system to require intermediaries to investigate the propriety of the transactions they are processing. The good faith obligation does not supplant the standards of conduct established in provisions of this kind. In Revised Article 8, the denition of good faith is not germane to the question whether a purchaser takes free from adverse claims. The rules on such questions as whether a purchaser who takes in suspicious circumstances is disqualied from protected purchaser status are treated not as an aspect of good faith but directly in the rules of Section 8-105 on notice of adverse claims. 11. Indorsement is dened as a signature made on a security certicate or separate document for purposes of transferring or redeeming the security. The denition is adapted from the language of Section 8-308(1) of the prior version and from the denition of indorsement in the Negotiable Instruments Article, see Section 3-204(a). The denition of indorsement does not include the requirement that the signature be made by an appropriate person or be authorized. Those questions are treated in the separate substantive provision on whether the indorsement is eective, rather than in the denition of indorsement. See Section 8-107. 12. Instruction is dened as a notication communicated to the issuer of an uncerticated security directing that transfer be registered or that the security be redeemed. Instructions are the analog for uncerticated securities of indorsements of certicated securities. 13. Registered form. The denition of registered form is substantially the same as in the prior version of Article 8. Like the denition of bearer form, it serves primarily to distinguish Article 8 securities from instruments governed by other law, such as Article 3. 14. Securities intermediary. A securities intermediary is a person that in the ordinary course of its business maintains securities accounts for others and is acting in that capacity. The most common examples of securities intermediaries would be clearing corporations holding securities for their participants, banks acting as securities custodians, and brokers holding securities on behalf of their customers. Clearing corporations are listed separately as a category of securities intermediary in subparagraph (i) even though in most circumstances they would fall within the general denition in subparagraph (ii). The reason is to simplify the analysis of arrangements such as the NSCC-DTC system in which NSCC performs the comparison, clearance, and netting function, while DTC acts as the depository. Because NSCC is a registered clearing agency under the federal securities laws, it is a clearing corporation and hence a securities intermediary under Article 8, regardless of whether it is at any particular time or in any particular aspect of its operations holding securities on behalf of its participants. The terms securities intermediary and broker have dierent meanings. Broker means a person engaged in the business of buying and selling securities, as agent for others or as principal. Securities intermediary means a person maintaining securities accounts for others. A stockbroker, in the colloquial sense, may or may not be acting as a securities intermediary. The denition of securities intermediary includes the requirement that the person in question is acting in the capacity of maintaining securities accounts for others. This is to take account of the fact that a particular entity, such as a bank, may act in many dierent capacities in securities transactions. A bank may act as a transfer agent for issuers, as a securities custodian for institutional investors and private investors, as a dealer in government securities, as a lender taking securities as collateral, and as a provider of general payment and collection services that might be used in connection with securities 739

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transactions. A bank that maintains securities accounts for its customers would be a securities intermediary with respect to those accounts; but if it takes a pledge of securities from a borrower to secure a loan, it is not thereby acting as a securities intermediary with respect to the pledged securities, since it holds them for its own account rather than for a customer. In other circumstances, those two functions might be combined. For example, if the bank is a government securities dealer it may maintain securities accounts for customers and also provide the customers with margin credit to purchase or carry the securities, in much the same way that brokers provide margin loans to their customers. 15. Security. The denition of security has three components. First, there is the subparagraph (i) test that the interest or obligation be fully transferable, in the sense that the issuer either maintains transfer books or the obligation or interest is represented by a certicate in bearer or registered form. Second, there is the subparagraph (ii) test that the interest or obligation be divisible, that is, one of a class or series, as distinguished from individual obligations of the sort governed by ordinary contract law or by Article 3. Third, there is the subparagraph (iii) functional test, which generally turns on whether the interest or obligation is, or is of a type, dealt in or traded on securities markets or securities exchanges. There is, however, an opt-in provision in subparagraph (iii) which permits the issuer of any interest or obligation that is a medium of investment to specify that it is a security governed by Article 8. The divisibility test of subparagraph (ii) applies to the securitythat is, the underlying intangible interestnot the means by which that interest is evidenced. Thus, securities issued in book-entry only form meet the divisibility test because the underlying intangible interest is divisible via the mechanism of the indirect holding system. This is so even though the clearing corporation is the only eligible direct holder of the security. The third component, the functional test in subparagraph (iii), provides exibility while ensuring that the Article 8 rules do not apply to interests or obligations in circumstances so unconnected with the securities markets that parties are unlikely to have thought of the possibility that Article 8 might apply. Subparagraph (iii)(A) covers interests or obligations that either are dealt in or traded on securities exchanges or securities markets, or are of a type dealt in or traded on securities exchanges or securities markets. The is dealt in or traded on phrase eliminates problems in the characterization of new forms of securities which are to be traded in the markets, even though no similar type has previously been dealt in or traded in the markets. Subparagraph (iii)(B) covers the broader category of media for investment, but it applies only if the terms of the interest or obligation specify that it is an Article 8 security. This opt-in provision allows for deliberate expansion of the scope of Article 8. Section 8-103 contains additional rules on the treatment of particular interests as securities or nancial assets. 16. Security certicate. The term security refers to the underlying asset, e.g., 1000 shares of common stock of Acme, Inc. The term security certicate refers to the paper certicates that have traditionally been used to embody the underlying intangible interest. 17. Security entitlement means the rights and property interest of a person who holds securities or other nancial assets through a securities intermediary. A security entitlement is both a package of personal rights against the securities intermediary and an interest in the property held by the securities intermediary. A security entitlement is not, however, a specic property interest in any nancial asset held by the securities intermediary or by the clearing corporation through which the securities intermediary holds the nancial asset. See Sections 8-104(c) and 8-503. The formal denition of security entitlement set out in subsection (a)(16) of this section is a cross-reference to the rules of Part 5. In a sense, then, the entirety of Part 5 is the denition of security entitlement. The Part 5 rules specify the rights and property interest that comprise a security entitlement. 18. Uncerticated security. The term uncerticated security means a security that is not represented by a security certicate. For uncerticated securities, there is no need to draw any distinction between the underlying asset and the means by which a direct holder's interest in that asset is evidenced. Compare certicated security and security certicate. Denitional Cross References: Agreement. Section 1-201(b)(3). Bank. Section 1-201(b)(4). Person. Section 1-201(b)(27). 740

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Send. Section 1-201(b)(36). Signed. Section 1-201(b)(37). Writing. Section 1-201(b)(43).

As amended in 1999 and 2001.

See Appendix I contained within revised Article 9 for material relating to changes made in Ocial Comment in 1999. See Appendix I contained within revised Article 1 for material relating to changes made in Ocial Comment in 2001.

8-103. Rules for Determining Whether Certain Obligations and Interests are Securities or Financial Assets. (a) A share or similar equity interest issued by a corporation, business trust, joint stock company, or similar entity is a security. (b) An investment company security is a security. Investment company security means a share or similar equity interest issued by an entity that is registered as an investment company under the federal investment company laws, an interest in a unit investment trust that is so registered, or a face-amount certicate issued by a face-amount certicate company that is so registered. Investment company security does not include an insurance policy or endowment policy or annuity contract issued by an insurance company. (c) An interest in a partnership or limited liability company is not a security unless it is dealt in or traded on securities exchanges or in securities markets, its terms expressly provide that it is a security governed by this Article, or it is an investment company security. However, an interest in a partnership or limited liability company is a nancial asset if it is held in a securities account. (d) A writing that is a security certicate is governed by this Article and not by Article 3, even though it also meets the requirements of that Article. However, a negotiable instrument governed by Article 3 is a nancial asset if it is held in a securities account. (e) An option or similar obligation issued by a clearing corporation to its participants is not a security, but is a nancial asset. (f) A commodity contract, as dened in Section 9-102(a)(15), is not a security or a nancial asset. (g) A document of title is not a nancial asset unless Section 8-102(a)(9) (iii) applies. As amended in 1999 and 2003.
See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999. See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. This section contains rules that supplement the denitions of nancial asset and security in Section 8-102. The Section 8-102 denitions are worded in general terms, because they must be suciently comprehensive and exible to cover the wide variety of investment products that now exist or may develop. The rules in this section are intended to foreclose interpretive issues concerning the application of the general denitions to several specic investment products. No implication is made about the application of the Section 8-102 denitions to investment products not covered by this section. 741

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2. Subsection (a) establishes an unconditional rule that ordinary corporate stock is a security. That is so whether or not the particular issue is dealt in or traded on securities exchanges or in securities markets. Thus, shares of closely held corporations are Article 8 securities. 3. Subsection (b) establishes that the Article 8 term security includes the various forms of the investment vehicles oered to the public by investment companies registered as such under the federal Investment Company Act of 1940, as amended. This clarication is prompted principally by the fact that the typical transaction in shares of open-end investment companies is an issuance or redemption, rather than a transfer of shares from one person to another as is the case with ordinary corporate stock. For similar reasons, the denitions of indorsement, instruction, and entitlement order in Section 8-102 refer to redemptions as well as transfers, to ensure that the Article 8 rules on such matters as signature guaranties, Section 8-306, assurances, Sections 8-402 and 8-507, and eectiveness, Section 8-107, apply to directions to redeem mutual fund shares. The exclusion of insurance products is needed because some insurance company separate accounts are registered under the Investment Company Act of 1940, but these are not traded under the usual Article 8 mechanics. 4. Subsection (c) is designed to foreclose interpretive questions that might otherwise be raised by the application of the of a type language of Section 8-102(a)(15)(iii) to partnership interests. Subsection (c) establishes the general rule that partnership interests or shares of limited liability companies are not Article 8 securities unless they are in fact dealt in or traded on securities exchanges or in securities markets. The issuer, however, may explicitly opt-in by specifying that the interests or shares are securities governed by Article 8. Partnership interests or shares of limited liability companies are included in the broader term nancial asset. Thus, if they are held through a securities account, the indirect holding system rules of Part 5 apply, and the interest of a person who holds them through such an account is a security entitlement. 5. Subsection (d) deals with the line between Article 3 negotiable instruments and Article 8 investment securities. It continues the rule of the prior version of Article 8 that a writing that meets the Article 8 denition is covered by Article 8 rather than Article 3, even though it also meets the denition of negotiable instrument. However, subsection (d) provides that an Article 3 negotiable instrument is a nancial asset so that the indirect holding system rules apply if the instrument is held through a securities intermediary. This facilitates making items such as money market instruments eligible for deposit in clearing corporations. 6. Subsection (e) is included to clarify the treatment of investment products such as traded stock options, which are treated as nancial assets but not securities. Thus, the indirect holding system rules of Part 5 apply, but the direct holding system rules of Parts 2, 3, and 4 do not. 7. Subsection (f) excludes commodity contracts from all of Article 8. However, under Article 9, commodity contracts are included in the denition of investment property. Therefore, the Article 9 rules on security interests in investment property do apply to security interests in commodity positions. See Section 9-102 and Comment 6 thereto. Commodity contract is dened in Section 9-102(a)(15). 8. Subsection (g) allows a document of title to be a nancial asset and thus subject to the indirect holding system rules of Part 5 only to the extent that the intermediary and the person entitled under the document agree to do so. This is to prevent the inadvertent application of the Part 5 rules to intermediaries who may hold either electronic or tangible documents of title. Denitional Cross References: Clearing corporation. Section 8-102(a)(5). Commodity contract. Section 9-102(a)(15). Financial asset. Section 8-102(a)(9). Security. Section 8-102(a)(15). Security certicate. Section 8-102(a)(16).

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.
742

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8-104. Acquisition of Security or Financial Asset or Interest Therein. (a) A person acquires a security or an interest therein, under this Article, if: (1) the person is a purchaser to whom a security is delivered pursuant to Section 8-301; or (2) the person acquires a security entitlement to the security pursuant to Section 8-501. (b) A person acquires a nancial asset, other than a security, or an interest therein, under this Article, if the person acquires a security entitlement to the nancial asset. (c) A person who acquires a security entitlement to a security or other nancial asset has the rights specied in Part 5, but is a purchaser of any security, security entitlement, or other nancial asset held by the securities intermediary only to the extent provided in Section 8-503. (d) Unless the context shows that a dierent meaning is intended, a person who is required by other law, regulation, rule, or agreement to transfer, deliver, present, surrender, exchange, or otherwise put in the possession of another person a security or nancial asset satises that requirement by causing the other person to acquire an interest in the security or nancial asset pursuant to subsection (a) or (b). Ocial Comment
1. This section lists the ways in which interests in securities and other nancial assets are acquired under Article 8. In that sense, it describes the scope of Article 8. Subsection (a) describes the two ways that a person may acquire a security or interest therein under this Article: (1) by delivery (Section 8-301), and (2) by acquiring a security entitlement. Each of these methods is described in detail in the relevant substantive provisions of this Article. Part 3, beginning with the denition of delivery in Section 8-301, describes how interests in securities are acquired in the direct holding system. Part 5, beginning with the rules of Section 8-501 on how security entitlements are acquired, describes how interests in securities are acquired in the indirect holding system. Subsection (b) species how a person may acquire an interest under Article 8 in a nancial asset other than a security. This Article deals with nancial assets other than securities only insofar as they are held in the indirect holding system. For example, a bankers' acceptance falls within the denition of nancial asset, so if it is held through a securities account the entitlement holder's right to it is a security entitlement governed by Part 5. The bankers' acceptance itself, however, is a negotiable instrument governed by Article 3, not by Article 8. Thus, the provisions of Parts 2, 3, and 4 of this Article that deal with the rights of direct holders of securities are not applicable. Article 3, not Article 8, species how one acquires a direct interest in a bankers' acceptance. If a bankers' acceptance is delivered to a clearing corporation to be held for the account of the clearing corporation's participants, the clearing corporation becomes the holder of the bankers' acceptance under the Article 3 rules specifying how negotiable instruments are transferred. The rights of the clearing corporation's participants, however, are governed by Part 5 of this Article. 2. The distinction in usage in Article 8 between the term security (and its correlatives security certicate and uncerticated security) on the one hand, and security entitlement on the other, corresponds to the distinction between the direct and indirect holding systems. For example, with respect to certicated securities that can be held either directly or through intermediaries, obtaining possession of a security certicate and acquiring a security entitlement are both means of holding the underlying security. For many other purposes, there is no need to draw a distinction between the means of holding. For purposes of commercial law analysis, however, the form of holding may make a dierence. Where an item of property can be held in dierent ways, the rules on how one deals with it, including how one transfers it or how one grants a security interest in it, dier depending on the 743

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form of holding. Although a security entitlement is means of holding the underlying security or other nancial asset, a person who has a security entitlement does not have any direct claim to a specic asset in the possession of the securities intermediary. Subsection (c) provides explicitly that a person who acquires a security entitlement is a purchaser of any security, security entitlement, or other nancial asset held by the securities intermediary only in the sense that under Section 8-503 a security entitlement is treated as a sui generis form of property interest. 3. Subsection (d) is designed to ensure that parties will retain their expected legal rights and duties under Revised Article 8. One of the major changes made by the revision is that the rules for the indirect holding system are stated in terms of the security entitlements held by investors, rather than speaking of them as holding direct interests in securities. Subsection (d) is designed as a translation rule to eliminate problems of co-ordination of terminology, and facilitate the continued use of systems for the ecient handling of securities and nancial assets through securities intermediaries and clearing corporations. The eciencies of a securities intermediary or clearing corporation are, in part, dependent on the ability to transfer securities credited to securities accounts in the intermediary or clearing corporation to the account of an issuer, its agent, or other person by book entry in a manner that permits exchanges, redemptions, conversions, and other transactions (which may be governed by pre-existing or new agreements, constitutional documents, or other instruments) to occur and to avoid the need to withdraw from immobilization in an intermediary or clearing corporation physical securities in order to deliver them for such purposes. Existing corporate charters, indentures and like documents may require the presentation, surrender, delivery, or transfer of securities or security certicates for purposes of exchange, redemption, conversion or other reason. Likewise, documents may use a wide variety of terminology to describe, in the context for example of a tender or exchange oer, the means of putting the oeror or the issuer or its agent in possession of the security. Subsection (d) takes the place of provisions of prior law which could be used to reach the legal conclusion that book-entry transfers are equivalent to physical delivery to the person to whose account the book entry is credited. Denitional Cross References: Delivery. Section 8-301. Financial asset. Section 8-102(a)(9). Person. Section 1-201(30). Purchaser. Sections 1-201(33) & 8-116. Security. Section 8-102(a)(15). Security entitlement. Section 8-102(a)(17).

8-105. Notice of Adverse Claim. (a) A person has notice of an adverse claim if: (1) the person knows of the adverse claim; (2) the person is aware of facts sucient to indicate that there is a signicant probability that the adverse claim exists and deliberately avoids information that would establish the existence of the adverse claim; or (3) the person has a duty, imposed by statute or regulation, to investigate whether an adverse claim exists, and the investigation so required would establish the existence of the adverse claim. (b) Having knowledge that a nancial asset or interest therein is or has been transferred by a representative imposes no duty of inquiry into the rightfulness of a transaction and is not notice of an adverse claim. However, a person who knows that a representative has transferred a nancial asset or interest therein in a transaction that is, or whose proceeds are being used, for the individual benet of the representative or otherwise in breach of duty has notice of an adverse claim. (c) An act or event that creates a right to immediate performance of the
744

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principal obligation represented by a security certicate or sets a date on or after which the certicate is to be presented or surrendered for redemption or exchange does not itself constitute notice of an adverse claim except in the case of a transfer more than: (1) one year after a date set for presentment or surrender for redemption or exchange; or (2) six months after a date set for payment of money against presentation or surrender of the certicate, if money was available for payment on that date. (d) A purchaser of a certicated security has notice of an adverse claim if the security certicate: (1) whether in bearer or registered form, has been indorsed for collection or for surrender or for some other purpose not involving transfer; or (2) is in bearer form and has on it an unambiguous statement that it is the property of a person other than the transferor, but the mere writing of a name on the certicate is not such a statement. (e) Filing of a nancing statement under Article 9 is not notice of an adverse claim to a nancial asset. Ocial Comment
1. The rules specifying whether adverse claims can be asserted against persons who acquire securities or security entitlements, Sections 8-303, 8-502, and 8-510, provide that one is protected against an adverse claim only if one takes without notice of the claim. This section denes notice of an adverse claim. The general Article 1 denition of notice in Section 1-201(25)which provides that a person has notice of a fact if from all the facts and circumstances known to him at the time in question he has reason to know that it existsdoes not apply to the interpretation of notice of adverse claims. The Section 1-201(25) denition of notice does, however, apply to usages of that term and its cognates in Article 8 in contexts other than notice of adverse claims. 2. This section must be interpreted in light of the denition of adverse claim in Section 8-102(a)(1). Adverse claim does not include all circumstances in which a third party has a property interest in securities, but only those situations where a security is transferred in violation of the claimant's property interest. Therefore, awareness that someone other than the transferor has a property interest is not notice of an adverse claim. The transferee must be aware that the transfer violates the other party's property interest. If A holds securities in which B has some form of property interest, and A transfers the securities to C, C may know that B has an interest, but infer that A is acting in accordance with A's obligations to B. The mere fact that C knew that B had a property interest does not mean that C had notice of an adverse claim. Whether C had notice of an adverse claim depends on whether C had sucient awareness that A was acting in violation of B's property rights. The rule in subsection (b) is a particularization of this general principle. 3. Paragraph (a)(1) provides that a person has notice of an adverse claim if the person has knowledge of the adverse claim. Knowledge is dened in Section 1-201(25) as actual knowledge. 4. Paragraph (a)(2) provides that a person has notice of an adverse claim if the person is aware of a signicant probability that an adverse claim exists and deliberately avoids information that might establish the existence of the adverse claim. This is intended to codify the willful blindness test that has been applied in such cases. See May v. Chapman, 16 M. & W. 355, 153 Eng.Rep. 1225 (1847); Goodman v. Simonds, 61 U.S. 343 (1857). The rst prong of the willful blindness test of paragraph (a)(2) turns on whether the person is aware facts sucient to indicate that there is a signicant probability that an adverse claim exists. The awareness aspect necessarily turns on the actor's state of mind. Whether facts known to a person make the person aware of a signicant probability that 745

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an adverse claim exists turns on facts about the world and the conclusions that would be drawn from those facts, taking account of the experience and position of the person in question. A particular set of facts might indicate a signicant probability of an adverse claim to a professional with considerable experience in the usual methods and procedures by which securities transactions are conducted, even though the same facts would not indicate a signicant probability of an adverse claim to a non-professional. The second prong of the willful blindness test of paragraph (a)(2) turns on whether the person deliberately avoids information that would establish the existence of the adverse claim. The test is the character of the person's response to the information the person has. The question is whether the person deliberately failed to seek further information because of concern that suspicions would be conrmed. Application of the deliberate avoidance test to a transaction by an organization focuses on the knowledge and the actions of the individual or individuals conducting the transaction on behalf of the organization. Thus, an organization that purchases a security is not willfully blind to an adverse claim unless the ocers or agents who conducted that purchase transaction are willfully blind to the adverse claim. Under the two prongs of the willful blindness test, the individual or individuals conducting a transaction must know of facts indicating a substantial probability that the adverse claim exists and deliberately fail to seek further information that might conrm or refute the indication. For this purpose, information known to individuals within an organization who are not conducting or aware of a transaction, but not forwarded to the individuals conducting the transaction, is not pertinent in determining whether the individuals conducting the transaction had knowledge of a substantial probability of the existence of the adverse claim. Cf. Section 1-201(27). An organization may also deliberately avoid information if it acts to preclude or inhibit transmission of pertinent information to those individuals responsible for the conduct of purchase transactions. 5. Paragraph (a)(3) provides that a person has notice of an adverse claim if the person would have learned of the adverse claim by conducting an investigation that is required by other statute or regulation. This rule applies only if there is some other statute or regulation that explicitly requires persons dealing with securities to conduct some investigation. The federal securities laws require that brokers and banks, in certain specied circumstances, check with a stolen securities registry to determine whether securities oered for sale or pledge have been reported as stolen. If securities that were listed as stolen in the registry are taken by an institution that failed to comply with requirement to check the registry, the institution would be held to have notice of the fact that they were stolen under paragraph (a)(3). Accordingly, the institution could not qualify as a protected purchaser under Section 8-303. The same result has been reached under the prior version of Article 8. See First Nat'l Bank of Cicero v. Lewco Securities, 860 F.2d 1407 (7th Cir.1988). 6. Subsection (b) provides explicitly for some situations involving purchase from one described or identiable as a representative. Knowledge of the existence of the representative relation is not enough in itself to constitute notice of an adverse claim that would disqualify the purchaser from protected purchaser status. A purchaser may take a security on the inference that the representative is acting properly. Knowledge that a security is being transferred to an individual account of the representative or that the proceeds of the transaction will be paid into that account is not sucient to constitute notice of an adverse claim, but knowledge that the proceeds will be applied to the personal indebtedness of the representative is. See State Bank of Binghamton v. Bache, 162 Misc. 128, 293 N.Y.S. 667 (1937). 7. Subsection (c) species whether a purchaser of a stale security is charged with notice of adverse claims, and therefore disqualied from protected purchaser status under Section 8-303. The fact of staleness is viewed as notice of certain defects after the lapse of stated periods, but the maturity of the security does not operate automatically to aect holders' rights. The periods of time here stated are shorter than those appearing in the provisions of this Article on staleness as notice of defects or defenses of an issuer (Section 8-203) since a purchaser who takes a security after funds or other securities are available for its redemption has more reason to suspect claims of ownership than issuer's defenses. An owner will normally turn in a security rather than transfer it at such a time. Of itself, a default never constitutes notice of a possible adverse claim. To provide otherwise would not tend to drive defaulted securities home and would serve only to disrupt current nancial markets where many defaulted securities are actively traded. Unpaid or overdue coupons attached to a 746

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bond do not bring it within the operation of this subsection, though they may be relevant under the general test of notice of adverse claims in subsection (a). 8. Subsection (d) provides the owner of a certicated security with a means of protection while a security certicate is being sent in for redemption or exchange. The owner may endorse it for collection or for surrender, and this constitutes notice of the owner's claims, under subsection (d). Denitional Cross References: Adverse claim. Section 8-102(a)(1). Bearer form. Section 8-102(a)(2). Certicated security. Section 8-102(a)(4). Financial asset. Section 8-102(a)(9). Knowledge. Section 1-201(25). Person. Section 1-201(30). Purchaser. Sections 1-201(33) & 8-116. Registered form. Section 8-102(a)(13). Representative. Section 1-201(35). Security certicate. Section 8-102(a)(16).

8-106. Control. (a) A purchaser has control of a certicated security in bearer form if the certicated security is delivered to the purchaser. (b) A purchaser has control of a certicated security in registered form if the certicated security is delivered to the purchaser, and: (1) the certicate is indorsed to the purchaser or in blank by an eective indorsement; or (2) the certicate is registered in the name of the purchaser, upon original issue or registration of transfer by the issuer. (c) A purchaser has control of an uncerticated security if: (1) the uncerticated security is delivered to the purchaser; or (2) the issuer has agreed that it will comply with instructions originated by the purchaser without further consent by the registered owner. (d) A purchaser has control of a security entitlement if: (1) the purchaser becomes the entitlement holder; (2) the securities intermediary has agreed that it will comply with entitlement orders originated by the purchaser without further consent by the entitlement holder; or (3) another person has control of the security entitlement on behalf of the purchaser or, having previously acquired control of the security entitlement, acknowledges that it has control on behalf of the purchaser. (e) If an interest in a security entitlement is granted by the entitlement holder to the entitlement holder's own securities intermediary, the securities intermediary has control. (f) A purchaser who has satised the requirements of subsection (c) or (d) has control, even if the registered owner in the case of subsection (c) or the entitlement holder in the case of subsection (d) retains the right to make substitutions for the uncerticated security or security entitlement, to originate instructions or entitlement orders to the issuer or securities intermediary, or otherwise to deal with the uncerticated security or security entitlement.
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(g) An issuer or a securities intermediary may not enter into an agreement of the kind described in subsection (c)(2) or (d)(2) without the consent of the registered owner or entitlement holder, but an issuer or a securities intermediary is not required to enter into such an agreement even though the registered owner or entitlement holder so directs. An issuer or securities intermediary that has entered into such an agreement is not required to conrm the existence of the agreement to another party unless requested to do so by the registered owner or entitlement holder. As amended in 1999.
See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999.

Ocial Comment
1. The concept of control plays a key role in various provisions dealing with the rights of purchasers, including secured parties. See Sections 8-303 (protected purchasers); 8-503(e) (purchasers from securities intermediaries); 8-510 (purchasers of security entitlements from entitlement holders); 9-314 (perfection of security interests); 9-328 (priorities among conicting security interests). Obtaining control means that the purchaser has taken whatever steps are necessary, given the manner in which the securities are held, to place itself in a position where it can have the securities sold, without further action by the owner. 2. Subsection (a) provides that a purchaser obtains control with respect to a certicated security in bearer form by taking delivery, as dened in Section 8-301. Subsection (b) provides that a purchaser obtains control with respect to a certicated security in registered form by taking delivery, as dened in Section 8-301, provided that the security certicate has been indorsed to the purchaser or in blank. Section 8-301 provides that delivery of a certicated security occurs when the purchaser obtains possession of the security certicate, or when an agent for the purchaser (other than a securities intermediary) either acquires possession or acknowledges that the agent holds for the purchaser. 3. Subsection (c) species the means by which a purchaser can obtain control over uncerticated securities which the transferor holds directly. Two mechanisms are possible. Under subsection (c)(1), securities can be delivered to a purchaser. Section 8-301(b) provides that delivery of an uncerticated security occurs when the purchaser becomes the registered holder. So far as the issuer is concerned, the purchaser would then be entitled to exercise all rights of ownership. See Section 8-207. As between the parties to a purchase transaction, however, the rights of the purchaser are determined by their contract. Cf. Section 9-202. Arrangements covered by this paragraph are analogous to arrangements in which bearer certicates are delivered to a secured partyso far as the issuer or any other parties are concerned, the secured party appears to be the outright owner, although it is in fact holding as collateral property that belongs to the debtor. Under subsection (c)(2), a purchaser has control if the issuer has agreed to act on the instructions of the purchaser, even though the owner remains listed as the registered owner. The issuer, of course, would be acting wrongfully against the registered owner if it entered into such an agreement without the consent of the registered owner. Subsection (g) makes this point explicit. The subsection (c)(2) provision makes it possible for issuers to offer a service akin to the registered pledge device of the 1978 version of Article 8, without mandating that all issuers oer that service. 4. Subsection (d) species the means by which a purchaser can obtain control of a security entitlement. Three mechanisms are possible, analogous to those provided in subsection (c) for uncerticated securities. Under subsection (d)(1), a purchaser has control if it is the entitlement holder. This subsection would apply whether the purchaser holds through the same intermediary that the debtor used, or has the securities position transferred to its own intermediary. Subsection (d)(2) provides that a purchaser has control if the securities intermediary has agreed to act on entitlement orders originated by the purchaser if no further consent by the entitlement holder is required. Under subsection (d)(2), control may be achieved even though the original entitlement holder remains as the entitlement holder. Finally, a purchaser may obtain control under subsection (d)(3) if another person has 748

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control and the person acknowledges that it has control on the purchaser's behalf. Control under subsection (d)(3) parallels the delivery of certicated securities and uncerticated securities under Section 8-301. Of course, the acknowledging person cannot be the debtor. This section species only the minimum requirements that such an arrangement must meet to confer control; the details of the arrangement can be specied by agreement. The arrangement might cover all of the positions in a particular account or subaccount, or only specied positions. There is no requirement that the control party's right to give entitlement orders be exclusive. The arrangement might provide that only the control party can give entitlement orders, or that either the entitlement holder or the control party can give entitlement orders. See subsection (f). The following examples illustrate the application of subsection (d): Example 1. Debtor grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Alpha also has an account with Able. Debtor instructs Able to transfer the shares to Alpha, and Able does so by crediting the shares to Alpha's account. Alpha has control of the 1000 shares under subsection (d)(1). Although Debtor may have become the benecial owner of the new securities entitlement, as between Debtor and Alpha, Able has agreed to act on Alpha's entitlement orders because, as between Able and Alpha, Alpha has become the entitlement holder. See Section 8-506. Example 2. Debtor grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Alpha does not have an account with Able. Alpha uses Beta as its securities custodian. Debtor instructs Able to transfer the shares to Beta, for the account of Alpha, and Able does so. Alpha has control of the 1000 shares under subsection (d)(1). As in Example 1, although Debtor may have become the benecial owner of the new securities entitlement, as between Debtor and Alpha, Beta has agreed to act on Alpha's entitlement orders because, as between Beta and Alpha, Alpha has become the entitlement holder. Example 3. Debtor grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Debtor, Able, and Alpha enter into an agreement under which Debtor will continue to receive dividends and distributions, and will continue to have the right to direct dispositions, but Alpha also has the right to direct dispositions. Alpha has control of the 1000 shares under subsection (d)(2). Example 4. Able & Co., a securities dealer, grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Able holds through an account with Clearing Corporation. Able causes Clearing Corporation to transfer the shares into Alpha's account at Clearing Corporation. As in Example 1, Alpha has control of the 1000 shares under subsection (d)(1). Example 5. Able & Co., a securities dealer, grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Able holds through an account with Clearing Corporation. Alpha does not have an account with Clearing Corporation. It holds its securities through Beta Bank, which does have an account with Clearing Corporation. Able causes Clearing Corporation to transfer the shares into Beta's account at Clearing Corporation. Beta credits the position to Alpha's account with Beta. As in Example 2, Alpha has control of the 1000 shares under subsection (d)(1). Example 6. Able & Co., a securities dealer, grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Able holds through an account with Clearing Corporation. Able causes Clearing Corporation to transfer the shares into a pledge account, pursuant to an agreement under which Able will continue to receive dividends, distributions, and the like, but Alpha has the right to direct dispositions. As in Example 3, Alpha has control of the 1000 shares under subsection (d)(2). Example 7. Able & Co., a securities dealer, grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Able holds through an account with Clearing Corporation. Able, Alpha, and Clearing Corporation enter into an agreement under which Clearing Corporation will act on instructions from Alpha with respect to the XYZ Co. stock carried in Able's account, but Able will continue to receive dividends, distributions, and the like, and will also have the right to direct dispositions. As in Example 3, Alpha has control of the 1000 shares under subsection (d)(2). Example 8. Able & Co., a securities dealer, holds a wide range of securities through 749

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its account at Clearing Corporation. Able enters into an arrangement with Alpha Bank pursuant to which Alpha provides nancing to Able secured by securities identied as the collateral on lists provided by Able to Alpha on a daily or other periodic basis. Able, Alpha, and Clearing Corporation enter into an agreement under which Clearing Corporation agrees that if at any time Alpha directs Clearing Corporation to do so, Clearing Corporation will transfer any securities from Able's account at Alpha's instructions. Because Clearing Corporation has agreed to act on Alpha's instructions with respect to any securities carried in Able's account, at the moment that Alpha's security interest attaches to securities listed by Able, Alpha obtains control of those securities under subsection (d)(2). There is no requirement that Clearing Corporation be informed of which securities Able has pledged to Alpha. Example 9. Debtor grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Beta Bank agrees with Alpha to act as Alpha's collateral agent with respect to the security entitlement. Debtor, Able, and Beta enter into an agreement under which Debtor will continue to receive dividends and distributions, and will continue to have the right to direct dispositions, but Beta also has the right to direct dispositions. Because Able has agreed that it will comply with entitlement orders originated by Beta without further consent by Debtor, Beta has control of the security entitlement (see Example 3). Because Beta has control on behalf of Alpha, Alpha also has control under subsection (d)(3). It is not necessary for Able to enter into an agreement directly with Alpha or for Able to be aware of Beta's agency relationship with Alpha. 5. For a purchaser to have control under subsection (c)(2) or (d)(2), it is essential that the issuer or securities intermediary, as the case may be, actually be a party to the agreement. If a debtor gives a secured party a power of attorney authorizing the secured party to act in the name of the debtor, but the issuer or securities intermediary does not specically agree to this arrangement, the secured party does not have control within the meaning of subsection (c)(2) or (d)(2) because the issuer or securities intermediary is not a party to the agreement. The secured party does not have control under subsection (c)(1) or (d)(1) because, although the power of attorney might give the secured party authority to act on the debtor's behalf as an agent, the secured party has not actually become the registered owner or entitlement holder. 6. Subsection (e) provides that if an interest in a security entitlement is granted by an entitlement holder to the securities intermediary through which the security entitlement is maintained, the securities intermediary has control. A common transaction covered by this provision is a margin loan from a broker to its customer. 7. The term control is used in a particular dened sense. The requirements for obtaining control are set out in this section. The concept is not to be interpreted by reference to similar concepts in other bodies of law. In particular, the requirements for possession derived from the common law of pledge are not to be used as a basis for interpreting subsection (c)(2) or (d)(2). Those provisions are designed to supplant the concepts of constructive possession and the like. A principal purpose of the control concept is to eliminate the uncertainty and confusion that results from attempting to apply common law possession concepts to modern securities holding practices. The key to the control concept is that the purchaser has the ability to have the securities sold or transferred without further action by the transferor. There is no requirement that the powers held by the purchaser be exclusive. For example, in a secured lending arrangement, if the secured party wishes, it can allow the debtor to retain the right to make substitutions, to direct the disposition of the uncerticated security or security entitlement, or otherwise to give instructions or entitlement orders. (As explained in Section 8-102, Comment 8, an entitlement order includes a direction under Section 8-508 to the securities intermediary to transfer a nancial asset to the account of the entitlement holder at another nancial intermediary or to cause the nancial asset to be transferred to the entitlement holder in the direct holding system (e.g., by delivery of a securities certicate registered in the name of the former entitlement holder).) Subsection (f) is included to make clear the general point stated in subsections (c) and (d) that the test of control is whether the purchaser has obtained the requisite power, not whether the debtor has retained other powers. There is no implication that retention by the debtor of powers other than those mentioned in subsection (f) is inconsistent with the purchaser having control. Nor is there a requirement that the purchaser's powers be unconditional, provided that fur750

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ther consent of the entitlement holder is not a condition. Example 10. Debtor grants to Alpha Bank and to Beta Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. By agreement among the parties, Alpha's security interest is senior and Beta's is junior. Able agrees to act on the entitlement orders of either Alpha or Beta. Alpha and Beta each has control under subsection (d)(2). Moreover, Beta has control notwithstanding a term of Able's agreement to the eect that Able's obligation to act on Beta's entitlement orders is conditioned on Alpha's consent. The crucial distinction is that Able's agreement to act on Beta's entitlement orders is not conditioned on Debtor's further consent. Example 11. Debtor grants to Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Able agrees to act on the entitlement orders of Alpha, but Alpha's right to give entitlement orders to the securities intermediary is conditioned on the Debtor's default. Alternatively, Alpha's right to give entitlement orders is conditioned upon Alpha's statement to Able that Debtor is in default. Because Able's agreement to act on Beta's Alpha's* entitlement orders is not conditioned on Debtor's further consent, Alpha has control of the securities entitlement under either alternative. In many situations, it will be better practice for both the securities intermediary and the purchaser to insist that any conditions relating in any way to the entitlement holder be effective only as between the purchaser and the entitlement holder. That practice would avoid the risk that the securities intermediary could be caught between conicting assertions of the entitlement holder and the purchaser as to whether the conditions in fact have been met. Nonetheless, the existence of unfullled conditions eective against the intermediary would not preclude the purchaser from having control. Denitional Cross References: Bearer form. Section 8-102(a)(2). Certicated security. Section 8-102(a)(4). Delivery. Section 8-301. Eective. Section 8-107. Entitlement holder. Section 8-102(a)(7). Entitlement order. Section 8-102(a)(8). Indorsement. Section 8-102(a)(11). Instruction. Section 8-102(a)(12). Purchaser. Sections 1-201(33) & 8-116. Registered form. Section 8-102(a)(13). Securities intermediary. Section 8-102(a)(14). Security entitlement. Section 8-102(a)(17). Uncerticated security. Section 8-102(a)(18).

As amended in 1999 and 2000.

See Appendix I contained within revised Article 9 for material relating to changes made in Ocial Comment in 1999. See Appendix P for material relating to changes made in Ocial Comment in 2000.

8-107. Whether Indorsement, Instruction, or Entitlement Order is Eective. (a) Appropriate person means: (1) with respect to an indorsement, the person specied by a security certicate or by an eective special indorsement to be entitled to the security;
[Section 8-106] *Amendments in italics approved by the Permanent Editorial Board for Uniform Commercial Code January 15, 2000. 751

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(2) with respect to an instruction, the registered owner of an uncerticated security; (3) with respect to an entitlement order, the entitlement holder; (4) if the person designated in paragraph (1), (2), or (3) is deceased, the designated person's successor taking under other law or the designated person's personal representative acting for the estate of the decedent; or (5) if the person designated in paragraph (1), (2), or (3) lacks capacity, the designated person's guardian, conservator, or other similar representative who has power under other law to transfer the security or nancial asset. (b) An indorsement, instruction, or entitlement order is eective if: (1) it is made by the appropriate person; (2) it is made by a person who has power under the law of agency to transfer the security or nancial asset on behalf of the appropriate person, including, in the case of an instruction or entitlement order, a person who has control under Section 8-106(c)(2) or (d)(2); or (3) the appropriate person has ratied it or is otherwise precluded from asserting its ineectiveness. (c) An indorsement, instruction, or entitlement order made by a representative is eective even if: (1) the representative has failed to comply with a controlling instrument or with the law of the State having jurisdiction of the representative relationship, including any law requiring the representative to obtain court approval of the transaction; or (2) the representative's action in making the indorsement, instruction, or entitlement order or using the proceeds of the transaction is otherwise a breach of duty. (d) If a security is registered in the name of or specially indorsed to a person described as a representative, or if a securities account is maintained in the name of a person described as a representative, an indorsement, instruction, or entitlement order made by the person is eective even though the person is no longer serving in the described capacity. (e) Eectiveness of an indorsement, instruction, or entitlement order is determined as of the date the indorsement, instruction, or entitlement order is made, and an indorsement, instruction, or entitlement order does not become ineective by reason of any later change of circumstances. Ocial Comment
1. This section denes two concepts, appropriate person and eective. Eectiveness is a broader concept than appropriate person. For example, if a security or securities account is registered in the name of Mary Roe, Mary Roe is the appropriate person, but an indorsement, instruction, or entitlement order made by John Doe is eective if, under agency or other law, Mary Roe is precluded from denying Doe's authority. Treating these two concepts separately facilitates statement of the rules of Article 8 that state the legal effect of an indorsement, instruction, or entitlement order. For example, a securities intermediary is protected against liability if it acts on an eective entitlement order, but has a duty to comply with an entitlement order only if it is originated by an appropriate person. See Sections 8-115 and 8-507. One important application of the eectiveness concept is in the direct holding system rules on the rights of purchasers. A purchaser of a certicated security in registered form 752

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can qualify as a protected purchaser who takes free from adverse claims under Section 8-303 only if the purchaser obtains control. Section 8-106 provides that a purchaser of a certicated security in registered form obtains control if there has been an eective indorsement. 2. Subsection (a) provides that the term appropriate person covers two categories: (1) the person who is actually designated as the person entitled to the security or security entitlement, and (2) the successor or legal representative of that person if that person has died or otherwise lacks capacity. Other law determines who has power to transfer a security on behalf of a person who lacks capacity. For example, if securities are registered in the name of more than one person and one of the designated persons dies, whether the survivor is the appropriate person depends on the form of tenancy. If the two were registered joint tenants with right of survivorship, the survivor would have that power under other law and thus would be the appropriate person. If securities are registered in the name of an individual and the individual dies, the law of decedents' estates determines who has power to transfer the decedent's securities. That would ordinarily be the executor or administrator, but if a small estate statute permits a widow to transfer a decedent's securities without administration proceedings, she would be the appropriate person. If the registration of a security or a securities account contains a designation of a death beneciary under the Uniform Transfer on Death Security Registration Act or comparable legislation, the designated beneciary would, under that law, have power to transfer upon the person's death and so would be the appropriate person. Article 8 does not contain a list of such representatives, because any list is likely to become outdated by developments in other law. 3. Subsection (b) sets out the general rule that an indorsement, instruction, or entitlement order is eective if it is made by the appropriate person or by a person who has power to transfer under agency law or if the appropriate person is precluded from denying its eectiveness. The control rules in Section 8-106 provide for arrangements where a person who holds securities through a securities intermediary, or holds uncerticated securities directly, enters into a control agreement giving the secured party the right to initiate entitlement orders of instructions. Paragraph 2 of subsection (b) states explicitly that an entitlement order or instruction initiated by a person who has obtained such a control agreement is eective. Subsections (c), (d), and (e) supplement the general rule of subsection (b) on eectiveness. The term representative, used in subsections (c) and (d), is dened in Section 1-201(35). 4. Subsection (c) provides that an indorsement, instruction, or entitlement order made by a representative is eective even though the representative's action is a violation of duties. The following example illustrates this subsection: Example 1. Certicated securities are registered in the name of John Doe. Doe dies and Mary Roe is appointed executor. Roe indorses the security certicate and transfers it to a purchaser in a transaction that is a violation of her duties as executor. Roe's indorsement is eective, because Roe is the appropriate person under subsection (a)(4). This is so even though Roe's transfer violated her obligations as executor. The policies of free transferability of securities that underlie Article 8 dictate that neither a purchaser to whom Roe transfers the securities nor the issuer who registers transfer should be required to investigate the terms of the will to determine whether Roe is acting properly. Although Roe's indorsement is eective under this section, her breach of duty may be such that her beneciary has an adverse claim to the securities that Roe transferred. The question whether that adverse claim can be asserted against purchasers is governed not by this section but by Section 8-303. Under Section 8-404, the issuer has no duties to an adverse claimant unless the claimant obtains legal process enjoining the issuer from registering transfer. 5. Subsection (d) deals with cases where a security or a securities account is registered in the name of a person specically designated as a representative. The following example illustrates this subsection: Example 2. Certicated securities are registered in the name of John Jones, trustee of the Smith Family Trust. John Jones is removed as trustee and Martha Moe is appointed successor trustee. The securities, however, are not reregistered, but remain registered in the name of John Jones, trustee of the Smith Family Trust. Jones indorses the security certicate and transfers it to a purchaser. Subsection (d) provides that an indorsement by John Jones as trustee is eective even 753

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though Jones is no longer serving in that capacity. Since the securities were registered in the name of John Jones, trustee of the Smith Family Trust, a purchaser, or the issuer when called upon to register transfer, should be entitled to assume without further inquiry that Jones has the power to act as trustee for the Smith Family Trust. Note that subsection (d) does not apply to a case where the security or securities account is registered in the name of principal rather than the representative as such. The following example illustrates this point: Example 3. Certicated securities are registered in the name of John Doe. John Doe dies and Mary Roe is appointed executor. The securities are not reregistered in the name of Mary Roe as executor. Later, Mary Roe is removed as executor and Martha Moe is appointed as her successor. After being removed, Mary Roe indorses the security certicate that is registered in the name of John Doe and transfers it to a purchaser. Mary Roe's indorsement is not made eective by subsection (d), because the securities were not registered in the name of Mary Roe as representative. A purchaser or the issuer registering transfer should be required to determine whether Roe has power to act for John Doe. Purchasers and issuers can protect themselves in such cases by requiring signature guaranties. See Section 8-306. 6. Subsection (e) provides that the eectiveness of an indorsement, instruction, or entitlement order is determined as of the date it is made. The following example illustrates this subsection: Example 4. Certicated securities are registered in the name of John Doe. John Doe dies and Mary Roe is appointed executor. Mary Roe indorses the security certicate that is registered in the name of John Doe and transfers it to a purchaser. After the indorsement and transfer, but before the security certicate is presented to the issuer for registration of transfer, Mary Roe is removed as executor and Martha Moe is appointed as her successor. Mary Roe's indorsement is eective, because at the time Roe indorsed she was the appropriate person under subsection (a)(4). Her later removal as executor does not render the indorsement ineective. Accordingly, the issuer would not be liable for registering the transfer. See Section 8-404. Denitional Cross References: Entitlement order. Section 8-102(a)(8). Financial asset. Section 8-102(a)(9). Indorsement. Section 8-102(a)(11). Instruction. Section 8-102(a)(12). Representative. Section 1-201(35). Securities account. Section 8-501. Security. Section 8-102(a)(15). Security certicate. Section 8-102(a)(16). Security entitlement. Section 8-102(a)(17). Uncerticated security. Section 8-102(a)(18).

8-108. Warranties in Direct Holding. (a) A person who transfers a certicated security to a purchaser for value warrants to the purchaser, and an indorser, if the transfer is by indorsement, warrants to any subsequent purchaser, that: (1) the certicate is genuine and has not been materially altered; (2) the transferor or indorser does not know of any fact that might impair the validity of the security; (3) there is no adverse claim to the security; (4) the transfer does not violate any restriction on transfer; (5) if the transfer is by indorsement, the indorsement is made by an appropriate person, or if the indorsement is by an agent, the agent has actual authority to act on behalf of the appropriate person; and (6) the transfer is otherwise eective and rightful.
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(b) A person who originates an instruction for registration of transfer of an uncerticated security to a purchaser for value warrants to the purchaser that: (1) the instruction is made by an appropriate person, or if the instruction is by an agent, the agent has actual authority to act on behalf of the appropriate person; (2) the security is valid; (3) there is no adverse claim to the security; and (4) at the time the instruction is presented to the issuer: (i) the purchaser will be entitled to the registration of transfer; (ii) the transfer will be registered by the issuer free from all liens, security interests, restrictions, and claims other than those specied in the instruction; (iii) the transfer will not violate any restriction on transfer; and (iv) the requested transfer will otherwise be eective and rightful. (c) A person who transfers an uncerticated security to a purchaser for value and does not originate an instruction in connection with the transfer warrants that: (1) the uncerticated security is valid; (2) there is no adverse claim to the security; (3) the transfer does not violate any restriction on transfer; and (4) the transfer is otherwise eective and rightful. (d) A person who indorses a security certicate warrants to the issuer that: (1) there is no adverse claim to the security; and (2) the indorsement is eective. (e) A person who originates an instruction for registration of transfer of an uncerticated security warrants to the issuer that: (1) the instruction is eective; and (2) at the time the instruction is presented to the issuer the purchaser will be entitled to the registration of transfer. (f) A person who presents a certicated security for registration of transfer or for payment or exchange warrants to the issuer that the person is entitled to the registration, payment, or exchange, but a purchaser for value and without notice of adverse claims to whom transfer is registered warrants only that the person has no knowledge of any unauthorized signature in a necessary indorsement. (g) If a person acts as agent of another in delivering a certicated security to a purchaser, the identity of the principal was known to the person to whom the certicate was delivered, and the certicate delivered by the agent was received by the agent from the principal or received by the agent from another person at the direction of the principal, the person delivering the security certicate warrants only that the delivering person has authority to act for the principal and does not know of any adverse claim to the certicated security. (h) A secured party who redelivers a security certicate received, or after payment and on order of the debtor delivers the security certicate to another person, makes only the warranties of an agent under subsection (g).
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(i) Except as otherwise provided in subsection (g), a broker acting for a customer makes to the issuer and a purchaser the warranties provided in subsections (a) through (f). A broker that delivers a security certicate to its customer, or causes its customer to be registered as the owner of an uncerticated security, makes to the customer the warranties provided in subsection (a) or (b), and has the rights and privileges of a purchaser under this section. The warranties of and in favor of the broker acting as an agent are in addition to applicable warranties given by and in favor of the customer. Ocial Comment
1. Subsections (a), (b), and (c) deal with warranties by security transferors to purchasers. Subsections (d) and (e) deal with warranties by security transferors to issuers. Subsection (f) deals with presentment warranties. 2. Subsection (a) species the warranties made by a person who transfers a certicated security to a purchaser for value. Paragraphs (3), (4), and (5) make explicit several key points that are implicit in the general warranty of paragraph (6) that the transfer is eective and rightful. Subsection (b) sets forth the warranties made to a purchaser for value by one who originates an instruction. These warranties are quite similar to those made by one transferring a certicated security, subsection (a), the principal dierence being the absolute warranty of validity. If upon receipt of the instruction the issuer should dispute the validity of the security, the burden of proving validity is upon the transferor. Subsection (c) provides for the limited circumstances in which an uncerticated security could be transferred without an instruction, see Section 8-301(b)(2). Subsections (d) and (e) give the issuer the benet of the warranties of an indorser or originator on those matters not within the issuer's knowledge. 3. Subsection (f) limits the warranties made by a purchaser for value without notice whose presentation of a security certicate is defective in some way but to whom the issuer does register transfer. The eect is to deny the issuer a remedy against such a person unless at the time of presentment the person had knowledge of an unauthorized signature in a necessary indorsement. The issuer can protect itself by refusing to make the transfer or, if it registers the transfer before it discovers the defect, by pursuing its remedy against a signature guarantor. 4. Subsection (g) eliminates all substantive warranties in the relatively unusual case of a delivery of certicated security by an agent of a disclosed principal where the agent delivers the exact certicate that it received from or for the principal. Subsection (h) limits the warranties given by a secured party who redelivers a certicate. Subsection (i) species the warranties of brokers in the more common scenarios. 5. Under Section 1-102(3) the warranty provisions apply unless otherwise agreed and the parties may enter into express agreements to allocate the risks of possible defects. Usual estoppel principles apply with respect to transfers of both certicated and uncerticated securities whenever the purchaser has knowledge of the defect, and these warranties will not be breached in such a case. Denitional Cross References: Adverse claim. Section 8-102(a)(1). Appropriate person. Section 8-107. Broker. Section 8-102(a)(3). Certicated security. Section 8-102(a)(4). Indorsement. Section 8-102(a)(11). Instruction. Section 8-102(a)(12). Issuer. Section 8-201. Person. Section 1-201(30). Purchaser. Sections 1-201(33) & 8-116. Secured party. Section 9-102(a)(72). Security. Section 8-102(a)(15). Security certicate. Section 8-102(a)(16). Uncerticated security. Section 8-102(a)(18). 756

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Value. Sections 1-201(44) & 8-116.

8-109. Warranties in Indirect Holding. (a) A person who originates an entitlement order to a securities intermediary warrants to the securities intermediary that: (1) the entitlement order is made by an appropriate person, or if the entitlement order is by an agent, the agent has actual authority to act on behalf of the appropriate person; and (2) there is no adverse claim to the security entitlement. (b) A person who delivers a security certicate to a securities intermediary for credit to a securities account or originates an instruction with respect to an uncerticated security directing that the uncerticated security be credited to a securities account makes to the securities intermediary the warranties specied in Section 8-108(a) or (b). (c) If a securities intermediary delivers a security certicate to its entitlement holder or causes its entitlement holder to be registered as the owner of an uncerticated security, the securities intermediary makes to the entitlement holder the warranties specied in Section 8-108(a) or (b). Ocial Comment
1. Subsection (a) provides that a person who originates an entitlement order warrants to the securities intermediary that the order is authorized, and warrants the absence of adverse claims. Subsection (b) species the warranties that are given when a person who holds securities directly has the holding converted into indirect form. A person who delivers a certicate to a securities intermediary or originates an instruction for an uncerticated security gives to the securities intermediary the transfer warranties under Section 8-108. If the securities intermediary in turn delivers the certicate to a higher level securities intermediary, it gives the same warranties. 2. Subsection (c) states the warranties that a securities intermediary gives when a customer who has been holding securities in an account with the securities intermediary requests that certicates be delivered or that uncerticated securities be registered in the customer's name. The warranties are the same as those that brokers make with respect to securities that the brokers sell to or buy on behalf of the customers. See Section 8-108(i). 3. As with the Section 8-108 warranties, the warranties specied in this section may be modied by agreement under Section 1-102(3). Denitional Cross References: Adverse claim. Section 8-102(a)(1). Appropriate person. Section 8-107. Entitlement holder. Section 8-102(a)(7). Entitlement order. Section 8-102(a)(8). Instruction. Section 8-102(a)(12). Person. Section 1-201(30). Securities account. Section 8-501. Securities intermediary. Section 8-102(a)(14). Security certicate. Section 8-102(a)(16). Uncerticated security. Section 8-102(a)(18).

8-110. Applicability; Choice of Law. (a) The local law of the issuer's jurisdiction, as specied in subsection (d), governs: (1) the validity of a security; (2) the rights and duties of the issuer with respect to registration of transfer;
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(3) the eectiveness of registration of transfer by the issuer; (4) whether the issuer owes any duties to an adverse claimant to a security; and (5) whether an adverse claim can be asserted against a person to whom transfer of a certicated or uncerticated security is registered or a person who obtains control of an uncerticated security. (b) The local law of the securities intermediary's jurisdiction, as specied in subsection (e), governs: (1) acquisition of a security entitlement from the securities intermediary; (2) the rights and duties of the securities intermediary and entitlement holder arising out of a security entitlement; (3) whether the securities intermediary owes any duties to an adverse claimant to a security entitlement; and (4) whether an adverse claim can be asserted against a person who acquires a security entitlement from the securities intermediary or a person who purchases a security entitlement or interest therein from an entitlement holder. (c) The local law of the jurisdiction in which a security certicate is located at the time of delivery governs whether an adverse claim can be asserted against a person to whom the security certicate is delivered. (d) Issuer's jurisdiction means the jurisdiction under which the issuer of the security is organized or, if permitted by the law of that jurisdiction, the law of another jurisdiction specied by the issuer. An issuer organized under the law of this State may specify the law of another jurisdiction as the law governing the matters specied in subsection (a)(2) through (5). (e) The following rules determine a securities intermediary's jurisdiction for purposes of this section: (1) If an agreement between the securities intermediary and its entitlement holder governing the securities account expressly provides that a particular jurisdiction is the securities intermediary's jurisdiction for purposes of this part, this article, or this [Act], that jurisdiction is the securities intermediary's jurisdiction. (2) If paragraph (1) does not apply and an agreement between the securities intermediary and its entitlement holder governing the securities account expressly provides that the agreement is governed by the law of a particular jurisdiction, that jurisdiction is the securities intermediary's jurisdiction. (3) If neither paragraph (1) nor paragraph (2) applies and an agreement between the securities intermediary and its entitlement holder governing the securities account expressly provides that the securities account is maintained at an oce in a particular jurisdiction, that jurisdiction is the securities intermediary's jurisdiction. (4) If none of the preceding paragraphs applies, the securities intermediary's jurisdiction is the jurisdiction in which the oce identied in an account statement as the oce serving the entitlement holder's account is located. (5) If none of the preceding paragraphs applies, the securities
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intermediary's jurisdiction is the jurisdiction in which the chief executive oce of the securities intermediary is located. (f) A securities intermediary's jurisdiction is not determined by the physical location of certicates representing nancial assets, or by the jurisdiction in which is organized the issuer of the nancial asset with respect to which an entitlement holder has a security entitlement, or by the location of facilities for data processing or other record keeping concerning the account. As amended in 1999.
See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999.

Ocial Comment
1. This section deals with applicability and choice of law issues concerning Article 8. The distinction between the direct and indirect holding systems plays a signicant role in determining the governing law. An investor in the direct holding system is registered on the books of the issuer and/or has possession of a security certicate. Accordingly, the jurisdiction of incorporation of the issuer or location of the certicate determine the applicable law. By contrast, an investor in the indirect holding system has a security entitlement, which is a bundle of rights against the securities intermediary with respect to a security, rather than a direct interest in the underlying security. Accordingly, in the rules for the indirect holding system, the jurisdiction of incorporation of the issuer of the underlying security or the location of any certicates that might be held by the intermediary or a higher tier intermediary, do not determine the applicable law. The phrase local law refers to the law of a jurisdiction other than its conict of laws rules. See Restatement (Second) of Conict of Laws 4. 2. Subsection (a) provides that the law of an issuer's jurisdiction governs certain issues where the substantive rules of Article 8 determine the issuer's rights and duties. Paragraph (1) of subsection (a) provides that the law of the issuer's jurisdiction governs the validity of the security. This ensures that a single body of law will govern the questions addressed in Part 2 of Article 8, concerning the circumstances in which an issuer can and cannot assert invalidity as a defense against purchasers. Similarly, paragraphs (2), (3), and (4) of subsection (a) ensure that the issuer will be able to look to a single body of law on the questions addressed in Part 4 of Article 8, concerning the issuer's duties and liabilities with respect to registration of transfer. Paragraph (5) of subsection (a) applies the law of an issuer's jurisdiction to the question whether an adverse claim can be asserted against a purchaser to whom transfer has been registered, or who has obtained control over an uncerticated security. Although this issue deals with the rights of persons other than the issuer, the law of the issuer's jurisdiction applies because the purchasers to whom the provision applies are those whose protection against adverse claims depends on the fact that their interests have been recorded on the books of the issuer. The principal policy reected in the choice of law rules in subsection (a) is that an issuer and others should be able to look to a single body of law on the matters specied in subsection (a), rather than having to look to the law of all of the dierent jurisdictions in which security holders may reside. The choice of law policies reected in this subsection do not require that the body of law governing all of the matters specied in subsection (a) be that of the jurisdiction in which the issuer is incorporated. Thus, subsection (d) provides that the term issuer's jurisdiction means the jurisdiction in which the issuer is organized, or, if permitted by that law, the law of another jurisdiction selected by the issuer. Subsection (d) also provides that issuers organized under the law of a State which adopts this Article may make such a selection, except as to the validity issue specied in paragraph (1). The question whether an issuer can assert the defense of invalidity may implicate signicant policies of the issuer's jurisdiction of incorporation. See, e.g., Section 8-202 and Comments thereto. Although subsection (a) provides that the issuer's rights and duties concerning registration of transfer are governed by the law of the issuer's jurisdiction, other matters related to 759

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registration of transfer, such as appointment of a guardian for a registered owner or the existence of agency relationships, might be governed by another jurisdiction's law. Neither this section nor Section 1-105 deals with what law governs the appointment of the administrator or executor; that question is determined under generally applicable choice of law rules. 3. Subsection (b) provides that the law of the securities intermediary's jurisdiction governs the issues concerning the indirect holding system that are dealt with in Article 8. Paragraphs (1) and (2) cover the matters dealt with in the Article 8 rules dening the concept of security entitlement and specifying the duties of securities intermediaries. Paragraph (3) provides that the law of the security intermediary's jurisdiction determines whether the intermediary owes any duties to an adverse claimant. Paragraph (4) provides that the law of the security intermediary's jurisdiction determines whether adverse claims can be asserted against entitlement holders and others. Subsection (e) determines what is a securities intermediary's jurisdiction. The policy of subsection (b) is to ensure that a securities intermediary and all of its entitlement holders can look to a single, readily-identiable body of law to determine their rights and duties. Accordingly, subsection (e) sets out a sequential series of tests to facilitate identication of that body of law. Paragraph (1) of subsection (e) permits specication of the securities intermediary's jurisdiction by agreement. In the absence of such a specication, the law chosen by the parties to govern the securities account determines the securities intermediary's jurisdiction. See paragraph (2). Because the policy of this section is to enable parties to determine, in advance and with certainty, what law will apply to transactions governed by this Article, the validation of the parties' selection of governing law by agreement is not conditioned upon a determination that the jurisdiction whose law is chosen bear a reasonable relation to the transaction. See Section 4A-507; compare Section 1-105(1). That is also true with respect to the similar provisions in subsection (d) of this section and in Section 9-305. The remaining paragraphs in subsection (e) contain additional default rules for determining the securities intermediary's jurisdiction. Subsection (f) makes explicit a point that is implicit in the Article 8 description of a security entitlement as a bundle of rights against the intermediary with respect to a security or other nancial asset, rather than as a direct interest in the underlying security or other nancial asset. The governing law for relationships in the indirect holding system is not determined by such matters as the jurisdiction of incorporation of the issuer of the securities held through the intermediary, or the location of any physical certicates held by the intermediary or a higher tier intermediary. 4. Subsection (c) provides a choice of law rule for adverse claim issues that may arise in connection with delivery of security certicates in the direct holding system. It applies the law of the place of delivery. If a certicated security issued by an Idaho corporation is sold, and the sale is settled by physical delivery of the certicate from Seller to Buyer in New York, under subsection (c), New York law determines whether Buyer takes free from adverse claims. The domicile of Seller, Buyer, and any adverse claimant is irrelevant. 5. The following examples illustrate how a court in a jurisdiction which has enacted this section would determine the governing law: Example 1. John Doe, a resident of Kansas, maintains a securities account with Able & Co. Able is incorporated in Delaware. Its chief executive oces are located in Illinois. The oce where Doe transacts business with Able is located in Missouri. The agreement between Doe and Able species that Illinois is the securities intermediary's (Able's) jurisdiction. Through the account, Doe holds securities of a Colorado corporation, which Able holds through Clearing Corporation. The rules of Clearing Corporation provide that the rights and duties of Clearing Corporation and its participants are governed by New York law. Subsection (a) species that a controversy concerning the rights and duties as between the issuer and Clearing Corporation is governed by Colorado law. Subsections (b) and (e) specify that a controversy concerning the rights and duties as between the Clearing Corporation and Able is governed by New York law, and that a controversy concerning the rights and duties as between Able and Doe is governed by Illinois law. Example 2. Same facts as to Doe and Able as in Example 1. Through the account, Doe holds securities of a Senegalese corporation, which Able holds through Clearing Corporation. Clearing Corporation's operations are located in Belgium, and its rules and agreements with its participants provide that they are governed by Belgian law. Clearing Corporation holds the securities through a custodial account at the Paris branch oce of 760

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Global Bank, which is organized under English law. The agreement between Clearing Corporation and Global Bank provides that it is governed by French law. Subsection (a) species that a controversy concerning the rights and duties as between the issuer and Global Bank is governed by Senegalese law. Subsections (b) and (e) specify that a controversy concerning the rights and duties as between Global Bank and Clearing Corporation is governed by French law, that a controversy concerning the rights and duties as between Clearing Corporation and Able is governed by Belgian law, and that a controversy concerning the rights and duties as between Able and Doe is governed by Illinois law. 6. To the extent that this section does not specify the governing law, general choice of law rules apply. For example, suppose that in either of the examples in the preceding Comment, Doe enters into an agreement with Roe, also a resident of Kansas, in which Doe agrees to transfer all of his interests in the securities held through Able to Roe. Article 8 does not deal with whether such an agreement is enforceable or whether it gives Roe some interest in Doe's security entitlement. This section species what jurisdiction's law governs the issues that are dealt with in Article 8. Article 8, however, does specify that securities intermediaries have only limited duties with respect to adverse claims. See Section 8-115. Subsection (b)(3) of this section provides that Illinois law governs whether Able owes any duties to an adverse claimant. Thus, if Illinois has adopted Revised Article 8, Section 8-115 as enacted in Illinois determines whether Roe has any rights against Able. 7. The choice of law provisions concerning security interests in securities and security entitlements are set out in Section 9-305. Denitional Cross References: Adverse claim. Section 8-102(a)(1). Agreement. Section 1-201(3). Certicated security. Section 8-102(a)(4). Entitlement holder. Section 8-102(a)(7). Financial asset. Section 8-102(a)(9). Issuer. Section 8-201. Person. Section 1-201(30). Purchase. Section 1-201(32). Securities intermediary. Section 8-102(a)(14). Security. Section 8-102(a)(15). Security certicate. Section 8-102(a)(16). Security entitlement. Section 8-102(a)(17). Uncerticated security. Section 8-102(a)(18).

As amended in 1999.
See Appendix I contained within revised Article 9 for material relating to changes made in Ocial Comment in 1999.

8-111. Clearing Corporation Rules. A rule adopted by a clearing corporation governing rights and obligations among the clearing corporation and its participants in the clearing corporation is eective even if the rule conicts with this [Act] and aects another party who does not consent to the rule. Ocial Comment
1. The experience of the past few decades shows that securities holding and settlement practices may develop rapidly, and in unforeseeable directions. Accordingly, it is desirable that the rules of Article 8 be adaptable both to ensure that commercial law can conform to changing practices and to ensure that commercial law does not operate as an obstacle to developments in securities practice. Even if practices were unchanging, it would not be possible in a general statute to specify in detail the rules needed to provide certainty in the operations of the clearance and settlement system. The provisions of this Article and Article 1 on the eect of agreements provide considerable exibility in the specication of the details of the rights and obligations of participants in the securities holding system by agreement. See Sections 8-504 through 8-509, and 761

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Section 1-102(3) and (4). Given the magnitude of the exposures involved in securities transactions, however, it may not be possible for the parties in developing practices to rely solely on private agreements, particularly with respect to matters that might aect others, such as creditors. For example, in order to be fully eective, rules of clearing corporations on the nality or reversibility of securities settlements must not only bind the participants in the clearing corporation but also be eective against their creditors. Section 8-111 provides that clearing corporation rules are eective even if they indirectly aect third parties, such as creditors of a participant. This provision does not, however, permit rules to be adopted that would govern the rights and obligations of third parties other than as a consequence of rules that specify the rights and obligations of the clearing corporation and its participants. 2. The denition of clearing corporation in Section 8-102 covers only federal reserve banks, entities registered as clearing agencies under the federal securities laws, and others subject to comparable regulation. The rules of registered clearing agencies are subject to regulatory oversight under the federal securities laws. Denitional Cross References: Clearing corporation. Section 8-102(a)(5).

8-112. Creditor's Legal Process. (a) The interest of a debtor in a certicated security may be reached by a creditor only by actual seizure of the security certicate by the ocer making the attachment or levy, except as otherwise provided in subsection (d). However, a certicated security for which the certicate has been surrendered to the issuer may be reached by a creditor by legal process upon the issuer. (b) The interest of a debtor in an uncerticated security may be reached by a creditor only by legal process upon the issuer at its chief executive ofce in the United States, except as otherwise provided in subsection (d). (c) The interest of a debtor in a security entitlement may be reached by a creditor only by legal process upon the securities intermediary with whom the debtor's securities account is maintained, except as otherwise provided in subsection (d). (d) The interest of a debtor in a certicated security for which the certificate is in the possession of a secured party, or in an uncerticated security registered in the name of a secured party, or a security entitlement maintained in the name of a secured party, may be reached by a creditor by legal process upon the secured party. (e) A creditor whose debtor is the owner of a certicated security, uncerticated security, or security entitlement is entitled to aid from a court of competent jurisdiction, by injunction or otherwise, in reaching the certicated security, uncerticated security, or security entitlement or in satisfying the claim by means allowed at law or in equity in regard to property that cannot readily be reached by other legal process. Ocial Comment
1. In dealing with certicated securities the instrument itself is the vital thing, and therefore a valid levy cannot be made unless all possibility of the certicate's wrongfully nding its way into a transferee's hands has been removed. This can be accomplished only when the certicate is in the possession of a public ocer, the issuer, or an independent third party. A debtor who has been enjoined can still transfer the security in contempt of court. See Overlock v. Jerome-Portland Copper Mining Co., 29 Ariz. 560, 243 P. 400 (1926). Therefore, although injunctive relief is provided in subsection (e) so that creditors may use this method to gain control of the certicated security, the security certicate itself must be reached to constitute a proper levy whenever the debtor has possession. 762

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2. Subsection (b) provides that when the security is uncerticated and registered in the debtor's name, the debtor's interest can be reached only by legal process upon the issuer. The most logical place to serve the issuer would be the place where the transfer records are maintained, but that location might be dicult to identify, especially when the separate elements of a computer network might be situated in dierent places. The chief executive oce is selected as the appropriate place by analogy to Section 9-307(b)(3). See Comment 2 to that section. This section indicates only how attachment is to be made, not when it is legally justied. For that reason there is no conict between this section and Shaer v. Heitner, 433 U.S. 186 (1977). 3. Subsection (c) provides that a security entitlement can be reached only by legal process upon the debtor's security intermediary. Process is eective only if directed to the debtor's own security intermediary. If Debtor holds securities through Broker, and Broker in turn holds through Clearing Corporation, Debtor's property interest is a security entitlement against Broker. Accordingly, Debtor's creditor cannot reach Debtor's interest by legal process directed to the Clearing Corporation. See also Section 8-115. 4. Subsection (d) provides that when a certicated security, an uncerticated security, or a security entitlement is controlled by a secured party, the debtor's interest can be reached by legal process upon the secured party. This section does not attempt to provide for rights as between the creditor and the secured party, as, for example, whether or when the secured party must liquidate the security. Denitional Cross References: Certicated security. Section 8-102(a)(4). Issuer. Section 8-201. Secured party. Section 9-102(a)(72). Securities intermediary. Section 8-102(a)(14). Security certicate. Section 8-102(a)(16). Security entitlement. Section 8-102(a)(17). Uncerticated security. Section 8-102(a)(18).

8-113. Statute of Frauds Inapplicable. A contract or modication of a contract for the sale or purchase of a security is enforceable whether or not there is a writing signed or record authenticated by a party against whom enforcement is sought, even if the contract or modication is not capable of performance within one year of its making. Ocial Comment
This section provides that the statute of frauds does not apply to contracts for the sale of securities, reversing prior law which had a special statute of frauds in Section 8-319 (1978). With the increasing use of electronic means of communication, the statute of frauds is unsuited to the realities of the securities business. For securities transactions, whatever benets a statute of frauds may play in ltering out fraudulent claims are outweighed by the obstacles it places in the development of modern commercial practices in the securities business. Denitional Cross References: Action. Section 1-201(1). Contract. Section 1-201(11). Writing. Section 1-201(46).

8-114. Evidentiary Rules Concerning Certicated Securities. The following rules apply in an action on a certicated security against the issuer: (1) Unless specically denied in the pleadings, each signature on a security certicate or in a necessary indorsement is admitted. (2) If the eectiveness of a signature is put in issue, the burden of establishing eectiveness is on the party claiming under the signature, but the signature is presumed to be genuine or authorized.
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(3) If signatures on a security certicate are admitted or established, production of the certicate entitles a holder to recover on it unless the defendant establishes a defense or a defect going to the validity of the security. (4) If it is shown that a defense or defect exists, the plainti has the burden of establishing that the plainti or some person under whom the plainti claims is a person against whom the defense or defect cannot be asserted. Ocial Comment
This section adapts the rules of negotiable instruments law concerning procedure in actions on instruments, see Section 3-308, to actions on certicated securities governed by this Article. An action on a security includes any action or proceeding brought against the issuer to enforce a right or interest that is part of the security, such as an action to collect principal or interest or a dividend, or to establish a right to vote or to receive a new security under an exchange oer or plan of reorganization. This section applies only to certicated securities; actions on uncerticated securities are governed by general evidentiary principles. Denitional Cross References: Action. Section 1-201(1). Burden of establishing. Section 1-201(8). Certicated security. Section 8-102(a)(4). Indorsement. Section 8-102(a)(11). Issuer. Section 8-201. Presumed. Section 1-201(31). Security. Section 8-102(a)(15). Security certicate. Section 8-102(a)(16).

8-115. Securities Intermediary and Others Not Liable to Adverse Claimant. A securities intermediary that has transferred a nancial asset pursuant to an eective entitlement order, or a broker or other agent or bailee that has dealt with a nancial asset at the direction of its customer or principal, is not liable to a person having an adverse claim to the nancial asset, unless the securities intermediary, or broker or other agent or bailee: (1) took the action after it had been served with an injunction, restraining order, or other legal process enjoining it from doing so, issued by a court of competent jurisdiction, and had a reasonable opportunity to act on the injunction, restraining order, or other legal process; or (2) acted in collusion with the wrongdoer in violating the rights of the adverse claimant; or (3) in the case of a security certicate that has been stolen, acted with notice of the adverse claim. Ocial Comment
1. Other provisions of Article 8 protect certain purchasers against adverse claims, both for the direct holding system and the indirect holding system. See Sections 8-303 and 8-502. This section deals with the related question of the possible liability of a person who acted as the conduit for a securities transaction. It covers both securities intermediaries the conduits in the indirect holding systemand brokers or other agents or baileesthe conduits in the direct holding system. The following examples illustrate its operation: Example 1. John Doe is a customer of the brokerage rm of Able & Co. Doe delivers to Able a certicate for 100 shares of XYZ Co. common stock, registered in Doe's name and properly indorsed, and asks the rm to sell it for him. Able does so. Later, John 764

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Doe's spouse Mary Doe brings an action against Able asserting that Able's action was wrongful against her because the XYZ Co. stock was marital property in which she had an interest, and John Doe was acting wrongfully against her in transferring the securities. Example 2. Mary Roe is a customer of the brokerage rm of Baker & Co. and holds her securities through a securities account with Baker. Roe instructs Baker to sell 100 shares of XYZ Co. common stock that she carried in her account. Baker does so. Later, Mary Roe's spouse John Roe brings an action against Baker asserting that Baker's action was wrongful against him because the XYZ Co. stock was marital property in which he had an interest, and Mary Roe was acting wrongfully against him in transferring the securities. Under common law conversion principles, Mary Doe might be able to assert that Able & Co. is liable to her in Example 1 for exercising dominion over property inconsistent with her rights in it. On that or some similar theory John Roe might assert that Baker is liable to him in Example 2. Section 8-115 protects both Able and Baker from liability. 2. The policy of this section is similar to that of many other rules of law that protect agents and bailees from liability as innocent converters. If a thief steals property and ships it by mail, express service, or carrier, to another person, the recipient of the property does not obtain good title, even though the recipient may have given value to the thief and had no notice or knowledge that the property was stolen. Accordingly, the true owner can recover the property from the recipient or obtain damages in a conversion or similar action. An action against the postal service, express company, or carrier presents entirely dierent policy considerations. Accordingly, general tort law protects agents or bailees who act on the instructions of their principals or bailors. See Restatement (Second) of Torts 235. See also UCC Section 7-404. 3. Except as provided in paragraph 3, this section applies even though the securities intermediary, or the broker or other agent or bailee, had notice or knowledge that another person asserts a claim to the securities. Consider the following examples: Example 3. Same facts as in Example 1, except that before John Doe brought the XYZ Co. security certicate to Able for sale, Mary Doe telephoned or wrote to the rm asserting that she had an interest in all of John Doe's securities and demanding that they not trade for him. Example 4. Same facts as in Example 2, except that before Mary Roe gave an entitlement order to Baker to sell the XYZ Co. securities from her account, John Doe telephoned or wrote to the rm asserting that he had an interest in all of Mary Roe's securities and demanding that they not trade for her. Section 8-115 protects Able and Baker from liability. The protections of Section 8-115 do not depend on the presence or absence of notice of adverse claims. It is essential to the securities settlement system that brokers and securities intermediaries be able to act promptly on the directions of their customers. Even though a rm has notice that someone asserts a claim to a customer's securities or security entitlements, the rm should not be placed in the position of having to make a legal judgment about the validity of the claim at the risk of liability either to its customer or to the third party for guessing wrong. Under this section, the broker or securities intermediary is privileged to act on the instructions of its customer or entitlement holder, unless it has been served with a restraining order or other legal process enjoining it from doing so. This is already the law in many jurisdictions. For example a section of the New York Banking Law provides that banks need not recognize any adverse claim to funds or securities on deposit with them unless they have been served with legal process. N.Y. Banking Law 134. Other sections of the UCC embody a similar policy. See Sections 3-602, 5-114(2)(b). Paragraph (1) of this section refers only to a court order enjoining the securities intermediary or the broker or other agent or bailee from acting at the instructions of the customer. It does not apply to cases where the adverse claimant tells the intermediary or broker that the customer has been enjoined, or shows the intermediary or broker a copy of a court order binding the customer. Paragraph (3) takes a dierent approach in one limited class of cases, those where a customer sells stolen certicated securities through a securities rm. Here the policies that lead to protection of securities rms against assertions of other sorts of claims must be weighed against the desirability of having securities rms guard against the disposition of stolen securities. Accordingly, paragraph (3) denies protection to a broker, custodian, or 765

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other agent or bailee who receives a stolen security certicate from its customer, if the broker, custodian, or other agent or bailee had notice of adverse claims. The circumstances that give notice of adverse claims are specied in Section 8-105. The result is that brokers, custodians, and other agents and bailees face the same liability for selling stolen certicated securities that purchasers face for buying them. 4. As applied to securities intermediaries, this section embodies one of the fundamental principles of the Article 8 indirect holding system rulesthat a securities intermediary owes duties only to its own entitlement holders. The following examples illustrate the operation of this section in the multi-tiered indirect holding system: Example 5. Able & Co., a broker-dealer, holds 50,000 shares of XYZ Co. stock in its account at Clearing Corporation. Able acquired the XYZ shares from another rm, Baker & Co., in a transaction that Baker contends was tainted by fraud, giving Baker a right to rescind the transaction and recover the XYZ shares from Able. Baker sends notice to Clearing Corporation stating that Baker has a claim to the 50,000 shares of XYZ Co. in Able's account. Able then initiates an entitlement order directing Clearing Corporation to transfer the 50,000 shares of XYZ Co. to another rm in settlement of a trade. Under Section 8-115, Clearing Corporation is privileged to comply with Able's entitlement order, without fear of liability to Baker. This is so even though Clearing Corporation has notice of Baker's claim, unless Baker obtains a court order enjoining Clearing Corporation from acting on Able's entitlement order. Example 6. Able & Co., a broker-dealer, holds 50,000 shares of XYZ Co. stock in its account at Clearing Corporation. Able initiates an entitlement order directing Clearing Corporation to transfer the 50,000 shares of XYZ Co. to another rm in settlement of a trade. That trade was made by Able for its own account, and the proceeds were devoted to its own use. Able becomes insolvent, and it is discovered that Able has a shortfall in the shares of XYZ Co. stock that it should have been carrying for its customers. Able's customers bring an action against Clearing Corporation asserting that Clearing Corporation acted wrongfully in transferring the XYZ shares on Able's order because those were shares that should have been held by Able for its customers. Under Section 8-115, Clearing Corporation is not liable to Able's customers, because Clearing Corporation acted on an eective entitlement order of its own entitlement holder, Able. Clearing Corporation's protection against liability does not depend on the presence or absence of notice or knowledge of the claim by Clearing Corporation. 5. If the conduct of a securities intermediary or a broker or other agent or bailee rises to a level of complicity in the wrongdoing of its customer or principal, the policies that favor protection against liability do not apply. Accordingly, paragraph (2) provides that the protections of this section do not apply if the securities intermediary or broker or other agent or bailee acted in collusion with the customer or principal in violating the rights of another person. The collusion test is intended to adopt a standard akin to the tort rules that determine whether a person is liable as an aider or abettor for the tortious conduct of a third party. See Restatement (Second) of Torts 876. Knowledge that the action of the customer is wrongful is a necessary but not sucient condition of the collusion test. The aspect of the role of securities intermediaries and brokers that Article 8 deals with is the clerical or ministerial role of implementing and recording the securities transactions that their customers conduct. Faithful performance of this role consists of following the instructions of the customer. It is not the role of the record-keeper to police whether the transactions recorded are appropriate, so mere awareness that the customer may be acting wrongfully does not itself constitute collusion. That, of course, does not insulate an intermediary or broker from responsibility in egregious cases where its action goes beyond the ordinary standards of the business of implementing and recording transactions, and reaches a level of armative misconduct in assisting the customer in the commission of a wrong. Denitional Cross References: Broker. Section 8-102(a)(3). Eective. Section 8-107. Entitlement order. Section 8-102(a)(8). Financial asset. Section 8-102(a)(9). Securities intermediary. Section 8-102(a)(14). Security certicate. Section 8-102(a)(16). 766

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8-116

8-116. Securities Intermediary as Purchaser For Value. A securities intermediary that receives a nancial asset and establishes a security entitlement to the nancial asset in favor of an entitlement holder is a purchaser for value of the nancial asset. A securities intermediary that acquires a security entitlement to a nancial asset from another securities intermediary acquires the security entitlement for value if the securities intermediary acquiring the security entitlement establishes a security entitlement to the nancial asset in favor of an entitlement holder. Ocial Comment
1. This section is intended to make explicit two points that, while implicit in other provisions, are of sucient importance to the operation of the indirect holding system that they warrant explicit statement. First, it makes clear that a securities intermediary that receives a nancial asset and establishes a security entitlement in respect thereof in favor of an entitlement holder is a purchaser of the nancial asset that the securities intermediary received. Second, it makes clear that by establishing a security entitlement in favor of an entitlement holder a securities intermediary gives value for any corresponding nancial asset that the securities intermediary receives or acquires from another party, whether the intermediary holds directly or indirectly. In many cases a securities intermediary that receives a nancial asset will also be transferring value to the person from whom the nancial asset was received. That, however, is not always the case. Payment may occur through a dierent system than settlement of the securities side of the transaction, or the securities might be transferred without a corresponding payment, as when a person moves an account from one securities intermediary to another. Even though the securities intermediary does not give value to the transferor, it does give value by incurring obligations to its own entitlement holder. Although the general denition of value in Section 1-201(44)(d) should be interpreted to cover the point, this section is included to make this point explicit. 2. The following examples illustrate the eect of this section: Example 1. Buyer buys 1000 shares of XYZ Co. common stock through Buyer's broker Able & Co. to be held in Buyer's securities account. In settlement of the trade, the selling broker delivers to Able a security certicate in street name, indorsed in blank, for 1000 shares XYZ Co. stock, which Able holds in its vault. Able credits Buyer's account for securities in that amount. Section 8-116 species that Able is a purchaser of the XYZ Co. stock certicate, and gave value for it. Thus, Able can obtain the benet of Section 8-303, which protects purchasers for value, if it satises the other requirements of that section. Example 2. Buyer buys 1000 shares XYZ Co. common stock through Buyer's broker Able & Co. to be held in Buyer's securities account. The trade is settled by crediting 1000 shares XYZ Co. stock to Able's account at Clearing Corporation. Able credits Buyer's account for securities in that amount. When Clearing Corporation credits Able's account, Able acquires a security entitlement under Section 8-501. Section 8-116 species that Able acquired this security entitlement for value. Thus, Able can obtain the benet of Section 8-502, which protects persons who acquire security entitlements for value, if it satises the other requirements of that section. Example 3. Thief steals a certicated bearer bond from Owner. Thief sends the certificate to his broker Able & Co. to be held in his securities account, and Able credits Thief's account for the bond. Section 8-116 species that Able is a purchaser of the bond and gave value for it. Thus, Able can obtain the benet of Section 8-303, which protects purchasers for value, if it satises the other requirements of that section. Denitional Cross References: Financial asset. Section 8-102(a)(9). Securities intermediary. Section 8-102(a)(14). Security entitlement. Section 8-102(a)(17). Entitlement holder. Section 8-102(a)(7). 767

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PART 2. ISSUE AND ISSUER

8-201. Issuer. (a) With respect to an obligation on or a defense to a security, an issuer includes a person that: (1) places or authorizes the placing of its name on a security certicate, other than as authenticating trustee, registrar, transfer agent, or the like, to evidence a share, participation, or other interest in its property or in an enterprise, or to evidence its duty to perform an obligation represented by the certicate; (2) creates a share, participation, or other interest in its property or in an enterprise, or undertakes an obligation, that is an uncerticated security; (3) directly or indirectly creates a fractional interest in its rights or property, if the fractional interest is represented by a security certicate; or (4) becomes responsible for, or in place of, another person described as an issuer in this section. (b) With respect to an obligation on or defense to a security, a guarantor is an issuer to the extent of its guaranty, whether or not its obligation is noted on a security certicate. (c) With respect to a registration of a transfer, issuer means a person on whose behalf transfer books are maintained. Ocial Comment
1. The denition of issuer in this section functions primarily to describe the persons whose defenses may be cut o under the rules in Part 2. In large measure it simply tracks the language of the denition of security in Section 8-102(a)(15). 2. Subsection (b) distinguishes the obligations of a guarantor as issuer from those of the principal obligor. However, it does not exempt the guarantor from the impact of subsection (d) of Section 8-202. Whether or not the obligation of the guarantor is noted on the security is immaterial. Typically, guarantors are parent corporations, or stand in some similar relationship to the principal obligor. If that relationship existed at the time the security was originally issued the guaranty would probably have been noted on the security. However, if the relationship arose afterward, e.g., through a purchase of stock or properties, or through merger or consolidation, probably the notation would not have been made. Nonetheless, the holder of the security is entitled to the benet of the obligation of the guarantor. 3. Subsection (c) narrows the denition of issuer for purposes of Part 4 of this Article (registration of transfer). It is supplemented by Section 8-407. Denitional Cross References: Person. Section 1-201(30). Security. Section 8-102(a)(15). Security certicate. Section 8-102(a)(16). Uncerticated security. Section 8-102(a)(18).

8-202. Issuer's Responsibility and Defenses; Notice of Defect or Defense. (a) Even against a purchaser for value and without notice, the terms of a certicated security include terms stated on the certicate and terms made part of the security by reference on the certicate to another instrument, indenture, or document or to a constitution, statute, ordinance, rule, regulation, order, or the like, to the extent the terms referred to do not
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conict with terms stated on the certicate. A reference under this subsection does not of itself charge a purchaser for value with notice of a defect going to the validity of the security, even if the certicate expressly states that a person accepting it admits notice. The terms of an uncerticated security include those stated in any instrument, indenture, or document or in a constitution, statute, ordinance, rule, regulation, order, or the like, pursuant to which the security is issued. (b) The following rules apply if an issuer asserts that a security is not valid: (1) A security other than one issued by a government or governmental subdivision, agency, or instrumentality, even though issued with a defect going to its validity, is valid in the hands of a purchaser for value and without notice of the particular defect unless the defect involves a violation of a constitutional provision. In that case, the security is valid in the hands of a purchaser for value and without notice of the defect, other than one who takes by original issue. (2) Paragraph (1) applies to an issuer that is a government or governmental subdivision, agency, or instrumentality only if there has been substantial compliance with the legal requirements governing the issue or the issuer has received a substantial consideration for the issue as a whole or for the particular security and a stated purpose of the issue is one for which the issuer has power to borrow money or issue the security. (c) Except as otherwise provided in Section 8-205, lack of genuineness of a certicated security is a complete defense, even against a purchaser for value and without notice. (d) All other defenses of the issuer of a security, including nondelivery and conditional delivery of a certicated security, are ineective against a purchaser for value who has taken the certicated security without notice of the particular defense. (e) This section does not aect the right of a party to cancel a contract for a security when, as and if issued or when distributed in the event of a material change in the character of the security that is the subject of the contract or in the plan or arrangement pursuant to which the security is to be issued or distributed. (f) If a security is held by a securities intermediary against whom an entitlement holder has a security entitlement with respect to the security, the issuer may not assert any defense that the issuer could not assert if the entitlement holder held the security directly. Ocial Comment
1. In this Article the rights of the purchaser for value without notice are divided into two aspects, those against the issuer, and those against other claimants to the security. Part 2 of this Article, and especially this section, deal with rights against the issuer. Subsection (a) states, in accordance with the prevailing case law, the right of the issuer (who prepares the text of the security) to include terms incorporated by adequate reference to an extrinsic source, so long as the terms so incorporated do not conict with the stated terms. Thus, the standard practice of referring in a bond or debenture to the trust indenture under which it is issued without spelling out its necessarily complex and lengthy provisions is approved. Every stock certicate refers in some manner to the charter or articles of incorporation of the issuer. At least where there is more than one class of stock authorized 769

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applicable corporation codes specically require a statement or summary as to preferences, voting powers and the like. References to constitutions, statutes, ordinances, rules, regulations or orders are not so common, except in the obligations of governments or governmental agencies or units; but where appropriate they t into the rule here stated. Courts have generally held that an issuer is estopped from denying representations made in the text of a security. Delaware-New Jersey Ferry Co. v. Leeds, 21 Del.Ch. 279, 186 A. 913 (1936). Nor is a defect in form or the invalidity of a security normally available to the issuer as a defense. Bonini v. Family Theatre Corporation, 327 Pa. 273, 194 A. 498 (1937); First National Bank of Fairbanks v. Alaska Airmotive, 119 F.2d 267 (C.C.A.Alaska 1941). 2. The rule in subsection (a) requiring that the terms of a security be noted or referred to on the certicate is based on practices and expectations in the direct holding system for certicated securities. This rule does not express a general rule or policy that the terms of a security are eective only if they are communicated to benecial owners in some particular fashion. Rather, subsection (a) is based on the principle that a purchaser who does obtain a certicate is entitled to assume that the terms of the security have been noted or referred to on the certicate. That policy does not come into play in a securities holding system in which purchasers do not take delivery of certicates. The provisions of subsection (a) concerning notation of terms on security certicates are necessary only because paper certicates play such an important role for certicated securities that a purchaser should be protected against assertion of any defenses or rights that are not noted on the certicate. No similar problem exists with respect to uncerticated securities. The last sentence of subsection (a) is, strictly speaking, unnecessary, since it only recognizes the fact that the terms of an uncerticated security are determined by whatever other law or agreement governs the security. It is included only to preclude any inference that uncerticated securities are subject to any requirement analogous to the requirement of notation of terms on security certicates. The rule of subsection (a) applies to the indirect holding system only in the sense that if a certicated security has been delivered to the clearing corporation or other securities intermediary, the terms of the security should be noted or referred to on the certicate. If the security is uncerticated, that principle does not apply even at the issuer-clearing corporation level. The benecial owners who hold securities through the clearing corporation are bound by the terms of the security, even though they do not actually see the certicate. Since entitlement holders in an indirect holding system have not taken delivery of certicates, the policy of subsection (a) does not apply. 3. The penultimate sentence of subsection (a) and all of subsection (b) embody the concept that it is the duty of the issuer, not of the purchaser, to make sure that the security complies with the law governing its issue. The penultimate sentence of subsection (a) makes clear that the issuer cannot, by incorporating a reference to a statute or other document, charge the purchaser with notice of the security's invalidity. Subsection (b) gives to a purchaser for value without notice of the defect the right to enforce the security against the issuer despite the presence of a defect that otherwise would render the security invalid. There are three circumstances in which a purchaser does not gain such rights: rst, if the defect involves a violation of constitutional provisions, these rights accrue only to a subsequent purchaser, that is, one who takes other than by original issue. This Article leaves to the law of each particular State the rights of a purchaser on original issue of a security with a constitutional defect. No negative implication is intended by the explicit grant of rights to a subsequent purchaser. Second, governmental issuers are distinguished in subsection (b) from other issuers as a matter of public policy, and additional safeguards are imposed before governmental issues are validated. Governmental issuers are estopped from asserting defenses only if there has been substantial compliance with the legal requirements governing the issue or if substantial consideration has been received and a stated purpose of the issue is one for which the issuer has power to borrow money or issue the security. The purpose of the substantial compliance requirement is to make certain that a mere technicality as, e.g., in the manner of publishing election notices, shall not be a ground for depriving an innocent purchaser of rights in the security. The policy is here adopted of such cases as Tommie v. City of Gadsden, 229 Ala. 521, 158 So. 763 (1935), in which minor discrepancies in the form of the election ballot used were overlooked and the bonds were declared valid since there had been substantial compliance with the statute. A long and well established line of federal cases recognizes the principle of estoppel in 770

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favor of purchasers for value without notices where municipalities issue bonds containing recitals of compliance with governing constitutional and statutory provisions, made by the municipal authorities entrusted with determining such compliance. Chaee County v. Potter, 142 U.S. 355 (1892); Oregon v. Jennings, 119 U.S. 74 (1886); Gunnison County Commissioners v. Rollins, 173 U.S. 255 (1898). This rule has been qualied, however, by requiring that the municipality have power to issue the security. Anthony v. County of Jasper, 101 U.S. 693 (1879); Town of South Ottawa v. Perkins, 94 U.S. 260 (1876). This section follows the case law trend, simplifying the rule by setting up two conditions for an estoppel against a governmental issuer: (1) substantial consideration given, and (2) power in the issuer to borrow money or issue the security for the stated purpose. As a practical matter the problem of policing governmental issuers has been alleviated by the present practice of requiring legal opinions as to the validity of the issue. The bulk of the case law on this point is nearly 100 years old and it may be assumed that the question now seldom arises. Section 8-210, regarding overissue, provides the third exception to the rule that an innocent purchase for value takes a valid security despite the presence of a defect that would otherwise give rise to invalidity. See that section and its Comment for further explanation. 4. Subsection (e) is included to make clear that this section does not aect the presently recognized right of either party to a when, as and if or when distributed contract to cancel the contract on substantial change. 5. Subsection (f) has been added because the introduction of the security entitlement concept requires some adaptation of the Part 2 rules, particularly those that distinguish between purchasers who take by original issue and subsequent purchasers. The basic concept of Part 2 is to apply to investment securities the principle of negotiable instruments law that an obligor is precluded from asserting most defenses against purchasers for value without notice. Section 8-202 describes in some detail which defenses issuers can raise against purchasers for value and subsequent purchasers for value. Because these rules were drafted with the direct holding system in mind, some interpretive problems might be presented in applying them to the indirect holding. For example, if a municipality issues a bond in book-entry only form, the only direct purchaser of that bond would be the clearing corporation. The policy of precluding the issuer from asserting defenses is, however, equally applicable. Subsection (f) is designed to ensure that the defense preclusion rules developed for the direct holding system will also apply to the indirect holding system. Denitional Cross References: Certicated security. Section 8-102(a)(4). Notice. Section 1-201(25). Purchaser. Sections 1-201(33) & 8-116. Security. Section 8-102(a)(15). Uncerticated security. Section 8-102(a)(18). Value. Sections 1-201(44) & 8-116.

8-203. Staleness as Notice of Defect or Defense. After an act or event, other than a call that has been revoked, creating a right to immediate performance of the principal obligation represented by a certicated security or setting a date on or after which the security is to be presented or surrendered for redemption or exchange, a purchaser is charged with notice of any defect in its issue or defense of the issuer, if the act or event: (1) requires the payment of money, the delivery of a certicated security, the registration of transfer of an uncerticated security, or any of them on presentation or surrender of the security certicate, the money or security is available on the date set for payment or exchange, and the purchaser takes the security more than one year after that date; or (2) is not covered by paragraph (1) and the purchaser takes the security more than two years after the date set for surrender or presentation or the date on which performance became due.
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Ocial Comment
1. The problem of matured or called securities is here dealt with in terms of the eect of such events in giving notice of the issuer's defenses and not in terms of negotiability. The substance of this section applies only to certicated securities because certicates may be transferred to a purchaser by delivery after the security has matured, been called, or become redeemable or exchangeable. It is contemplated that uncerticated securities which have matured or been called will merely be canceled on the books of the issuer and the proceeds sent to the registered owner. Uncerticated securities which have become redeemable or exchangeable, at the option of the owner, may be transferred to a purchaser, but the transfer is eectuated only by registration of transfer, thus necessitating communication with the issuer. If defects or defenses in such securities exist, the issuer will necessarily have the opportunity to bring them to the attention of the purchaser. 2. The fact that a security certicate is in circulation long after it has been called for redemption or exchange must give rise to the question in a purchaser's mind as to why it has not been surrendered. After the lapse of a reasonable period of time a purchaser can no longer claim no reason to know of any defects or irregularities in its issue. Where funds are available for the redemption the security certicate is normally turned in more promptly and a shorter time is set as the reasonable period than is set where funds are not available. Defaulted certicated securities may be traded on nancial markets in the same manner as unmatured and undefaulted instruments and a purchaser might not be placed upon notice of irregularity by the mere fact of default. An issuer, however, should at some point be placed in a position to determine denitely its liability on an invalid or improper issue, and for this purpose a security under this section becomes stale two years after the default. A dierent rule applies when the question is notice not of issuer's defenses but of claims of ownership. Section 8-105 and Comment. 3. Nothing in this section is designed to extend the life of preferred stocks called for redemption as shares of stock beyond the redemption date. After such a call, the security represents only a right to the funds set aside for redemption. Denitional Cross References: Certicated security. Section 8-102(a)(4). Notice. Section 1-201(25). Purchaser. Sections 1-201(33) & 8-116. Security. Section 8-102(a)(15). Security certicate. Section 8-102(a)(16). Uncerticated security. Section 8-102(a)(18).

8-204. Eect of Issuer's Restriction on Transfer. A restriction on transfer of a security imposed by the issuer, even if otherwise lawful, is ineective against a person without knowledge of the restriction unless: (1) the security is certicated and the restriction is noted conspicuously on the security certicate; or (2) the security is uncerticated and the registered owner has been notied of the restriction. Ocial Comment
1. Restrictions on transfer of securities are imposed by issuers in a variety of circumstances and for a variety of purposes, such as to retain control of a close corporation or to ensure compliance with federal securities laws. Other law determines whether such restrictions are permissible. This section deals only with the consequences of failure to note the restriction on a security certicate. This section imposes no bar to enforcement of a restriction on transfer against a person who has actual knowledge of it. 2. A restriction on transfer of a certicated security is ineective against a person without knowledge of the restriction unless the restriction is noted conspicuously on the certicate. The word noted is used to make clear that the restriction need not be set forth in full text. 772

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Investment Securities

8-205

Refusal by an issuer to register a transfer on the basis of an unnoted restriction would be a violation of the issuer's duty to register under Section 8-401. 3. The policy of this section is the same as in Section 8-202. A purchaser who takes delivery of a certicated security is entitled to rely on the terms stated on the certicate. That policy obviously does not apply to uncerticated securities. For uncerticated securities, this section requires only that the registered owner has been notied of the restriction. Suppose, for example, that A is the registered owner of an uncerticated security, and that the issuer has notied A of a restriction on transfer. A agrees to sell the security to B, in violation of the restriction. A completes a written instruction directing the issuer to register transfer to B, and B pays A for the security at the time A delivers the instruction to B. A does not inform B of the restriction, and B does not otherwise have notice or knowledge of it at the time B pays and receives the instruction. B presents the instruction to the issuer, but the issuer refuses to register the transfer on the grounds that it would violate the restriction. The issuer has complied with this section, because it did notify the registered owner A of the restriction. The issuer's refusal to register transfer is not wrongful. B has an action against A for breach of transfer warranty, see Section 8-108(b)(4)(iii). B's mistake was treating an uncerticated security transaction in the fashion appropriate only for a certicated security. The mechanism for transfer of uncerticated securities is registration of transfer on the books of the issuer; handing over an instruction only initiates the process. The purchaser should make arrangements to ensure that the price is not paid until it knows that the issuer has or will register transfer. 4. In the indirect holding system, investors neither take physical delivery of security certicates nor have uncerticated securities registered in their names. So long as the requirements of this section have been satised at the level of the relationship between the issuer and the securities intermediary that is a direct holder, this section does not preclude the issuer from enforcing a restriction on transfer. See Section 8-202(a) and Comment 2 thereto. 5. This section deals only with restrictions imposed by the issuer. Restrictions imposed by statute are not aected. See Quiner v. Marblehead Social Co., 10 Mass. 476 (1813); Madison Bank v. Price, 79 Kan. 289, 100 P. 280 (1909); Healey v. Steele Center Creamery Ass'n, 115 Minn. 451, 133 N.W. 69 (1911). Nor does it deal with private agreements between stockholders containing restrictive covenants as to the sale of the security. Denitional Cross References: Certicated security. Section 8-102(a)(4). Conspicuous. Section 1-201(10). Issuer. Section 8-201. Knowledge. Section 1-201(25). Notify. Section 1-201(25). Purchaser. Sections 1-201(33) & 8-116. Security. Section 8-102(a)(15). Security certicate. Section 8-102(a)(16). Uncerticated security. Section 8-102(a)(18).

8-205. Eect of Unauthorized Signature on Security Certicate. An unauthorized signature placed on a security certicate before or in the course of issue is ineective, but the signature is eective in favor of a purchaser for value of the certicated security if the purchaser is without notice of the lack of authority and the signing has been done by: (1) an authenticating trustee, registrar, transfer agent, or other person entrusted by the issuer with the signing of the security certicate or of similar security certicates, or the immediate preparation for signing of any of them; or (2) an employee of the issuer, or of any of the persons listed in paragraph (1), entrusted with responsible handling of the security certicate. Ocial Comment
1. The problem of forged or unauthorized signatures may arise where an employee of the issuer, transfer agent, or registrar has access to securities which the employee is required 773

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Art. 8

to prepare for issue by axing the corporate seal or by adding a signature necessary for issue. This section is based upon the issuer's duty to avoid the negligent entrusting of securities to such persons. Issuers have long been held responsible for signatures placed upon securities by parties whom they have held out to the public as authorized to prepare such securities. See Fifth Avenue Bank of New York v. The Forty-Second & Grand Street Ferry Railroad Co., 137 N.Y. 231, 33 N.E. 378, 19 L.R.A. 331, 33 Am.St.Rep. 712 (1893); Jarvis v. Manhattan Beach Co., 148 N.Y. 652, 43 N.E. 68, 31 L.R.A. 776, 51 Am.St.Rep. 727 (1896). The apparent authority concept of some of the case-law, however, is here extended and this section expressly rejects the technical distinction, made by courts reluctant to recognize forged signatures, between cases where forgers sign signatures they are authorized to sign under proper circumstances and those in which they sign signatures they are never authorized to sign. Citizens' & Southern National Bank v. Trust Co. of Georgia, 50 Ga.App. 681, 179 S.E. 278 (1935). Normally the purchaser is not in a position to determine which signature a forger, entrusted with the preparation of securities, has apparent authority to sign. The issuer, on the other hand, can protect itself against such fraud by the careful selection and bonding of agents and employees, or by action over against transfer agents and registrars who in turn may bond their personnel. 2. The issuer cannot be held liable for the honesty of employees not entrusted, directly or indirectly, with the signing, preparation, or responsible handling of similar securities and whose possible commission of forgery it has no reason to anticipate. The result in such cases as Hudson Trust Co. v. American Linseed Co., 232 N.Y. 350, 134 N.E. 178 (1922), and Dollar Savings Fund & Trust Co. v. Pittsburgh Plate Glass Co., 213 Pa. 307, 62 A. 916, 5 Ann.Cas. 248 (1906) is here adopted. 3. This section is not concerned with forged or unauthorized indorsements, but only with unauthorized signatures of issuers, transfer agents, etc., placed upon security certicates during the course of their issue. The protection here stated is available to all purchasers for value without notice and not merely to subsequent purchasers. Denitional Cross References: Certicated security. Section 8-102(a)(4). Issuer. Section 8-201. Notice. Section 1-201(25). Purchaser. Sections 1-201(33) & 8-116. Security certicate. Section 8-102(a)(14). Unauthorized signature. Section 1-201(43).

8-206. Completion of Alteration of Security Certicate. (a) If a security certicate contains the signatures necessary to its issue or transfer but is incomplete in any other respect: (1) any person may complete it by lling in the blanks as authorized; and (2) even if the blanks are incorrectly lled in, the security certicate as completed is enforceable by a purchaser who took it for value and without notice of the incorrectness. (b) A complete security certicate that has been improperly altered, even if fraudulently, remains enforceable, but only according to its original terms. Ocial Comment
1. The problem of forged or unauthorized signatures necessary for the issue or transfer of a security is not involved here, and a person in possession of a blank certicate is not, by this section, given authority to ll in blanks with such signatures. Completion of blanks left in a transfer instruction is dealt with elsewhere (Section 8-305(a)). 2. Blanks left upon issue of a security certicate are the only ones dealt with here, and a purchaser for value without notice is protected. A purchaser is not in a good position to determine whether blanks were completed by the issuer or by some person not authorized to complete them. On the other hand the issuer can protect itself by not placing its signature 774

Art. 8

Investment Securities

8-207

on the writing until the blanks are completed or, if it does sign before all blanks are completed, by carefully selecting the agents and employees to whom it entrusts the writing after authentication. With respect to a security certicate that is completed by the issuer but later is altered, the issuer has done everything it can to protect the purchaser and thus is not charged with the terms as altered. However, it is charged according to the original terms, since it is not thereby prejudiced. If the completion or alteration is obviously irregular, the purchaser may not qualify as a purchaser who took without notice under this section. 3. Only the purchaser who physically takes the certicate is directly protected. However, a transferee may receive protection indirectly through Section 8-302(a). 4. The protection granted a purchaser for value without notice under this section is modied to the extent that an overissue may result where an incorrect amount is inserted into a blank (Section 8-210). Denitional Cross References: Notice. Section 1-201(25). Purchaser. Sections 1-201(33) & 8-116. Security certicate. Section 8-102(a)(16). Unauthorized signature. Section 1-201(43). Value. Sections 1-201(44) & 8-116.

8-207. Rights and Duties of Issuer with Respect to Registered Owners. (a) Before due presentment for registration of transfer of a certicated security in registered form or of an instruction requesting registration of transfer of an uncerticated security, the issuer or indenture trustee may treat the registered owner as the person exclusively entitled to vote, receive notications, and otherwise exercise all the rights and powers of an owner. (b) This Article does not aect the liability of the registered owner of a security for a call, assessment, or the like. Ocial Comment
1. Subsection (a) states the issuer's right to treat the registered owner of a security as the person entitled to exercise all the rights of an owner. This right of the issuer is limited by the provisions of Part 4 of this article. Once there has been due presentation for registration of transfer, the issuer has a duty to register ownership in the name of the transferee. Section 8-401. Thus its right to treat the old registered owner as exclusively entitled to the rights of ownership must cease. The issuer may under this section make distributions of money or securities to the registered owners of securities without requiring further proof of ownership, provided that such distributions are distributable to the owners of all securities of the same issue and the terms of the security do not require surrender of a security certicate as a condition of payment or exchange. Any such distribution shall constitute a defense against a claim for the same distribution by a person, even if that person is in possession of the security certicate and is a protected purchaser of the security. See PEB Commentary No. 4, dated March 10, 1990. 2. Subsection (a) is permissive and does not require that the issuer deal exclusively with the registered owner. It is free to require proof of ownership before paying out dividends or the like if it chooses to. Barbato v. Breeze Corporation, 128 N.J.L. 309, 26 A.2d 53 (1942). 3. This section does not operate to determine who is nally entitled to exercise voting and other rights or to receive payments and distributions. The parties are still free to incorporate their own arrangements as to these matters in seller-purchaser agreements which may be denitive as between them. 4. No change in existing state laws as to the liability of registered owners for calls and assessments is here intended; nor is anything in this section designed to estop record holders from denying ownership when assessments are levied if they are otherwise entitled to do so under state law. See State ex rel. Squire v. Murfey, Blosson & Co., 131 Ohio St. 289, 2 N.E.2d 866 (1936); Willing v. Delaplaine, 23 F.Supp. 579 (1937). 775

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5. No interference is intended with the common practice of closing the transfer books or taking a record date for dividend, voting, and other purposes, as provided for in by-laws, charters, and statutes. Denitional Cross References: Certicated security. Section 8-102(a)(4). Instruction. Section 8-102(a)(12). Issuer. Section 8-201. Registered form. Section 8-102(a)(13). Security. Section 8-102(a)(15). Uncerticated security. Section 8-102(a)(18).

8-208. Eect of Signature of Authenticating Trustee, Registrar, or Transfer Agent. (a) A person signing a security certicate as authenticating trustee, registrar, transfer agent, or the like, warrants to a purchaser for value of the certicated security, if the purchaser is without notice of a particular defect, that: (1) the certicate is genuine; (2) the person's own participation in the issue of the security is within the person's capacity and within the scope of the authority received by the person from the issuer; and (3) the person has reasonable grounds to believe that the certicated security is in the form and within the amount the issuer is authorized to issue. (b) Unless otherwise agreed, a person signing under subsection (a) does not assume responsibility for the validity of the security in other respects. Ocial Comment
1. The warranties here stated express the current understanding and prevailing case law as to the eect of the signatures of authenticating trustees, transfer agents, and registrars. See Jarvis v. Manhattan Beach Co., 148 N.Y. 652, 43 N.E. 68, 31 L.R.A. 776, 51 Am.St.Rep. 727 (1896). Although it has generally been regarded as the particular obligation of the transfer agent to determine whether securities are in proper form as provided by the bylaws and Articles of Incorporation, neither a registrar nor an authenticating trustee should properly place a signature upon a certicate without determining whether it is at least regular on its face. The obligations of these parties in this respect have therefore been made explicit in terms of due care. See Feldmeier v. Mortgage Securities, Inc., 34 Cal.App.2d 201, 93 P.2d 593 (1939). 2. Those cases which hold that an authenticating trustee is not liable for any defect in the mortgage or property which secures the bond or for any fraudulent misrepresentations made by the issuer are not here aected since these matters do not involve the genuineness or proper form of the security. Ainsa v. Mercantile Trust Co., 174 Cal. 504, 163 P. 898 (1917); Tschetinian v. City Trust Co., 186 N.Y. 432, 79 N.E. 401 (1906); Davidge v. Guardian Trust Co. of New York, 203 N.Y. 331, 96 N.E. 751 (1911). 3. The charter or an applicable statute may aect the capacity of a bank or other corporation undertaking to act as an authenticating trustee, registrar, or transfer agent. See, for example, the Federal Reserve Act (U.S.C.A., Title 12, Banks and Banking, Section 248) under which the Board of Governors of the Federal Reserve Bank is authorized to grant special permits to National Banks permitting them to act as trustees. Such corporations are therefore held to certify as to their legal capacity to act as well as to their authority. 4. Authenticating trustees, registrars, and transfer agents have normally been held liable for an issue in excess of the authorized amount. Jarvis v. Manhattan Beach Co., supra; Mullen v. Eastern Trust & Banking Co., 108 Me. 498, 81 A. 948 (1911). In imposing upon these parties a duty of due care with respect to the amount they are authorized to help issue, this section does not necessarily validate the security, but merely holds persons 776

Art. 8

Investment Securities

8-210

responsible for the excess issue liable in damages for any loss suered by the purchaser. 5. Aside from questions of genuineness and excess issue, these parties are not held to certify as to the validity of the security unless they specically undertake to do so. The case law which has recognized a unique responsibility on the transfer agent's part to testify as to the validity of any security which it countersigns is rejected. 6. This provision does not prevent a transfer agent or issuer from agreeing with a registrar of stock to protect the registrar in respect of the genuineness and proper form of a security certicate signed by the issuer or the transfer agent or both. Nor does it interfere with proper indemnity arrangements between the issuer and trustees, transfer agents, registrars, and the like. 7. An unauthorized signature is a signature for purposes of this section if and only if it is made eective by Section 8-205. Denitional Cross References: Certicated security. Section 8-102(a)(4). Genuine. Section 1-201(18). Issuer. Section 8-201. Notice. Section 1-201(25). Purchaser. Sections 1-201(33) & 8-116. Security. Section 8-102(a)(15). Security certicate. Section 8-102(a)(16). Uncerticated security. Section 8-102(a)(18). Value. Sections 1-201(44) & 8-116.

8-209. Issuer's Lien. A lien in favor of an issuer upon a certicated security is valid against a purchaser only if the right of the issuer to the lien is noted conspicuously on the security certicate. Ocial Comment
This section is similar to Sections 8-202 and 8-204 which require that the terms of a certicated security and any restriction on transfer imposed by the issuer be noted on the security certicate. This section diers from those two sections in that the purchaser's knowledge of the issuer's claim is irrelevant. Noted makes clear that the text of the lien provisions need not be set forth in full. However, this would not override a provision of an applicable corporation code requiring statement in haec verba. This section does not apply to uncerticated securities. It applies to the indirect holding system in the same fashion as Sections 8-202 and 8-204, see Comment 2 to Section 8-202. Denitional Cross References: Certicated security. Section 8-102(a)(4). Issuer. Section 8-201. Purchaser. Sections 1-201(33) & 8-116. Security. Section 8-102(a)(15). Security certicate. Section 8-102(a)(16).

8-210. Overissue. (a) In this section, overissue means the issue of securities in excess of the amount the issuer has corporate power to issue, but an overissue does not occur if appropriate action has cured the overissue. (b) Except as otherwise provided in subsections (c) and (d), the provisions of this Article which validate a security or compel its issue or reissue do not apply to the extent that validation, issue, or reissue would result in overissue. (c) If an identical security not constituting an overissue is reasonably available for purchase, a person entitled to issue or validation may compel the issuer to purchase the security and deliver it if certicated or register
777

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Art. 8

its transfer if uncerticated, against surrender of any security certicate the person holds. (d) If a security is not reasonably available for purchase, a person entitled to issue or validation may recover from the issuer the price the person or the last purchaser for value paid for it with interest from the date of the person's demand. Ocial Comment
1. Deeply embedded in corporation law is the conception that corporate power to issue securities stems from the statute, either general or special, under which the corporation is organized. Corporation codes universally require that the charter or articles of incorporation state, at least as to capital shares, maximum limits in terms of number of shares or total dollar capital. Historically, special incorporation statutes are similarly drawn and sometimes similarly limit the face amount of authorized debt securities. The theory is that issue of securities in excess of the authorized amounts is prohibited. See, for example, McWilliams v. Geddes & Moss Undertaking Co., 169 So. 894 (1936, La.); Crawford v. Twin City Oil Co., 216 Ala. 216, 113 So. 61 (1927); New York and New Haven R.R. Co. v. Schuyler, 34 N.Y. 30 (1865). This conception persists despite modern corporation codes under which, by action of directors and stockholders, additional shares can be authorized by charter amendment and thereafter issued. This section does not give a person entitled to validation, issue, or reissue of a security, the right to compel amendment of the charter to authorize additional shares. Therefore, in a case where issue of an additional security would require charter amendment, the plainti is limited to the two alternate remedies set forth in subsections (c) and (d). The last clause of subsection (a), which is added in Revised Article 8, does, however, recognize that under modern conditions, overissue may be a relatively minor technical problem that can be cured by appropriate action under governing corporate law. 2. Where an identical security is reasonably available for purchase, whether because traded on an organized market, or because one or more security owners may be willing to sell at a not unreasonable price, the issuer, although unable to issue additional shares, will be able to purchase them and may be compelled to follow that procedure. West v. Tintic Standard Mining Co., 71 Utah 158, 263 P. 490 (1928). 3. The right to recover damages from an issuer who has permitted an overissue to occur is well settled. New York and New Haven R.R. Co. v. Schuyler, 34 N.Y. 30 (1865). The measure of such damages, however, has been open to question, some courts basing them upon the value of stock at the time registration is refused; some upon the value at the time of trial; and some upon the highest value between the time of refusal and the time of trial. Allen v. South Boston Railroad, 150 Mass. 200, 22 N.E. 917, 5 L.R.A. 716, 15 Am.St.Rep. 185 (1889); Commercial Bank v. Kortright, 22 Wend. (N.Y.) 348 (1839). The purchase price of the security to the last purchaser who gave value for it is here adopted as being the fairest means of reducing the possibility of speculation by the purchaser. Interest may be recovered by the best available measure of compensation for delay. Denitional Cross References: Issuer. Section 8-201. Security. Section 8-102(a)(15). Security certicate. Section 8-102(a)(16). Uncerticated security. Section 8-102(a)(18).

PART 3. TRANSFER OF CERTIFICATED AND UNCERTIFICATED SECURITIES

8-301. Delivery. (a) Delivery of a certicated security to a purchaser occurs when: (1) the purchaser acquires possession of the security certicate; (2) another person, other than a securities intermediary, either acquires possession of the security certicate on behalf of the purchaser
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Investment Securities

8-301

or, having previously acquired possession of the certicate, acknowledges that it holds for the purchaser; or (3) a securities intermediary acting on behalf of the purchaser acquires possession of the security certicate, only if the certicate is in registered form and is (i) registered in the name of the purchaser, (ii) payable to the order of the purchaser, or (iii) specially indorsed to the purchaser by an eective indorsement and has not been indorsed to the securities intermediary or in blank. (b) Delivery of an uncerticated security to a purchaser occurs when: (1) the issuer registers the purchaser as the registered owner, upon original issue or registration of transfer; or (2) another person, other than a securities intermediary, either becomes the registered owner of the uncerticated security on behalf of the purchaser or, having previously become the registered owner, acknowledges that it holds for the purchaser. As amended in 1999.
See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999.

Ocial Comment
1. This section species the requirements for delivery of securities. Delivery is used in Article 8 to describe the formal steps necessary for a purchaser to acquire a direct interest in a security under this Article. The concept of delivery refers to the implementation of a transaction, not the legal categorization of the transaction which is consummated by delivery. Issuance and transfer are dierent kinds of transaction, though both may be implemented by delivery. Sale and pledge are dierent kinds of transfers, but both may be implemented by delivery. 2. Subsection (a) denes delivery with respect to certicated securities. Paragraph (1) deals with simple cases where purchasers themselves acquire physical possession of certicates. Paragraphs (2) and (3) of subsection (a) specify the circumstances in which delivery to a purchaser can occur although the certicate is in the possession of a person other than the purchaser. Paragraph (2) contains the general rule that a purchaser can take delivery through another person, so long as the other person is actually acting on behalf of the purchaser or acknowledges that it is holding on behalf of the purchaser. Paragraph (2) does not apply to acquisition of possession by a securities intermediary, because a person who holds securities through a securities account acquires a security entitlement, rather than having a direct interest. See Section 8-501. Subsection (a)(3) species the limited circumstances in which delivery of security certicates to a securities intermediary is treated as a delivery to the customer. Note that delivery is a method of perfecting a security interest in a certicated security. See Section 9-313(a), (e). 3. Subsection (b) denes delivery with respect to uncerticated securities. Use of the term delivery with respect to uncerticated securities, does, at least on rst hearing, seem a bit solecistic. The word delivery is, however, routinely used in the securities business in a broader sense than manual tradition. For example, settlement by entries on the books of a clearing corporation is commonly called delivery, as in the expression delivery versus payment. The diction of this section has the advantage of using the same term for uncerticated securities as for certicated securities, for which delivery is conventional usage. Paragraph (1) of subsection (b) provides that delivery occurs when the purchaser becomes the registered owner of an uncerticated security, either upon original issue or registration of transfer. Paragraph (2) provides for delivery of an uncerticated security through a third person, in a fashion analogous to subsection (a)(2). Denitional Cross References: Certicated security. Section 8-102(a)(4). Eective. Section 8-107. Issuer. Section 8-201. 779

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Purchaser. Sections 1-201(33) & 8-116. Registered form. Section 8-102(a)(13). Securities intermediary. Section 8-102(a)(14). Security certicate. Section 8-102(a)(16). Special indorsement. Section 8-304(a). Uncerticated security. Section 8-102(a)(18).

As amended in 1999.
See Appendix I contained within revised Article 9 for material relating to changes made in Ocial Comment in 1999.

8-302. Rights of Purchaser. (a) Except as otherwise provided in subsections (b) and (c), a purchaser of a certicated or uncerticated security acquires all rights in the security that the transferor had or had power to transfer. (b) A purchaser of a limited interest acquires rights only to the extent of the interest purchased. (c) A purchaser of a certicated security who as a previous holder had notice of an adverse claim does not improve its position by taking from a protected purchaser. As amended in 1999.
See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999.

Ocial Comment
1. Subsection (a) provides that a purchaser of a certicated or uncerticated security acquires all rights that the transferor had or had power to transfer. This statement of the familiar shelter principle is qualied by the exceptions that a purchaser of a limited interest acquires only that interest, subsection (b), and that a person who does not qualify as a protected purchaser cannot improve its position by taking from a subsequent protected purchaser, subsection (c). 2. Although this section provides that a purchaser acquires a property interest in a certicated or uncerticated security, it does not state that a person can acquire an interest in a security only by purchase. Article 8 also is not a comprehensive codication of all of the law governing the creation or transfer of interests in securities by purchase.* For example, the grant of a security interest is a transfer of a property interest, but the formal steps necessary to eectuate such a transfer are governed by Article 9, not by Article 8. Under the Article 9 rules, a security interest in a certicated or uncerticated security can be created by execution of a security agreement under Section 9-203 and can be perfected by ling. A transfer of an Article 9 security interest can be implemented by an Article 8 delivery, but need not be. Similarly, Article 8 does not determine whether a property interest in certicated or uncerticated security is acquired under other law, such as the law of gifts, trusts, or equitable remedies. Nor does Article 8 deal with transfers by operation of law. For example, transfers from decedent to administrator, from ward to guardian, and from bankrupt to trustee in bankruptcy are governed by other law as to both the time they occur and the substance of the transfer. The Article 8 rules do, however, determine whether the issuer is obligated to recognize the rights that a third party, such as a transferee, may acquire under other law. See Sections 8-207, 8-401, and 8-404. Denitional Cross References: Certicated security. Section 8-102(a)(4). Notice of adverse claim. Section 8-105. [Section 8-302] *Amendments in italics approved by 780 the Permanent Editorial Board for Uniform Commercial Code January 15, 2000.

Art. 8

Investment Securities

8-303

Protected purchaser. Section 8-303. Purchaser. Sections 1-201(33) & 8-116. Uncerticated security. Section 8-102(a)(18). Delivery. Section 8-301.

As amended in 1999 and 2000.

See Appendix I contained within revised Article 9 for material relating to changes made in Ocial Comment in 1999. See Appendix P for material relating to changes made in Ocial Comment in 2000.

8-303. Protected Purchaser. (a) Protected purchaser means a purchaser of a certicated or uncerticated security, or of an interest therein, who: (1) gives value; (2) does not have notice of any adverse claim to the security; and (3) obtains control of the certicated or uncerticated security. (b) In addition to acquiring the rights of a purchaser, a protected purchaser also acquires its interest in the security free of any adverse claim. Ocial Comment
1. Subsection (a) lists the requirements that a purchaser must meet to qualify as a protected purchaser. Subsection (b) provides that a protected purchaser takes its interest free from adverse claims. Purchaser is dened broadly in Section 1-201. A secured party as well as an outright buyer can qualify as a protected purchaser. Also, purchase includes taking by issue, so a person to whom a security is originally issued can qualify as a protected purchaser. 2. To qualify as a protected purchaser, a purchaser must give value, take without notice of any adverse claim, and obtain control. Value is used in the broad sense dened in Section 1-201(44). See also Section 8-116 (securities intermediary as purchaser for value). Adverse claim is dened in Section 8-102(a)(1). Section 8-105 species whether a purchaser has notice of an adverse claim. Control is dened in Section 8-106. To qualify as a protected purchaser there must be a time at which all of the requirements are satised. Thus if a purchaser obtains notice of an adverse claim before giving value or satisfying the requirements for control, the purchaser cannot be a protected purchaser. See also Section 8-304(d). The requirement that a protected purchaser obtain control expresses the point that to qualify for the adverse claim cut-o rule a purchaser must take through a transaction that is implemented by the appropriate mechanism. By contrast, the rules in Part 2 provide that any purchaser for value of a security without notice of a defense may take free of the issuer's defense based on that defense. See Section 8-202. 3. The requirements for control dier depending on the form of the security. For securities represented by bearer certicates, a purchaser obtains control by delivery. See Sections 8-106(a) and 8-301(a). For securities represented by certicates in registered form, the requirements for control are: (1) delivery as dened in Section 8-301(b), plus (2) either an eective indorsement or registration of transfer by the issuer. See Section 8-106(b). Thus, a person who takes through a forged indorsement does not qualify as a protected purchaser by virtue of the delivery alone. If, however, the purchaser presents the certicate to the issuer for registration of transfer, and the issuer registers transfer over the forged indorsement, the purchaser can qualify as a protected purchaser of the new certicate. If the issuer registers transfer on a forged indorsement, the true owner will be able to recover from the issuer for wrongful registration, see Section 8-404, unless the owner's delay in notifying the issuer of a loss or theft of the certicate results in preclusion under Section 8-406. For uncerticated securities, a purchaser can obtain control either by delivery, see Sections 8-106(c)(1) and 8-301(b), or by obtaining an agreement pursuant to which the issuer agrees to act on instructions from the purchaser without further consent from the registered owner, see Section 8-106(c)(2). The control agreement device of Section 8-106(c) 781

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(2) takes the place of the registered pledge concept of the 1978 version of Article 8. A secured lender who obtains a control agreement under Section 8-106(c)(2) can qualify as a protected purchaser of an uncerticated security. 4. This section states directly the rules determining whether one takes free from adverse claims without using the phrase good faith. Whether a person who takes under suspicious circumstances is disqualied is determined by the rules of Section 8-105 on notice of adverse claims. The term protected purchaser, which replaces the term bona de purchaser used in the prior version of Article 8, is derived from the term protected holder used in the Convention on International Bills and Notes prepared by the United Nations Commission on International Trade Law (UNCITRAL). Denitional Cross References: Adverse claim. Section 8-102(a)(1). Certicated security. Section 8-102(a)(4). Control. Section 8-106. Notice of adverse claim. Section 8-105. Purchaser. Sections 1-201(33) & 8-116. Uncerticated security. Section 8-102(a)(18). Value. Sections 1-201(44) & 8-116.

8-304. Indorsement. (a) An indorsement may be in blank or special. An indorsement in blank includes an indorsement to bearer. A special indorsement species to whom a security is to be transferred or who has power to transfer it. A holder may convert a blank indorsement to a special indorsement. (b) An indorsement purporting to be only of part of a security certicate representing units intended by the issuer to be separately transferable is eective to the extent of the indorsement. (c) An indorsement, whether special or in blank, does not constitute a transfer until delivery of the certicate on which it appears or, if the indorsement is on a separate document, until delivery of both the document and the certicate. (d) If a security certicate in registered form has been delivered to a purchaser without a necessary indorsement, the purchaser may become a protected purchaser only when the indorsement is supplied. However, against a transferor, a transfer is complete upon delivery and the purchaser has a specically enforceable right to have any necessary indorsement supplied. (e) An indorsement of a security certicate in bearer form may give notice of an adverse claim to the certicate, but it does not otherwise aect a right to registration that the holder possesses. (f) Unless otherwise agreed, a person making an indorsement assumes only the obligations provided in Section 8-108 and not an obligation that the security will be honored by the issuer. Ocial Comment
1. By virtue of the denition of indorsement in Section 8-102 and the rules of this section, the simplied method of indorsing certicated securities previously set forth in the Uniform Stock Transfer Act is continued. Although more than one special indorsement on a given security certicate is possible, the desire for dividends or interest, as the case may be, should operate to bring the certicate home for registration of transfer within a reasonable period of time. The usual form of assignment which appears on the back of a stock certicate or in a separate power may be lled up either in the form of an assignment, a power of attorney to transfer, or both. If it is not lled up at all but merely signed, the indorse782

Art. 8

Investment Securities

8-305

ment is in blank. If lled up either as an assignment or as a power of attorney to transfer, the indorsement is special. 2. Subsection (b) recognizes the validity of a partial indorsement, e.g., as to fty shares of the one hundred represented by a single certicate. The rights of a transferee under a partial indorsement to the status of a protected purchaser are left to the case law. 3. Subsection (c) deals with the eect of an indorsement without delivery. There must be a voluntary parting with control in order to eect a valid transfer of a certicated security as between the parties. Levey v. Nason, 279 Mass. 268, 181 N.E. 193 (1932), and National Surety Co. v. Indemnity Insurance Co. of North America, 237 App.Div. 485, 261 N.Y.S. 605 (1933). The provision in Section 10 of the Uniform Stock Transfer Act that an attempted transfer without delivery amounts to a promise to transfer is omitted. Even under that Act the eect of such a promise was left to the applicable law of contracts, and this Article by making no reference to such situations intends to achieve a similar result. With respect to delivery there is no counterpart to subsection (d) on right to compel indorsement, such as is envisaged in Johnson v. Johnson, 300 Mass. 24, 13 N.E.2d 788 (1938), where the transferee under a written assignment was given the right to compel a transfer of the certicate. 4. Subsection (d) deals with the eect of delivery without indorsement. As between the parties the transfer is made complete upon delivery, but the transferee cannot become a protected purchaser until indorsement is made. The indorsement does not operate retroactively, and notice may intervene between delivery and indorsement so as to prevent the transferee from becoming a protected purchaser. Although a purchaser taking without a necessary indorsement may be subject to claims of ownership, any issuer's defense of which the purchaser had no notice at the time of delivery will be cut o, since the provisions of this Article protect all purchasers for value without notice (Section 8-202). The transferee's right to compel an indorsement where a security certicate has been delivered with intent to transfer is recognized in the case law. See Coats v. Guaranty Bank & Trust Co., 170 La. 871, 129 So. 513 (1930). A proper indorsement is one of the requisites of transfer which a purchaser of a certicated security has a right to obtain (Section 8-307). A purchaser may not only compel an indorsement under that section but may also recover for any reasonable expense incurred by the transferor's failure to respond to the demand for an indorsement. 5. Subsection (e) deals with the signicance of an indorsement on a security certicate in bearer form. The concept of indorsement applies only to registered securities. A purported indorsement of bearer paper is normally of no eect. An indorsement for collection, for surrender or the like, charges a purchaser with notice of adverse claims (Section 8-105(d)) but does not operate beyond this to interfere with any right the holder may otherwise possess to have the security registered. 6. Subsection (f) makes clear that the indorser of a security certicate does not warrant that the issuer will honor the underlying obligation. In view of the nature of investment securities and the circumstances under which they are normally transferred, a transferor cannot be held to warrant as to the issuer's actions. As a transferor the indorser, of course, remains liable for breach of the warranties set forth in this Article (Section 8-108). Denitional Cross References: Bearer form. Section 8-102(a)(2). Certicated security. Section 8-102(a)(4). Indorsement. Section 8-102(a)(11). Purchaser. Sections 1-201(33) & 8-116. Registered form. Section 8-102(a)(13). Security certicate. Section 8-102(a)(16).

8-305. Instruction. (a) If an instruction has been originated by an appropriate person but is incomplete in any other respect, any person may complete it as authorized and the issuer may rely on it as completed, even though it has been completed incorrectly. (b) Unless otherwise agreed, a person initiating an instruction assumes only the obligations imposed by Section 8-108 and not an obligation that the security will be honored by the issuer.
783

 8-305

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Art. 8

Ocial Comment
1. The term instruction is dened in Section 8-102(a)(12) as a notication communicated to the issuer of an uncerticated security directing that transfer be registered. Section 8-107 species who may initiate an eective instruction. Functionally, presentation of an instruction is quite similar to the presentation of an indorsed certicate for registration. Note that instruction is dened in terms of communicate, see Section 8-102(a)(6). Thus, the instruction may be in the form of a writing signed by the registered owner or in any other form agreed upon by the issuer and the registered owner. Allowing nonwritten forms of instructions will permit the development and employment of means of transmitting instructions electronically. When a person who originates an instruction leaves a blank and the blank later is completed, subsection (a) gives the issuer the same rights it would have had against the originating person had that person completed the blank. This is true regardless of whether the person completing the instruction had authority to complete it. Compare Section 8-206 and its Comment, dealing with blanks left upon issue. 2. Subsection (b) makes clear that the originator of an instruction, like the indorser of a security certicate, does not warrant that the issuer will honor the underlying obligation, but does make warranties as a transferor under Section 8-108. Denitional Cross References: Appropriate person. Section 8-107. Instruction. Section 8-102(a)(12). Issuer. Section 8-201.

8-306. Eect of Guaranteeing Signature, Indorsement, or Instruction. (a) A person who guarantees a signature of an indorser of a security certicate warrants that at the time of signing: (1) the signature was genuine; (2) the signer was an appropriate person to indorse, or if the signature is by an agent, the agent had actual authority to act on behalf of the appropriate person; and (3) the signer had legal capacity to sign. (b) A person who guarantees a signature of the originator of an instruction warrants that at the time of signing: (1) the signature was genuine; (2) the signer was an appropriate person to originate the instruction, or if the signature is by an agent, the agent had actual authority to act on behalf of the appropriate person, if the person specied in the instruction as the registered owner was, in fact, the registered owner, as to which fact the signature guarantor does not make a warranty; and (3) the signer had legal capacity to sign. (c) A person who specially guarantees the signature of an originator of an instruction makes the warranties of a signature guarantor under subsection (b) and also warrants that at the time the instruction is presented to the issuer: (1) the person specied in the instruction as the registered owner of the uncerticated security will be the registered owner; and (2) the transfer of the uncerticated security requested in the instruction will be registered by the issuer free from all liens, security interests, restrictions, and claims other than those specied in the instruction. (d) A guarantor under subsections (a) and (b) or a special guarantor
784

Art. 8

Investment Securities

8-306

under subsection (c) does not otherwise warrant the rightfulness of the transfer. (e) A person who guarantees an indorsement of a security certicate makes the warranties of a signature guarantor under subsection (a) and also warrants the rightfulness of the transfer in all respects. (f) A person who guarantees an instruction requesting the transfer of an uncerticated security makes the warranties of a special signature guarantor under subsection (c) and also warrants the rightfulness of the transfer in all respects. (g) An issuer may not require a special guaranty of signature, a guaranty of indorsement, or a guaranty of instruction as a condition to registration of transfer. (h) The warranties under this section are made to a person taking or dealing with the security in reliance on the guaranty, and the guarantor is liable to the person for loss resulting from their breach. An indorser or originator of an instruction whose signature, indorsement, or instruction has been guaranteed is liable to a guarantor for any loss suered by the guarantor as a result of breach of the warranties of the guarantor. Ocial Comment
1. Subsection (a) provides that a guarantor of the signature of the indorser of a security certicate warrants that the signature is genuine, that the signer is an appropriate person or has actual authority to indorse on behalf of the appropriate person, and that the signer has legal capacity. Subsection (b) provides similar, though not identical, warranties for the guarantor of a signature of the originator of an instruction for transfer of an uncerticated security. Appropriate person is dened in Section 8-107(a) to include a successor or person who has power under other law to act for a person who is deceased or lacks capacity. Thus if a certicate registered in the name of Mary Roe is indorsed by Jane Doe as executor of Mary Roe, a guarantor of the signature of Jane Doe warrants that she has power to act as executor. Although the denition of appropriate person in Section 8-107(a) does not itself include an agent, an indorsement by an agent is eective under Section 8-107(b) if the agent has authority to act for the appropriate person. Accordingly, this section provides an explicit warranty of authority for agents. 2. The rationale of the principle that a signature guarantor warrants the authority of the signer, rather than simply the genuineness of the signature, was explained in the leading case of Jennie Clarkson Home for Children v. Missouri, K. & T.R. Co., 182 N.Y. 47, 74 N.E. 571, 70 A.L.R. 787 (1905), which dealt with a guaranty of the signature of a person indorsing on behalf of a corporation. If stock is held by an individual who is executing a power of attorney for its transfer, the member of the exchange who signs as a witness thereto guaranties not only the genuineness of the signature axed to the power of attorney, but that the person signing is the individual in whose name the stock stands. With reference to stock standing in the name of a corporation, which can only sign a power of attorney through its authorized ocers or agents, a dierent situation is presented. If the witnessing of the signature of the corporation is only that of the signature of a person who signs for the corporation, then the guaranty is of no value, and there is nothing to protect purchasers or the companies who are called upon to issue new stock in the place of that transferred from the frauds of persons who have signed the names of corporations without authority. If such is the only eect of the guaranty, purchasers and transfer agents must rst go to the corporation in whose name the stock stands and ascertain whether the individual who signed the power of attorney had authority to do so. This will require time, and in many cases will necessitate the postponement of the completion of the purchase by the payment of the money until the facts can be ascertained. The broker who is acting for the owner has an opportunity to become acquainted with his customer, and may readily before sale ascertain, in case of a corporation, the name of the ocer who is authorized to execute 785

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Art. 8

the power of attorney. It was therefore, we think, the purpose of the rule to cast upon the broker who witnesses the signature the duty of ascertaining whether the person signing the name of the corporation had authority to do so, and making the witness a guarantor that it is the signature of the corporation in whose name the stock stands. 3. Subsection (b) sets forth the warranties that can reasonably be expected from the guarantor of the signature of the originator of an instruction, who, though familiar with the signer, does not have any evidence that the purported owner is in fact the owner of the subject uncerticated security. This is in contrast to the position of the person guaranteeing a signature on a certicate who can see a certicate in the signer's possession in the name of or indorsed to the signer or in blank. Thus, the warranty in paragraph (2) of subsection (b) is expressly conditioned on the actual registration's conforming to that represented by the originator. If the signer purports to be the owner, the guarantor under paragraph (2), warrants only the identity of the signer. If, however, the signer is acting in a representative capacity, the guarantor warrants both the signer's identity and authority to act for the purported owner. The issuer needs no warranty as to the facts of registration because those facts can be ascertained from the issuer's own records. 4. Subsection (c) sets forth a special guaranty of signature under which the guarantor additionally warrants both registered ownership and freedom from undisclosed defects of record. The guarantor of the signature of an indorser of a security certicate eectively makes these warranties to a purchaser for value on the evidence of a clean certicate issued in the name of the indorser, indorsed to the indorser or indorsed in blank. By specially guaranteeing under subsection (c), the guarantor warrants that the instruction will, when presented to the issuer, result in the requested registration free from defects not specied. 5. Subsection (d) makes clear that the warranties of a signature guarantor are limited to those specied in this section and do not include a general warranty of rightfulness. On the other hand subsections (e) and (f) provide that a person guaranteeing an indorsement or an instruction does warrant that the transfer is rightful in all respects. 6. Subsection (g) makes clear what can be inferred from the combination of Sections 8-401 and 8-402, that the issuer may not require as a condition to transfer a guaranty of the indorsement or instruction nor may it require a special signature guaranty. 7. Subsection (h) species to whom the warranties in this section run, and also provides that a person who gives a guaranty under this section has an action against the indorser or originator for any loss suered by the guarantor. Denitional Cross References: Appropriate person. Section 8-107. Genuine. Section 1-201(18). Indorsement. Section 8-102(a)(11). Instruction. Section 8-102(a)(12). Issuer. Section 8-201. Security certicate. Section 8-102(a)(16). Uncerticated security. Section 8-102(a)(18).

8-307. Purchaser's Right to Requisites for Registration of Transfer. Unless otherwise agreed, the transferor of a security on due demand shall supply the purchaser with proof of authority to transfer or with any other requisite necessary to obtain registration of the transfer of the security, but if the transfer is not for value, a transferor need not comply unless the purchaser pays the necessary expenses. If the transferor fails within a reasonable time to comply with the demand, the purchaser may reject or rescind the transfer. Ocial Comment
1. Because registration of the transfer of a security is a matter of vital importance, a purchaser is here provided with the means of obtaining such formal requirements for registration as signature guaranties, proof of authority, transfer tax stamps and the like. The transferor is the one in a position to supply most conveniently whatever documenta786

Art. 8

Investment Securities

8-401

tion may be requisite for registration of transfer, and the duty to do so upon demand within a reasonable time is here stated armatively. If an essential item is peculiarly within the province of the transferor so that the transferor is the only one who can obtain it, the purchaser may specically enforce the right to obtain it. Compare Section 8-304(d). If a transfer is not for value the transferor need not pay expenses. 2. If the transferor's duty is not performed the transferee may reject or rescind the contract to transfer. The transferee is not bound to do so. An action for damages for breach of contract may be preferred. Denitional Cross References: Purchaser. Sections 1-201(33) & 8-116. Security. Section 8-102(a)(15). Value. Sections 1-201(44) & 8-116.

PART 4. REGISTRATION
8-401. Duty of Issuer to Register Transfer. (a) If a certicated security in registered form is presented to an issuer with a request to register transfer or an instruction is presented to an issuer with a request to register transfer of an uncerticated security, the issuer shall register the transfer as requested if: (1) under the terms of the security the person seeking registration of transfer is eligible to have the security registered in its name; (2) the indorsement or instruction is made by the appropriate person or by an agent who has actual authority to act on behalf of the appropriate person; (3) reasonable assurance is given that the indorsement or instruction is genuine and authorized (Section 8-402); (4) any applicable law relating to the collection of taxes has been complied with; (5) the transfer does not violate any restriction on transfer imposed by the issuer in accordance with Section 8-204; (6) a demand that the issuer not register transfer has not become effective under Section 8-403, or the issuer has complied with Section 8-403(b) but no legal process or indemnity bond is obtained as provided in Section 8-403(d); and (7) the transfer is in fact rightful or is to a protected purchaser. (b) If an issuer is under a duty to register a transfer of a security, the issuer is liable to a person presenting a certicated security or an instruction for registration or to the person's principal for loss resulting from unreasonable delay in registration or failure or refusal to register the transfer. Ocial Comment
1. This section states the duty of the issuer to register transfers. A duty exists only if certain preconditions exist. If any of the preconditions do not exist, there is no duty to register transfer. If an indorsement on a security certicate is a forgery, there is no duty. If an instruction to transfer an uncerticated security is not originated by an appropriate person, there is no duty. If there has not been compliance with applicable tax laws, there is no duty. If a security certicate is properly indorsed but nevertheless the transfer is in fact wrongful, there is no duty unless the transfer is to a protected purchaser (and the other preconditions exist). This section does not constitute a mandate that the issuer must establish that all preconditions are met before the issuer registers a transfer. The issuer may waive the rea787

 8-401

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Art. 8

sonable assurances specied in paragraph (a)(3). If it has condence in the responsibility of the persons requesting transfer, it may ignore questions of compliance with tax laws. Although an issuer has no duty if the transfer is wrongful, the issuer has no duty to inquire into adverse claims, see Section 8-404. 2. By subsection (b) the person entitled to registration may not only compel it but may hold the issuer liable in damages for unreasonable delay. 3. Section 8-201(c) provides that with respect to registration of transfer, issuer means the person on whose behalf transfer books are maintained. Transfer agents, registrars or the like within the scope of their respective functions have rights and duties under this Part similar to those of the issuer. See Section 8-407. Denitional Cross References: Appropriate person. Section 8-107. Certicated security. Section 8-102(a)(4). Genuine. Section 1-201(18). Indorsement. Section 8-102(a)(11). Instruction. Section 8-102(a)(12). Issuer. Section 8-201. Protected purchaser. Section 8-303. Registered form. Section 8-102(a)(13). Uncerticated security. Section 8-102(a)(18).

8-402. Assurance that Indorsement or Instruction is Eective. (a) An issuer may require the following assurance that each necessary indorsement or each instruction is genuine and authorized: (1) in all cases, a guaranty of the signature of the person making an indorsement or originating an instruction including, in the case of an instruction, reasonable assurance of identity; (2) if the indorsement is made or the instruction is originated by an agent, appropriate assurance of actual authority to sign; (3) if the indorsement is made or the instruction is originated by a duciary pursuant to Section 8-107(a)(4) or (a)(5), appropriate evidence of appointment or incumbency; (4) if there is more than one duciary, reasonable assurance that all who are required to sign have done so; and (5) if the indorsement is made or the instruction is originated by a person not covered by another provision of this subsection, assurance appropriate to the case corresponding as nearly as may be to the provisions of this subsection. (b) An issuer may elect to require reasonable assurance beyond that specied in this section. (c) In this section: (1) Guaranty of the signature means a guaranty signed by or on behalf of a person reasonably believed by the issuer to be responsible. An issuer may adopt standards with respect to responsibility if they are not manifestly unreasonable. (2) Appropriate evidence of appointment or incumbency means: (i) in the case of a duciary appointed or qualied by a court, a certicate issued by or under the direction or supervision of the court or an ocer thereof and dated within 60 days before the date of presentation for transfer; or (ii) in any other case, a copy of a document showing the appoint788

Art. 8

Investment Securities

8-403

ment or a certicate issued by or on behalf of a person reasonably believed by an issuer to be responsible or, in the absence of that document or certicate, other evidence the issuer reasonably considers appropriate. Ocial Comment
1. An issuer is absolutely liable for wrongful registration of transfer if the indorsement or instruction is ineective. See Section 8-404. Accordingly, an issuer is entitled to require such assurance as is reasonable under the circumstances that all necessary indorsements are eective, and thus to minimize its risk. This section establishes the requirements the issuer may make in terms of documentation which, except in the rarest of instances, should be easily furnished. Subsection (b) provides that an issuer may require additional assurances if that requirement is reasonable under the circumstances, but if the issuer demands more than reasonable assurance that the instruction or the necessary indorsements are genuine and authorized, the presenter may refuse the demand and sue for improper refusal to register. Section 8-401(b). 2. Under subsection (a)(1), the issuer may require in all cases a guaranty of signature. See Section 8-306. When an instruction is presented the issuer always may require reasonable assurance as to the identity of the originator. Subsection (c) allows the issuer to require that the person making these guaranties be one reasonably believed to be responsible, and the issuer may adopt standards of responsibility which are not manifestly unreasonable. Regulations under the federal securities laws, however, place limits on the requirements transfer agents may impose concerning the responsibility of eligible signature guarantors. See 17 CFR 240.17Ad-15. 3. This section, by paragraphs (2) through (5) of subsection (a), permits the issuer to seek conrmation that the indorsement or instruction is genuine and authorized. The permitted methods act as a double check on matters which are within the warranties of the signature guarantor. See Section 8-306. Thus, an agent may be required to submit a power of attorney, a corporation to submit a certied resolution evidencing the authority of its signing ocer to sign, an executor or administrator to submit the usual shortform certicate, etc. But failure of a duciary to obtain court approval of the transfer or to comply with other requirements does not make the duciary's signature ineective. Section 8-107(c). Hence court orders and other controlling instruments are omitted from subsection (a). Subsection (a)(3) authorizes the issuer to require appropriate evidence of appointment or incumbency, and subsection (c) indicates what evidence will be appropriate. In the case of a duciary appointed or qualied by a court that evidence will be a court certicate dated within sixty days before the date of presentation, subsection (c)(2)(i). Where the duciary is not appointed or qualied by a court, as in the case of a successor trustee, subsection (c)(2)(ii) applies. In that case, the issuer may require a copy of a trust instrument or other document showing the appointment, or it may require the certicate of a responsible person. In the absence of such a document or certicate, it may require other appropriate evidence. If the security is registered in the name of the duciary as such, the person's signature is eective even though the person is no longer serving in that capacity, see Section 8-107(d), hence no evidence of incumbency is needed. 4. Circumstances may indicate that a necessary signature was unauthorized or was not that of an appropriate person. Such circumstances would be ignored at risk of absolute liability. To minimize that risk the issuer may properly exercise the option given by subsection (b) to require assurance beyond that specied in subsection (a). On the other hand, the facts at hand may reect only on the rightfulness of the transfer. Such facts do not create a duty of inquiry, because the issuer is not liable to an adverse claimant unless the claimant obtains legal process. See Section 8-404. Denitional Cross References: Appropriate person. Section 8-107. Genuine. Section 1-201(18). Indorsement. Section 8-102(a)(11). Instruction. Section 8-102(a)(12). Issuer. Section 8-201.

8-403. Demand that Issuer Not Register Transfer. (a) A person who is an appropriate person to make an indorsement or
789

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Uniform Commercial Code

Art. 8

originate an instruction may demand that the issuer not register transfer of a security by communicating to the issuer a notication that identies the registered owner and the issue of which the security is a part and provides an address for communications directed to the person making the demand. The demand is eective only if it is received by the issuer at a time and in a manner aording the issuer reasonable opportunity to act on it. (b) If a certicated security in registered form is presented to an issuer with a request to register transfer or an instruction is presented to an issuer with a request to register transfer of an uncerticated security after a demand that the issuer not register transfer has become eective, the issuer shall promptly communicate to (i) the person who initiated the demand at the address provided in the demand and (ii) the person who presented the security for registration of transfer or initiated the instruction requesting registration of transfer a notication stating that: (1) the certicated security has been presented for registration of transfer or the instruction for registration of transfer of the uncerticated security has been received; (2) a demand that the issuer not register transfer had previously been received; and (3) the issuer will withhold registration of transfer for a period of time stated in the notication in order to provide the person who initiated the demand an opportunity to obtain legal process or an indemnity bond. (c) The period described in subsection (b)(3) may not exceed 30 days after the date of communication of the notication. A shorter period may be specied by the issuer if it is not manifestly unreasonable. (d) An issuer is not liable to a person who initiated a demand that the issuer not register transfer for any loss the person suers as a result of registration of a transfer pursuant to an eective indorsement or instruction if the person who initiated the demand does not, within the time stated in the issuer's communication, either: (1) obtain an appropriate restraining order, injunction, or other process from a court of competent jurisdiction enjoining the issuer from registering the transfer; or (2) le with the issuer an indemnity bond, sucient in the issuer's judgment to protect the issuer and any transfer agent, registrar, or other agent of the issuer involved from any loss it or they may suer by refusing to register the transfer. (e) This section does not relieve an issuer from liability for registering transfer pursuant to an indorsement or instruction that was not eective. Ocial Comment
1. The general rule under this Article is that if there has been an eective indorsement or instruction, a person who contends that registration of the transfer would be wrongful should not be able to interfere with the registration process merely by sending notice of the assertion to the issuer. Rather, the claimant must obtain legal process. See Section 8-404. Section 8-403 is an exception to this general rule. It permits the registered ownerbut not third partiesto demand that the issuer not register a transfer. 2. This section is intended to alleviate the problems faced by registered owners of certicated securities who lose or misplace their certicates. A registered owner who realizes that a certicate may have been lost or stolen should promptly report that fact to the 790

Art. 8

Investment Securities

8-404

issuer, lest the owner be precluded from asserting a claim for wrongful registration. See Section 8-406. The usual practice of issuers and transfer agents is that when a certicate is reported as lost, the owner is notied that a replacement can be obtained if the owner provides an indemnity bond. See Section 8-405. If the registered owner does not plan to transfer the securities, the owner might choose not to obtain a replacement, particularly if the owner suspects that the certicate has merely been misplaced. Under this section, the owner's notication that the certicate has been lost would constitute a demand that the issuer not register transfer. No indemnity bond or legal process is necessary. If the original certicate is presented for registration of transfer, the issuer is required to notify the registered owner of that fact, and defer registration of transfer for a stated period. In order to prevent undue delay in the process of registration, the stated period may not exceed thirty days. This gives the registered owner an opportunity to either obtain legal process or post an indemnity bond and thereby prevent the issuer from registering transfer. 3. Subsection (e) makes clear that this section does not relieve an issuer from liability for registering a transfer pursuant to an ineective indorsement. An issuer's liability for wrongful registration in such cases does not depend on the presence or absence of notice that the indorsement was ineective. Registered owners who are condent that they neither indorsed the certicates, nor did anything that would preclude them from denying the eectiveness of another's indorsement, see Sections 8-107(b) and 8-406, might prefer to pursue their rights against the issuer for wrongful registration rather than take advantage of the opportunity to post a bond or seek a restraining order when notied by the issuer under this section that their lost certicates have been presented for registration in apparently good order. Denitional Cross References: Appropriate person. Section 8-107. Certicated security. Section 8-102(a)(4). Communicate. Section 8-102(a)(6). Eective. Section 8-107. Indorsement. Section 8-102(a)(11). Instruction. Section 8-102(a)(12). Issuer. Section 8-201. Registered form. Section 8-102(a)(13). Uncerticated security. Section 8-102(a)(18).

8-404. Wrongful Registration. (a) Except as otherwise provided in Section 8-406, an issuer is liable for wrongful registration of transfer if the issuer has registered a transfer of a security to a person not entitled to it, and the transfer was registered: (1) pursuant to an ineective indorsement or instruction; (2) after a demand that the issuer not register transfer became eective under Section 8-403(a) and the issuer did not comply with Section 8-403(b); (3) after the issuer had been served with an injunction, restraining order, or other legal process enjoining it from registering the transfer, issued by a court of competent jurisdiction, and the issuer had a reasonable opportunity to act on the injunction, restraining order, or other legal process; or (4) by an issuer acting in collusion with the wrongdoer. (b) An issuer that is liable for wrongful registration of transfer under subsection (a) on demand shall provide the person entitled to the security with a like certicated or uncerticated security, and any payments or distributions that the person did not receive as a result of the wrongful registration. If an overissue would result, the issuer's liability to provide the person with a like security is governed by Section 8-210.
791

 8-404

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(c) Except as otherwise provided in subsection (a) or in a law relating to the collection of taxes, an issuer is not liable to an owner or other person suering loss as a result of the registration of a transfer of a security if registration was made pursuant to an eective indorsement or instruction. Ocial Comment
1. Subsection (a)(1) provides that an issuer is liable if it registers transfer pursuant to an indorsement or instruction that was not eective. For example, an issuer that registers transfer on a forged indorsement is liable to the registered owner. The fact that the issuer had no reason to suspect that the indorsement was forged or that the issuer obtained the ordinary assurances under Section 8-402 does not relieve the issuer from liability. The reason that issuers obtain signature guaranties and other assurances is that they are liable for wrongful registration. Subsection (b) species the remedy for wrongful registration. Pre-Code cases established the registered owner's right to receive a new security where the issuer had wrongfully registered a transfer, but some cases also allowed the registered owner to elect between an equitable action to compel issue of a new security and an action for damages. Cf. Casper v. Kalt-Zimmers Mfg. Co., 159 Wis. 517, 149 N.W. 754 (1914). Article 8 does not allow such election. The true owner of a certicated security is required to take a new security except where an overissue would result and a similar security is not reasonably available for purchase. See Section 8-210. The true owner of an uncerticated security is entitled and required to take restoration of the records to their proper state, with a similar exception for overissue. 2. Read together, subsections (c) and (a) have the eect of providing that an issuer has no duties to an adverse claimant unless the claimant serves legal process on the issuer to enjoin registration. Issuers, or their transfer agents, perform a record-keeping function for the direct holding system that is analogous to the functions performed by clearing corporations and securities intermediaries in the indirect holding system. This section applies to the record-keepers for the direct holding system the same standard that Section 8-115 applies to the record-keepers for the indirect holding system. Thus, issuers are not liable to adverse claimants merely on the basis of notice. As in the case of the analogous rules for the indirect holding system, the policy of this section is to protect the right of investors to have their securities transfers processed without the disruption or delay that might result if the record-keepers risked liability to third parties. It would be undesirable to apply different standards to the direct and indirect holding systems, since doing so might operate as a disincentive to the development of a book-entry direct holding system. 3. This section changes prior law under which an issuer could be held liable, even though it registered transfer on an eective indorsement or instruction, if the issuer had in some fashion been notied that the transfer might be wrongful against a third party, and the issuer did not appropriately discharge its duty to inquire into the adverse claim. See Section 8-403 (1978). The rule of former Section 8-403 was anomalous inasmuch as Section 8-207 provides that the issuer is entitled to treat the registered owner as the person exclusively entitled to vote, receive notications, and otherwise exercise all the rights and powers of an owner. Under Section 8-207, the fact that a third person noties the issuer of a claim does not preclude the issuer from treating the registered owner as the person entitled to the security. See Kerrigan v. American Orthodontics Corp., 960 F.2d 43 (7th Cir.1992). The change made in the present version of Section 8-404 ensures that the rights of registered owners and the duties of issuers with respect to registration of transfer will be protected against thirdparty interference in the same fashion as other rights of registered ownership. Denitional Cross References: Certicated security. Section 8-102(a)(4). Eective. Section 8-107. Indorsement. Section 8-102(a)(11). Instruction. Section 8-102(a)(12). Issuer. Section 8-201. Security. Section 8-102(a)(15). Uncerticated security. Section 8-102(a)(18). 792

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8-405. Replacement of Lost, Destroyed, or Wrongfully Taken Security Certicate. (a) If an owner of a certicated security, whether in registered or bearer form, claims that the certicate has been lost, destroyed, or wrongfully taken, the issuer shall issue a new certicate if the owner: (1) so requests before the issuer has notice that the certicate has been acquired by a protected purchaser; (2) les with the issuer a sucient indemnity bond; and (3) satises other reasonable requirements imposed by the issuer. (b) If, after the issue of a new security certicate, a protected purchaser of the original certicate presents it for registration of transfer, the issuer shall register the transfer unless an overissue would result. In that case, the issuer's liability is governed by Section 8-210. In addition to any rights on the indemnity bond, an issuer may recover the new certicate from a person to whom it was issued or any person taking under that person, except a protected purchaser. Ocial Comment
1. This section enables the owner to obtain a replacement of a lost, destroyed or stolen certicate, provided that reasonable requirements are satised and a sucient indemnity bond supplied. 2. Where an original security certicate has reached the hands of a protected purchaser, the registered ownerwho was in the best position to prevent the loss, destruction or theft of the security certicateis now deprived of the new security certicate issued as a replacement. This changes the pre-UCC law under which the original certicate was ineffective after the issue of a replacement except insofar as it might represent an action for damages in the hands of a purchaser for value without notice. Keller v. Eureka Brick Mach. Mfg. Co., 43 Mo.App. 84, 11 L.R.A. 472 (1890). Where both the original and the new certificate have reached protected purchasers the issuer is required to honor both certicates unless an overissue would result and the security is not reasonably available for purchase. See Section 8-210. In the latter case alone, the protected purchaser of the original certicate is relegated to an action for damages. In either case, the issuer itself may recover on the indemnity bond. Denitional Cross References: Bearer form. Section 8-102(a)(2). Certicated security. Section 8-102(a)(4). Issuer. Section 8-201. Notice. Section 1-201(25). Overissue. Section 8-210. Protected purchaser. Section 8-303. Registered form. Section 8-102(a)(13). Security certicate. Section 8-102(a)(16).

8-406. Obligation to Notify Issuer of Lost, Destroyed, or Wrongfully Taken Security Certicate. If a security certicate has been lost, apparently destroyed, or wrongfully taken, and the owner fails to notify the issuer of that fact within a reasonable time after the owner has notice of it and the issuer registers a transfer of the security before receiving notication, the owner may not assert against the issuer a claim for registering the transfer under Section 8-404 or a claim to a new security certicate under Section 8-405. Ocial Comment
An owner who fails to notify the issuer within a reasonable time after the owner knows or has reason to know of the loss or theft of a security certicate is estopped from asserting 793

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the ineectiveness of a forged or unauthorized indorsement and the wrongfulness of the registration of the transfer. If the lost certicate was indorsed by the owner, then the registration of the transfer was not wrongful under Section 8-404, unless the owner made an eective demand that the issuer not register transfer under Section 8-403. Denitional Cross References: Issuer. Section 8-201. Notify. Section 1-201(25). Security certicate. Section 8-102(a)(16).

8-407. Authenticating Trustee, Transfer Agent, and Registrar. A person acting as authenticating trustee, transfer agent, registrar, or other agent for an issuer in the registration of a transfer of its securities, in the issue of new security certicates or uncerticated securities, or in the cancellation of surrendered security certicates has the same obligation to the holder or owner of a certicated or uncerticated security with regard to the particular functions performed as the issuer has in regard to those functions. Ocial Comment
1. Transfer agents, registrars, and the like are here expressly held liable both to the issuer and to the owner for wrongful refusal to register a transfer as well as for wrongful registration of a transfer in any case within the scope of their respective functions where the issuer would itself be liable. Those cases which have regarded these parties solely as agents of the issuer and have therefore refused to recognize their liability to the owner for mere nonfeasance, i.e., refusal to register a transfer, are rejected. Hulse v. Consolidated Quicksilver Mining Corp., 65 Idaho 768, 154 P.2d 149 (1944); Nicholson v. Morgan, 119 Misc. 309, 196 N.Y.Supp. 147 (1922); Lewis v. Hargadine-McKittrick Dry Goods Co., 305 Mo. 396, 274 S.W. 1041 (1924). 2. The practice frequently followed by authenticating trustees of issuing certicates of indebtedness rather than authenticating duplicate certicates where securities have been lost or stolen became obsolete in view of the provisions of Section 8-405, which makes express provision for the issue of substitute securities. It is not a breach of trust or lack of due diligence for trustees to authenticate new securities. Cf. Switzerland General Ins. Co. v. N.Y.C. & H.R.R. Co., 152 App.Div. 70, 136 N.Y.S. 726 (1912). Denitional Cross References: Certicated security. Section 8-102(a)(4). Issuer. Section 8-201. Security. Section 8-102(a)(15). Security certicate. Section 8-102(a)(16). Uncerticated security. Section 8-102(a)(18).

PART 5. SECURITY ENTITLEMENTS

8-501. Securities Account; Acquisition of Security Entitlement from Securities Intermediary. (a) Securities account means an account to which a nancial asset is or may be credited in accordance with an agreement under which the person maintaining the account undertakes to treat the person for whom the account is maintained as entitled to exercise the rights that comprise the nancial asset. (b) Except as otherwise provided in subsections (d) and (e), a person acquires a security entitlement if a securities intermediary: (1) indicates by book entry that a nancial asset has been credited to the person's securities account;
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(2) receives a nancial asset from the person or acquires a nancial asset for the person and, in either case, accepts it for credit to the person's securities account; or (3) becomes obligated under other law, regulation, or rule to credit a nancial asset to the person's securities account. (c) If a condition of subsection (b) has been met, a person has a security entitlement even though the securities intermediary does not itself hold the nancial asset. (d) If a securities intermediary holds a nancial asset for another person, and the nancial asset is registered in the name of, payable to the order of, or specially indorsed to the other person, and has not been indorsed to the securities intermediary or in blank, the other person is treated as holding the nancial asset directly rather than as having a security entitlement with respect to the nancial asset. (e) Issuance of a security is not establishment of a security entitlement. Ocial Comment
1. Part 5 rules apply to security entitlements, and Section 8-501(b) provides that a person has a security entitlement when a nancial asset has been credited to a securities account. Thus, the term securities account species the type of arrangements between institutions and their customers that are covered by Part 5. A securities account is a consensual arrangement in which the intermediary undertakes to treat the customer as entitled to exercise the rights that comprise the nancial asset. The consensual aspect is covered by the requirement that the account be established pursuant to agreement. The term agreement is used in the broad sense dened in Section 1-201(3). There is no requirement that a formal or written agreement be signed. As the securities business is presently conducted, several signicant relationships clearly fall within the denition of a securities account, including the relationship between a clearing corporation and its participants, a broker and customers who leave securities with the broker, and a bank acting as securities custodian and its custodial customers. Given the enormous variety of arrangements concerning securities that exist today, and the certainty that new arrangements will evolve in the future, it is not possible to specify all of the arrangements to which the term does and does not apply. Whether an arrangement between a rm and another person concerning a security or other nancial asset is a securities account under this Article depends on whether the rm has undertaken to treat the other person as entitled to exercise the rights that comprise the security or other nancial asset. Section 1-102, however, states the fundamental principle of interpretation that the Code provisions should be construed and applied to promote their underlying purposes and policies. Thus, the question whether a given arrangement is a securities account should be decided not by dictionary analysis of the words of the denition taken out of context, but by considering whether it promotes the objectives of Article 8 to include the arrangement within the term securities account. The eect of concluding that an arrangement is a securities account is that the rules of Part 5 apply. Accordingly, the denition of securities account must be interpreted in light of the substantive provisions in Part 5, which describe the core features of the type of relationship for which the commercial law rules of Revised Article 8 concerning security entitlements were designed. There are many arrangements between institutions and other persons concerning securities or other nancial assets which do not fall within the denition of securities account because the institutions have not undertaken to treat the other persons as entitled to exercise the ordinary rights of an entitlement holder specied in the Part 5 rules. For example, the term securities account does not cover the relationship between a bank and its depositors or the relationship between a trustee and the beneciary of an ordinary trust, because those are not relationships in which the holder of a nancial asset has undertaken to treat the other as entitled to exercise the rights that comprise the nancial asset in the fashion contemplated by the Part 5 rules. In short, the primary factor in deciding whether an arrangement is a securities account 795

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is whether application of the Part 5 rules is consistent with the expectations of the parties to the relationship. Relationships not governed by Part 5 may be governed by other parts of Article 8 if the relationship gives rise to a new security, or may be governed by other law entirely. 2. Subsection (b) of this section species what circumstances give rise to security entitlements. Paragraph (1) of subsection (b) sets out the most important rule. It turns on the intermediary's conduct, reecting a basic operating assumption of the indirect holding system that once a securities intermediary has acknowledged that it is carrying a position in a nancial asset for its customer or participant, the intermediary is obligated to treat the customer or participant as entitled to the nancial asset. Paragraph (1) does not attempt to specify exactly what accounting, record-keeping, or information transmission steps suce to indicate that the intermediary has credited the account. That is left to agreement, trade practice, or rule in order to provide the exibility necessary to accommodate varying or changing accounting and information processing systems. The point of paragraph (1) is that once an intermediary has acknowledged that it is carrying a position for the customer or participant, the customer or participant has a security entitlement. The precise form in which the intermediary manifests that acknowledgment is left to private ordering. Paragraph (2) of subsection (b) sets out a dierent operational test, turning not on the intermediary's accounting system but on the facts that accounting systems are supposed to represent. Under paragraph (b)(2) a person has a security entitlement if the intermediary has received and accepted a nancial asset for credit to the account of its customer or participant. For example, if a customer of a broker or bank custodian delivers a security certicate in proper form to the broker or bank to be held in the customer's account, the customer acquires a security entitlement. Paragraph (b)(2) also covers circumstances in which the intermediary receives a nancial asset from a third person for credit to the account of the customer or participant. Paragraph (b)(2) is not limited to circumstances in which the intermediary receives security certicates or other nancial assets in physical form. Paragraph (b)(2) also covers circumstances in which the intermediary acquires a security entitlement with respect to a nancial asset which is to be credited to the account of the intermediary's own customer. For example, if a customer transfers her account from Broker A to Broker B, she acquires security entitlements against Broker B once the clearing corporation has credited the positions to Broker B's account. It should be noted, however, that paragraph (b)(2) provides that a person acquires a security entitlement when the intermediary not only receives but also accepts the nancial asset for credit to the account. This limitation is included to take account of the fact that there may be circumstances in which an intermediary has received a nancial asset but is not willing to undertake the obligations that ow from establishing a security entitlement. For example, a security certicate which is sent to an intermediary may not be in proper form, or may represent a type of nancial asset which the intermediary is not willing to carry for others. It should be noted that in all but extremely unusual cases, the circumstances covered by paragraph (2) will also be covered by paragraph (1), because the intermediary will have credited the positions to the customer's account. Paragraph (3) of subsection (b) sets out a residual test, to avoid any implication that the failure of an intermediary to make the appropriate entries to credit a position to a customer's securities account would prevent the customer from acquiring the rights of an entitlement holder under Part 5. As is the case with the paragraph (2) test, the paragraph (3) test would not be needed for the ordinary cases, since they are covered by paragraph (1). 3. In a sense, Section 8-501(b) is analogous to the rules set out in the provisions of Sections 8-313(1)(d) and 8-320 of the prior version of Article 8 that specied what acts by a securities intermediary or clearing corporation suced as a transfer of securities held in fungible bulk. Unlike the prior version of Article 8, however, this section is not based on the idea that an entitlement holder acquires rights only by virtue of a transfer from the securities intermediary to the entitlement holder. In the indirect holding system, the significant fact is that the securities intermediary has undertaken to treat the customer as entitled to the nancial asset. It is up to the securities intermediary to take the necessary steps to ensure that it will be able to perform its undertaking. It is, for example, entirely possible that a securities intermediary might make entries in a customer's account reecting that customer's acquisition of a certain security at a time when the securities intermediary did not itself happen to hold any units of that security. The person from whom the securities intermediary bought the security might have failed to deliver and it might have 796

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taken some time to clear up the problem, or there may have been an operational gap in time between the crediting of a customer's account and the receipt of securities from another securities intermediary. The entitlement holder's rights against the securities intermediary do not depend on whether or when the securities intermediary acquired its interests. Subsection (c) is intended to make this point clear. Subsection (c) does not mean that the intermediary is free to create security entitlements without itself holding sucient nancial assets to satisfy its entitlement holders. The duty of a securities intermediary to maintain sucient assets is governed by Section 8-504 and regulatory law. Subsection (c) is included only to make it clear the question whether a person has acquired a security entitlement does not depend on whether the intermediary has complied with that duty. 4. Part 5 of Article 8 sets out a carefully designed system of rules for the indirect holding system. Persons who hold securities through brokers or custodians have security entitlements that are governed by Part 5, rather than being treated as the direct holders of securities. Subsection (d) species the limited circumstance in which a customer who leaves a nancial asset with a broker or other securities intermediary has a direct interest in the nancial asset, rather than a security entitlement. The customer can be a direct holder only if the security certicate, or other nancial asset, is registered in the name of, payable to the order of, or specially indorsed to the customer, and has not been indorsed by the customer to the securities intermediary or in blank. The distinction between those circumstances where the customer can be treated as direct owner and those where the customer has a security entitlement is essentially the same as the distinction drawn under the federal bankruptcy code between customer name securities and customer property. The distinction does not turn on any form of physical identication or segregation. A customer who delivers certicates to a broker with blank indorsements or stock powers is not a direct holder but has a security entitlement, even though the broker holds those certicates in some form of separate safe-keeping arrangement for that particular customer. The customer remains the direct holder only if there is no indorsement or stock power so that further action by the customer is required to place the certicates in a form where they can be transferred by the broker. The rule of subsection (d) corresponds to the rule set out in Section 8-301(a)(3) specifying when acquisition of possession of a certicate by a securities intermediary counts as delivery to the customer. 5. Subsection (e) is intended to make clear that Part 5 does not apply to an arrangement in which a security is issued representing an interest in underlying assets, as distinguished from arrangements in which the underlying assets are carried in a securities account. A common mechanism by which new nancial instruments are devised is that a nancial institution that holds some security, nancial instrument, or pool thereof, creates interests in that asset or pool which are sold to others. In many such cases, the interests so created will fall within the denition of security in Section 8-102(a)(15). If so, then by virtue of subsection (e) of Section 8-501, the relationship between the institution that creates the interests and the persons who hold them is not a security entitlement to which the Part 5 rules apply. Accordingly, an arrangement such as an American depositary receipt facility which creates freely transferable interests in underlying securities will be issuance of a security under Article 8 rather than establishment of a security entitlement to the underlying securities. The subsection (e) rule can be regarded as an aspect of the denitional rules specifying the meaning of securities account and security entitlement. Among the key components of the denition of security in Section 8-102(a)(15) are the transferability and divisibility tests. Securities, in the Article 8 sense, are fungible interests or obligations that are intended to be tradable. The concept of security entitlement under Part 5 is quite dierent. A security entitlement is the package of rights that a person has against the person's own intermediary with respect to the positions carried in the person's securities account. That package of rights is not, as such, something that is traded. When a customer sells a security that she had held through a securities account, her security entitlement is terminated; when she buys a security that she will hold through her securities account, she acquires a security entitlement. In most cases, settlement of a securities trade will involve termination of one person's security entitlement and acquisition of a security entitlement by another person. That transaction, however, is not a transfer of the same entitlement from one person to another. That is not to say that an entitlement holder cannot transfer an interest in her security entitlement as such; granting a security interest in a security 797

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entitlement is such a transfer. On the other hand, the nature of a security entitlement is that the intermediary is undertaking duties only to the person identied as the entitlement holder. Denitional Cross References: Financial asset. Section 8-102(a)(9). Indorsement. Section 8-102(a)(11). Securities intermediary. Section 8-102(a)(14). Security. Section 8-102(a)(15). Security entitlement. Section 8-102(a)(17).

8-502. Assertion of Adverse Claim Against Entitlement Holder. An action based on an adverse claim to a nancial asset, whether framed in conversion, replevin, constructive trust, equitable lien, or other theory, may not be asserted against a person who acquires a security entitlement under Section 8-501 for value and without notice of the adverse claim. Ocial Comment
1. The section provides investors in the indirect holding system with protection against adverse claims by specifying that no adverse claim can be asserted against a person who acquires a security entitlement under Section 8-501 for value and without notice of the adverse claim. It plays a role in the indirect holding system analogous to the rule of the direct holding system that protected purchasers take free from adverse claims (Section 8-303). This section does not use the locution takes free from adverse claims because that could be confusing as applied to the indirect holding system. The nature of indirect holding system is that an entitlement holder has an interest in common with others who hold positions in the same nancial asset through the same intermediary. Thus, a particular entitlement holder's interest in the nancial assets held by its intermediary is necessarily subject to the interests of others. See Section 8-503. The rule stated in this section might have been expressed by saying that a person who acquires a security entitlement under Section 8-501 for value and without notice of adverse claims takes that security entitlement free from adverse claims. That formulation has not been used, however, for fear that it would be misinterpreted as suggesting that the person acquires a right to the underlying nancial assets that could not be aected by the competing rights of others claiming through common or higher tier intermediaries. A security entitlement is a complex bundle of rights. This section does not deal with the question of what rights are in the bundle. Rather, this section provides that once a person has acquired the bundle, someone else cannot take it away on the basis of assertion that the transaction in which the security entitlement was created involved a violation of the claimant's rights. 2. Because securities trades are typically settled on a net basis by book-entry movements, it would ordinarily be impossible for anyone to trace the path of any particular security, no matter how the interest of parties who hold through intermediaries is described. Suppose, for example, that S has a 1000 share position in XYZ common stock through an account with a broker, Able & Co. S's identical twin impersonates S and directs Able to sell the securities. That same day, B places an order with Baker & Co., to buy 1000 shares of XYZ common stock. Later, S discovers the wrongful act and seeks to recover her shares. Even if S can show that, at the stage of the trade, her sell order was matched with B's buy order, that would not suce to show that her shares went to B. Settlement between Able and Baker occurs on a net basis for all trades in XYZ that day; indeed Able's net position may have been such that it received rather than delivered shares in XYZ through the settlement system. In the unlikely event that this was the only trade in XYZ common stock executed in the market that day, one could follow the shares from S's account to B's account. The plainti in an action in conversion or similar legal action to enforce a property interest must show that the defendant has an item of property that belongs to the plainti. In this example, B's security entitlement is not the same item of property that formerly was held by S, it is a new package of rights that B acquired against Baker under Section 8-501. Principles of equitable remedies might, however, provide S with a basis for contending that if the posi798

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tion B received was the traceable product of the wrongful taking of S's property by S's twin, a constructive trust should be imposed on B's property in favor of S. See G. Palmer, The Law of Restitution 2.14. Section 8-502 ensures that no such claims can be asserted against a person, such as B in this example, who acquires a security entitlement under Section 8-501 for value and without notice, regardless of what theory of law or equity is used to describe the basis of the assertion of the adverse claim. In the above example, S would ordinarily have no reason to pursue B unless Able is insolvent and S's claim will not be satised in the insolvency proceedings. Because S did not give an entitlement order for the disposition of her security entitlement, Able must recredit her account for the 1000 shares of XYZ common stock. See Section 8-507(b). 3. The following examples illustrate the operation of Section 8-502. Example 1. Thief steals bearer bonds from Owner. Thief delivers the bonds to Broker for credit to Thief's securities account, thereby acquiring a security entitlement under Section 8-501(b). Under other law, Owner may have a claim to have a constructive trust imposed on the security entitlement as the traceable product of the bonds that Thief misappropriated. Because Thief was himself the wrongdoer, Thief obviously had notice of Owner's adverse claim. Accordingly, Section 8-502 does not preclude Owner from asserting an adverse claim against Thief. Example 2. Thief steals bearer bonds from Owner. Thief owes a personal debt to Creditor. Creditor has a securities account with Broker. Thief agrees to transfer the bonds to Creditor as security for or in satisfaction of his debt to Creditor. Thief does so by sending the bonds to Broker for credit to Creditor's securities account. Creditor thereby acquires a security entitlement under Section 8-501(b). Under other law, Owner may have a claim to have a constructive trust imposed on the security entitlement as the traceable product of the bonds that Thief misappropriated. Creditor acquired the security entitlement for value, since Creditor acquired it as security for or in satisfaction of Thief's debt to Creditor. See Section 1-201(44). If Creditor did not have notice of Owner's claim, Section 8-502 precludes any action by Owner against Creditor, whether framed in constructive trust or other theory. Section 8-105 species what counts as notice of an adverse claim. Example 3. Father, as trustee for Son, holds XYZ Co. shares in a securities account with Able & Co. In violation of his duciary duties, Father sells the XYZ Co. shares and uses the proceeds for personal purposes. Father dies, and his estate is insolvent. Assumeimplausiblythat Son is able to trace the XYZ Co. shares and show that the same shares ended up in Buyer's securities account with Baker & Co. Section 8-502 precludes any action by Son against Buyer, whether framed in constructive trust or other theory, provided that Buyer acquired the security entitlement for value and without notice of adverse claims. Example 4. Debtor holds XYZ Co. shares in a securities account with Able & Co. As collateral for a loan from Bank, Debtor grants Bank a security interest in the security entitlement to the XYZ Co. shares. Bank perfects by a method which leaves Debtor with the ability to dispose of the shares. See Section 9-312. In violation of the security agreement, Debtor sells the XYZ Co. shares and absconds with the proceeds. Assume implausiblythat Bank is able to trace the XYZ Co. shares and show that the same shares ended up in Buyer's securities account with Baker & Co. Section 8-502 precludes any action by Bank against Buyer, whether framed in constructive trust or other theory, provided that Buyer acquired the security entitlement for value and without notice of adverse claims. Example 5. Debtor owns controlling interests in various public companies, including Acme and Ajax. Acme owns 60% of the stock of another public company, Beta. Debtor causes the Beta stock to be pledged to Lending Bank as collateral for Ajax's debt. Acme holds the Beta stock through an account with a securities custodian, C Bank, which in turn holds through Clearing Corporation. Lending Bank is also a Clearing Corporation participant. The pledge of the Beta stock is implemented by Acme instructing C Bank to instruct Clearing Corporation to debit C Bank's account and credit Lending Bank's account. Acme and Ajax both become insolvent. The Beta stock is still valuable. Acme's liquidator asserts that the pledge of the Beta stock for Ajax's debt was wrongful as against Acme and seeks to recover the Beta stock from Lending Bank. Because the pledge was implemented by an outright transfer into Lending Bank's account at Clearing Corporation, Lending Bank acquired a security entitlement to the Beta stock under 799

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Section 8-501. Lending Bank acquired the security entitlement for value, since it acquired it as security for a debt. See Section 1-201(44). If Lending Bank did not have notice of Acme's claim, Section 8-502 will preclude any action by Acme against Lending Bank, whether framed in constructive trust or other theory. Example 6. Debtor grants Alpha Co. a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Alpha also has an account with Able. Debtor instructs Able to transfer the shares to Alpha, and Able does so by crediting the shares to Alpha's account. Alpha has control of the 1000 shares under Section 8-106(d). (The facts to this point are identical to those in Section 8-106, Comment 4, Example 1, except that Alpha Co. was Alpha Bank.) Alpha next grants Beta Co. a security interest in the 1000 shares included in Alpha's security entitlement. See Section 9-207(c)(3). Alpha instructs Able to transfer the shares to Gamma Co., Beta's custodian. Able does so, and Gamma credits the 1000 shares to Beta's account. Beta now has control under Section 8-106(d). By virtue of Debtor's explicit permission or by virtue of the permission inherent in Debtor's creation of a security interest in favor of Alpha and Alpha's resulting power to grant a security interest under Section 9-207, Debtor has no adverse claim to assert against Beta, assuming implausibly that Debtor could trace an interest to the Gamma account. Moreover, even if Debtor did hold an adverse claim, if Beta did not have notice of Debtor's claim, Section 8-502 will preclude any action by Debtor against Beta, whether framed in constructive trust or other theory. 4. Although this section protects entitlement holders against adverse claims, it does not protect them against the risk that their securities intermediary will not itself have sufcient nancial assets to satisfy the claims of all of its entitlement holders. Suppose that Customer A holds 1000 shares of XYZ Co. stock in an account with her broker, Able & Co. Able in turn holds 1000 shares of XYZ Co. through its account with Clearing Corporation, but has no other positions in XYZ Co. shares, either for other customers or for its own proprietary account. Customer B places an order with Able for the purchase of 1000 shares of XYZ Co. stock, and pays the purchase price. Able credits B's account with a 1000 share position in XYZ Co. stock, but Able does not itself buy any additional XYZ Co. shares. Able fails, having only 1000 shares to satisfy the claims of A and B. Unless other insolvency law establishes a dierent distributional rule, A and B would share the 1000 shares held by Able pro rata, without regard to the time that their respective entitlements were established. See Section 8-503(b). Section 8-502 protects entitlement holders, such as A and B, against adverse claimants. In this case, however, the problem that A and B face is not that someone is trying to take away their entitlements, but that the entitlements are not worth what they thought. The only role that Section 8-502 plays in this case is to preclude any assertion that A has some form of claim against B by virtue of the fact that Able's establishment of an entitlement in favor of B diluted A's rights to the limited assets held by Able. Denitional Cross References: Adverse claim. Section 8-102(a)(1). Financial asset. Section 8-102(a)(9). Notice of adverse claim. Section 8-105. Security entitlement. Section 8-102(a)(17). Value. Sections 1-201(44) & 8-116.

As amended in 1999.
See Appendix I contained within revised Article 9 for material relating to changes made in Ocial Comment in 1999.

8-503. Property Interest of Entitlement Holder in Financial Asset Held By Securities Intermediary. (a) To the extent necessary for a securities intermediary to satisfy all security entitlements with respect to a particular nancial asset, all interests in that nancial asset held by the securities intermediary are held by the securities intermediary for the entitlement holders, are not property of the securities intermediary, and are not subject to claims of creditors of the securities intermediary, except as otherwise provided in Section 8-511.
800

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(b) An entitlement holder's property interest with respect to a particular nancial asset under subsection (a) is a pro rata property interest in all interests in that nancial asset held by the securities intermediary, without regard to the time the entitlement holder acquired the security entitlement or the time the securities intermediary acquired the interest in that nancial asset. (c) An entitlement holder's property interest with respect to a particular nancial asset under subsection (a) may be enforced against the securities intermediary only by exercise of the entitlement holder's rights under Sections 8-505 through 8-508. (d) An entitlement holder's property interest with respect to a particular nancial asset under subsection (a) may be enforced against a purchaser of the nancial asset or interest therein only if: (1) insolvency proceedings have been initiated by or against the securities intermediary; (2) the securities intermediary does not have sucient interests in the nancial asset to satisfy the security entitlements of all of its entitlement holders to that nancial asset; (3) the securities intermediary violated its obligations under Section 8-504 by transferring the nancial asset or interest therein to the purchaser; and (4) the purchaser is not protected under subsection (e). The trustee or other liquidator, acting on behalf of all entitlement holders having security entitlements with respect to a particular nancial asset, may recover the nancial asset, or interest therein, from the purchaser. If the trustee or other liquidator elects not to pursue that right, an entitlement holder whose security entitlement remains unsatised has the right to recover its interest in the nancial asset from the purchaser. (e) An action based on the entitlement holder's property interest with respect to a particular nancial asset under subsection (a), whether framed in conversion, replevin, constructive trust, equitable lien, or other theory, may not be asserted against any purchaser of a nancial asset or interest therein who gives value, obtains control, and does not act in collusion with the securities intermediary in violating the securities intermediary's obligations under Section 8-504. Ocial Comment
1. This section species the sense in which a security entitlement is an interest in the property held by the securities intermediary. It expresses the ordinary understanding that securities that a rm holds for its customers are not general assets of the rm subject to the claims of creditors. Since securities intermediaries generally do not segregate securities in such fashion that one could identify particular securities as the ones held for customers, it would not be realistic for this section to state that customers' securities are not subject to creditors' claims. Rather subsection (a) provides that to the extent necessary to satisfy all customer claims, all units of that security held by the rm are held for the entitlement holders, are not property of the securities intermediary, and are not subject to creditors' claims, except as otherwise provided in Section 8-511. An entitlement holder's property interest under this section is an interest with respect to a specic issue of securities or nancial assets. For example, customers of a rm who have positions in XYZ common stock have security entitlements with respect to the XYZ common stock held by the intermediary, while other customers who have positions in ABC common stock have security entitlements with respect to the ABC common stock held by the 801

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intermediary. Subsection (b) makes clear that the property interest described in subsection (a) is an interest held in common by all entitlement holders who have entitlements to a particular security or other nancial asset. Temporal factors are irrelevant. One entitlement holder cannot claim that its rights to the assets held by the intermediary are superior to the rights of another entitlement holder by virtue of having acquired those rights before, or after, the other entitlement holder. Nor does it matter whether the intermediary had sufcient assets to satisfy all entitlement holders' claims at one point, but no longer does. Rather, all entitlement holders have a pro rata interest in whatever positions in that nancial asset the intermediary holds. Although this section describes the property interest of entitlement holders in the assets held by the intermediary, it does not necessarily determine how property held by a failed intermediary will be distributed in insolvency proceedings. If the intermediary fails and its aairs are being administered in an insolvency proceeding, the applicable insolvency law governs how the various parties having claims against the rm are treated. For example, the distributional rules for stockbroker liquidation proceedings under the Bankruptcy Code and Securities Investor Protection Act (SIPA) provide that all customer property is distributed pro rata among all customers in proportion to the dollar value of their total positions, rather than dividing the property on an issue by issue basis. For intermediaries that are not subject to the Bankruptcy Code and SIPA, other insolvency law would determine what distributional rule is applied. 2. Although this section recognizes that the entitlement holders of a securities intermediary have a property interest in the nancial assets held by the intermediary, the incidents of this property interest are established by the rules of Article 8, not by common law property concepts. The traditional Article 8 rules on certicated securities were based on the idea that a paper certicate could be regarded as a nearly complete reication of the underlying right. The rules on transfer and the consequences of wrongful transfer could then be written using the same basic concepts as the rules for physical chattels. A person's claim of ownership of a certicated security is a right to a specic identiable physical object, and that right can be asserted against any person who ends up in possession of that physical certicate, unless cut o by the rules protecting purchasers for value without notice. Those concepts do not work for the indirect holding system. A security entitlement is not a claim to a specic identiable thing; it is a package of rights and interests that a person has against the person's securities intermediary and the property held by the intermediary. The idea that discrete objects might be traced through the hands of dierent persons has no place in the Revised Article 8 rules for the indirect holding system. The fundamental principles of the indirect holding system rules are that an entitlement holder's own intermediary has the obligation to see to it that the entitlement holder receives all of the economic and corporate rights that comprise the nancial asset, and that the entitlement holder can look only to that intermediary for performance of the obligations. The entitlement holder cannot assert rights directly against other persons, such as other intermediaries through whom the intermediary holds the positions, or third parties to whom the intermediary may have wrongfully transferred interests, except in extremely unusual circumstances where the third party was itself a participant in the wrongdoing. Subsections (c) through (e) reect these fundamental principles. Subsection (c) provides that an entitlement holder's property interest can be enforced against the intermediary only by exercise of the entitlement holder's rights under Sections 8-505 through 8-508. These are the provisions that set out the duty of an intermediary to see to it that the entitlement holder receives all of the economic and corporate rights that comprise the security. If the intermediary is in insolvency proceedings and can no longer perform in accordance with the ordinary Part 5 rules, the applicable insolvency law will determine how the intermediary's assets are to be distributed. Subsections (d) and (e) specify the limited circumstances in which an entitlement holder's property interest can be asserted against a third person to whom the intermediary transferred a nancial asset that was subject to the entitlement holder's claim when held by the intermediary. Subsection (d) provides that the property interest of entitlement holders cannot be asserted against any transferee except in the circumstances therein specied. So long as the intermediary is solvent, the entitlement holders must look to the intermediary to satisfy their claims. If the intermediary does not hold nancial assets corresponding to the entitlement holders' claims, the intermediary has the duty to acquire them. See 802

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Section 8-504. Thus, paragraphs (1), (2), and (3) of subsection (d) specify that the only occasion in which the entitlement holders can pursue transferees is when the intermediary is unable to perform its obligation, and the transfer to the transferee was a violation of those obligations. Even in that case, a transferee who gave value and obtained control is protected by virtue of the rule in subsection (e), unless the transferee acted in collusion with the intermediary. Subsections (d) and (e) have the eect of protecting transferees from an intermediary against adverse claims arising out of assertions by the intermediary's entitlement holders that the intermediary acted wrongfully in transferring the nancial assets. These rules, however, operate in a slightly dierent fashion than traditional adverse claim cut-o rules. Rather than specifying that a certain class of transferee takes free from all claims, subsections (d) and (e) specify the circumstances in which this particular form of claim can be asserted against a transferee. Revised Article 8 also contains general adverse claim cut-o rules for the indirect holding system. See Sections 8-502 and 8-510. The rule of subsections (d) and (e) takes precedence over the general cut-o rules of those sections, because Section 8-503 itself denes and sets limits on the assertion of the property interest of entitlement holders. Thus, the question whether entitlement holders' property interest can be asserted as an adverse claim against a transferee from the intermediary is governed by the collusion test of Section 8-503(e), rather than by the without notice test of Sections 8-502 and 8-510. 3. The limitations that subsections (c) through (e) place on the ability of customers of a failed intermediary to recover securities or other nancial assets from transferees are consistent with the fundamental policies of investor protection that underlie this Article and other bodies of law governing the securities business. The commercial law rules for the securities holding and transfer system must be assessed from the forward-looking perspective of their impact on the vast number of transactions in which no wrongful conduct occurred or will occur, rather than from the post hoc perspective of what rule might be most advantageous to a particular class of persons in litigation that might arise out of the occasional case in which someone has acted wrongfully. Although one can devise hypothetical scenarios where particular customers might nd it advantageous to be able to assert rights against someone other than the customers' own intermediary, commercial law rules that permitted customers to do so would impair rather than promote the interest of investors and the safe and ecient operation of the clearance and settlement system. Suppose, for example, that Intermediary A transfers securities to B, that Intermediary A acted wrongfully as against its customers in so doing, and that after the transaction Intermediary A did not have sufcient securities to satisfy its obligations to its entitlement holders. Viewed solely from the standpoint of the customers of Intermediary A, it would seem that permitting the property to be recovered from B, would be good for investors. That, however, is not the case. B may itself be an intermediary with its own customers, or may be some other institution through which individuals invest, such as a pension fund or investment company. There is no reason to think that rules permitting customers of an intermediary to trace and recover securities that their intermediary wrongfully transferred work to the advantage of investors in general. To the contrary, application of such rules would often merely shift losses from one set of investors to another. The uncertainties that would result from rules permitting such recoveries would work to the disadvantage of all participants in the securities markets. The use of the collusion test in Section 8-503(e) furthers the interests of investors generally in the sound and ecient operation of the securities holding and settlement system. The eect of the choice of this standard is that customers of a failed intermediary must show that the transferee from whom they seek to recover was armatively engaged in wrongful conduct, rather than casting on the transferee any burden of showing that the transferee had no awareness of wrongful conduct by the failed intermediary. The rule of Section 8-503(e) is based on the long-standing policy that it is undesirable to impose upon purchasers of securities any duty to investigate whether their sellers may be acting wrongfully. Rather than imposing duties to investigate, the general policy of the commercial law of the securities holding and transfer system has been to eliminate legal rules that might induce participants to conduct investigations of the authority of persons transferring securities on behalf of others for fear that they might be held liable for participating in a wrongful transfer. The rules in Part 4 of Article 8 concerning transfers by duciaries provide a good example. Under Lowry v. Commercial & Farmers' Bank, 15 F.Cas. 1040 803

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(C.C.D.Md.1848) (No. 8581), an issuer could be held liable for wrongful transfer if it registered transfer of securities by a duciary under circumstances where it had any reason to believe that the duciary may have been acting improperly. In one sense that seems to be advantageous for beneciaries who might be harmed by wrongful conduct by duciaries. The consequence of the Lowry rule, however, was that in order to protect against risk of such liability, issuers developed the practice of requiring extensive documentation for duciary stock transfers, making such transfers cumbersome and time consuming. Accordingly, the rules in Part 4 of Article 8, and in the prior duciary transfer statutes, were designed to discourage transfer agents from conducting investigations into the rightfulness of transfers by duciaries. The rules of Revised Article 8 implement for the indirect holding system the same policies that the rules on protected purchasers and registration of transfer adopt for the direct holding system. A securities intermediary is, by denition, a person who is holding securities on behalf of other persons. There is nothing unusual or suspicious about a transaction in which a securities intermediary sells securities that it was holding for its customers. That is exactly what securities intermediaries are in business to do. The interests of customers of securities intermediaries would not be served by a rule that required counterparties to transfers from securities intermediaries to investigate whether the intermediary was acting wrongfully against its customers. Quite the contrary, such a rule would impair the ability of securities intermediaries to perform the function that customers want. The rules of Section 8-503(c) through (e) apply to transferees generally, including pledgees. The reasons for treating pledgees in the same fashion as other transferees are discussed in the Comments to Section 8-511. The statement in subsection (a) that an intermediary holds nancial assets for customers and not as its own property does not, of course, mean that the intermediary lacks power to transfer the nancial assets to others. For example, although Article 9 provides that for a security interest to attach the debtor must either have rights in the collateral or the power to transfer rights in the collateral to a secured party, see Section 9-203, the fact that an intermediary is holding a nancial asset in a form that permits ready transfer means that it has such rights, even if the intermediary is acting wrongfully against its entitlement holders in granting the security interest. The question whether the secured party takes subject to the entitlement holder's claim in such a case is governed by Section 8-511, which is an application to secured transactions of the general principles expressed in subsections (d) and (e) of this section. Denitional Cross References: Control. Section 8-106. Entitlement holder. Section 8-102(a)(7). Financial asset. Section 8-102(a)(9). Insolvency proceedings. Section 1-201(22). Purchaser. Sections 1-201(33) & 8-116. Securities intermediary. Section 8-102(a)(14). Security entitlement. Section 8-102(a)(17). Value. Sections 1-201(44) & 8-116.

8-504. Duty of Securities Intermediary to Maintain Financial Asset. (a) A securities intermediary shall promptly obtain and thereafter maintain a nancial asset in a quantity corresponding to the aggregate of all security entitlements it has established in favor of its entitlement holders with respect to that nancial asset. The securities intermediary may maintain those nancial assets directly or through one or more other securities intermediaries. (b) Except to the extent otherwise agreed by its entitlement holder, a securities intermediary may not grant any security interests in a nancial asset it is obligated to maintain pursuant to subsection (a). (c) A securities intermediary satises the duty in subsection (a) if:
804

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(1) the securities intermediary acts with respect to the duty as agreed upon by the entitlement holder and the securities intermediary; or (2) in the absence of agreement, the securities intermediary exercises due care in accordance with reasonable commercial standards to obtain and maintain the nancial asset. (d) This section does not apply to a clearing corporation that is itself the obligor of an option or similar obligation to which its entitlement holders have security entitlements. Ocial Comment
1. This section expresses one of the core elements of the relationships for which the Part 5 rules were designed, to wit, that a securities intermediary undertakes to hold nancial assets corresponding to the security entitlements of its entitlement holders. The locution shall promptly obtain and shall thereafter maintain is taken from the corresponding regulation under federal securities law, 17 C.F.R. 240.15c3-3. This section recognizes the reality that as the securities business is conducted today, it is not possible to identify particular securities as belonging to customers as distinguished from other particular securities that are the rm's own property. Securities rms typically keep all securities in fungible form, and may maintain their inventory of a particular security in various locations and forms, including physical securities held in vaults or in transit to transfer agents, and book entry positions at one or more clearing corporations. Accordingly, this section states that a securities intermediary shall maintain a quantity of nancial assets corresponding to the aggregate of all security entitlements it has established. The last sentence of subsection (a) provides explicitly that the securities intermediary may hold directly or indirectly. That point is implicit in the use of the term nancial asset, inasmuch as Section 8-102(a)(9) provides that the term nancial asset may refer either to the underlying asset or the means by which it is held, including both security certicates and security entitlements. 2. Subsection (b) states explicitly a point that is implicit in the notion that a securities intermediary must maintain nancial assets corresponding to the security entitlements of its entitlement holders, to wit, that it is wrongful for a securities intermediary to grant security interests in positions that it needs to satisfy customers' claims, except as authorized by the customers. This statement does not determine the rights of a secured party to whom a securities intermediary wrongfully grants a security interest; that issue is governed by Sections 8-503 and 8-511. Margin accounts are common examples of arrangements in which an entitlement holder authorizes the securities intermediary to grant security interests in the positions held for the entitlement holder. Securities rms commonly obtain the funds needed to provide margin loans to their customers by rehypothecating the customers' securities. In order to facilitate rehypothecation, agreements between margin customers and their brokers commonly authorize the broker to commingle securities of all margin customers for rehypothecation to the lender who provides the nancing. Brokers commonly rehypothecate customer securities having a value somewhat greater than the amount of the loan made to the customer, since the lenders who provide the necessary nancing to the broker need some cushion of protection against the risk of decline in the value of the rehypothecated securities. The extent and manner in which a rm may rehypothecate customers' securities are determined by the agreement between the intermediary and the entitlement holder and by applicable regulatory law. Current regulations under the federal securities laws require that brokers obtain the explicit consent of customers before pledging customer securities or commingling dierent customers' securities for pledge. Federal regulations also limit the extent to which a broker may rehypothecate customer securities to 110% of the aggregate amount of the borrowings of all customers. 3. The statement in this section that an intermediary must obtain and maintain nancial assets corresponding to the aggregate of all security entitlements it has established is intended only to capture the general point that one of the key elements that distinguishes securities accounts from other relationships, such as deposit accounts, is that the intermediary undertakes to maintain a direct correspondence between the positions it holds and the claims of its customers. This section is not intended as a detailed specication of precisely how the intermediary is to perform this duty, nor whether there may be special circum805

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stances in which an intermediary's general duty is excused. Accordingly, the general statement of the duties of a securities intermediary in this and the following sections is supplemented by two other provisions. First, each of Sections 8-504 through 8-508 contains an agreement/due care provision. Second, Section 8-509 sets out general qualications on the duties stated in these sections, including the important point that compliance with corresponding regulatory provisions constitutes compliance with the Article 8 duties. 4. The agreement/due care provision in subsection (c) of this section is necessary to provide sucient exibility to accommodate the general duty stated in subsection (a) to the wide variety of circumstances that may be encountered in the modern securities holding system. For the most common forms of publicly traded securities, the modern depositorybased indirect holding system has made the likelihood of an actual loss of securities remote, though correctable errors in accounting or temporary interruptions of data processing facilities may occur. Indeed, one of the reasons for the evolution of book-entry systems is to eliminate the risk of loss or destruction of physical certicates. There are, however, some forms of securities and other nancial assets which must still be held in physical certicated form, with the attendant risk of loss or destruction. Risk of loss or delay may be a more signicant consideration in connection with foreign securities. An American securities intermediary may well be willing to hold a foreign security in a securities account for its customer, but the intermediary may have relatively little choice of or control over foreign intermediaries through which the security must in turn be held. Accordingly, it is common for American securities intermediaries to disclaim responsibility for custodial risk of holding through foreign intermediaries. Subsection (c)(1) provides that a securities intermediary satises the duty stated in subsection (a) if the intermediary acts with respect to that duty in accordance with the agreement between the intermediary and the entitlement holder. Subsection (c)(2) provides that if there is no agreement on the matter, the intermediary satises the subsection (a) duty if the intermediary exercises due care in accordance with reasonable commercial standards to obtain and maintain the nancial asset in question. This formulation does not state that the intermediary has a universally applicable statutory duty of due care. Section 1-102(3) provides that statutory duties of due care cannot be disclaimed by agreement, but the agreement/due care formula contemplates that there may be particular circumstances where the parties do not wish to create a specic duty of due care, for example, with respect to foreign securities. Under subsection (c)(1), compliance with the agreement constitutes satisfaction of the subsection (a) duty, whether or not the agreement provides that the intermediary will exercise due care. In each of the sections where the agreement/due care formula is used, it provides that entering into an agreement and performing in accordance with that agreement is a method by which the securities intermediary may satisfy the statutory duty stated in that section. Accordingly, the general obligation of good faith performance of statutory and contract duties, see Sections 1-203 and 8-102(a)(10), would apply to such an agreement. It would not be consistent with the obligation of good faith performance for an agreement to purport to establish the usual sort of arrangement between an intermediary and entitlement holder, yet disclaim altogether one of the basic elements that dene that relationship. For example, an agreement stating that an intermediary assumes no responsibilities whatsoever for the safekeeping any of the entitlement holder's securities positions would not be consistent with good faith performance of the intermediary's duty to obtain and maintain nancial assets corresponding to the entitlement holder's security entitlements. To the extent that no agreement under subsection (c)(1) has specied the details of the intermediary's performance of the subsection (a) duty, subsection (c)(2) provides that the intermediary satises that duty if it exercises due care in accordance with reasonable commercial standards. The duty of care includes both care in the intermediary's own operations and care in the selection of other intermediaries through whom the intermediary holds the assets in question. The statement of the obligation of due care is meant to incorporate the principles of the common law under which the specic actions or precautions necessary to meet the obligation of care are determined by such factors as the nature and value of the property, the customs and practices of the business, and the like. 5. This section necessarily states the duty of a securities intermediary to obtain and maintain nancial assets only at the very general and abstract level. For the most part, these matters are specied in great detail by regulatory law. Broker-dealers registered under the federal securities laws are subject to detailed regulation concerning the 806

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safeguarding of customer securities. See 17 C.F.R. 240.15c3-3. Section 8-509(a) provides explicitly that if a securities intermediary complies with such regulatory law, that constitutes compliance with Section 8-503. In certain circumstances, these rules permit a rm to be in a position where it temporarily lacks a sucient quantity of nancial assets to satisfy all customer claims. For example, if another rm has failed to make a delivery to the rm in settlement of a trade, the rm is permitted a certain period of time to clear up the problem before it is obligated to obtain the necessary securities from some other source. 6. Subsection (d) is intended to recognize that there are some circumstances, where the duty to maintain a sucient quantity of nancial assets does not apply because the intermediary is not holding anything on behalf of others. For example, the Options Clearing Corporation is treated as a securities intermediary under this Article, although it does not itself hold options on behalf of its participants. Rather, it becomes the issuer of the options, by virtue of guaranteeing the obligations of participants in the clearing corporation who have written or purchased the options cleared through it. See Section 8-103(e). Accordingly, the general duty of an intermediary under subsection (a) does not apply, nor would other provisions of Part 5 that depend upon the existence of a requirement that the securities intermediary hold nancial assets, such as Sections 8-503 and 8-508. Denitional Cross References: Agreement. Section 1-201(3). Clearing corporation. Section 8-102(a)(5). Entitlement holder. Section 8-102(a)(7). Financial asset. Section 8-102(a)(9). Securities intermediary. Section 8-102(a)(14). Security entitlement. Section 8-102(a)(17).

8-505. Duty of Securities Intermediary with Respect to Payments and Distributions. (a) A securities intermediary shall take action to obtain a payment or distribution made by the issuer of a nancial asset. A securities intermediary satises the duty if: (1) the securities intermediary acts with respect to the duty as agreed upon by the entitlement holder and the securities intermediary; or (2) in the absence of agreement, the securities intermediary exercises due care in accordance with reasonable commercial standards to attempt to obtain the payment or distribution. (b) A securities intermediary is obligated to its entitlement holder for a payment or distribution made by the issuer of a nancial asset if the payment or distribution is received by the securities intermediary. Ocial Comment
1. One of the core elements of the securities account relationships for which the Part 5 rules were designed is that the securities intermediary passes through to the entitlement holders the economic benet of ownership of the nancial asset, such as payments and distributions made by the issuer. Subsection (a) expresses the ordinary understanding that a securities intermediary will take appropriate action to see to it that any payments or distributions made by the issuer are received. One of the main reasons that investors make use of securities intermediaries is to obtain the services of a professional in performing the record-keeping and other functions necessary to ensure that payments and other distributions are received. 2. Subsection (a) incorporates the same agreement/due care formula as the other provisions of Part 5 dealing with the duties of a securities intermediary. See Comment 4 to Section 8-504. This formulation permits the parties to specify by agreement what action, if any, the intermediary is to take with respect to the duty to obtain payments and distributions. In the absence of specication by agreement, the intermediary satises the duty if the intermediary exercises due care in accordance with reasonable commercial standards. The provisions of Section 8-509 also apply to the Section 8-505 duty, so that 807

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compliance with applicable regulatory requirements constitutes compliance with the Section 8-505 duty. 3. Subsection (b) provides that a securities intermediary is obligated to its entitlement holder for those payments or distributions made by the issuer that are in fact received by the intermediary. It does not deal with the details of the time and manner of payment. Moreover, as with any other monetary obligation, the obligation to pay may be subject to other rights of the obligor, by way of set-o counterclaim or the like. Section 8-509(c) makes this point explicit. Denitional Cross References: Agreement. Section 1-201(3). Entitlement holder. Section 8-102(a)(7). Financial asset. Section 8-102(a)(9). Securities intermediary. Section 8-102(a)(14). Security entitlement. Section 8-102(a)(17).

8-506. Duty of Securities Intermediary to Exercise Rights as Directed by Entitlement Holder. A securities intermediary shall exercise rights with respect to a nancial asset if directed to do so by an entitlement holder. A securities intermediary satises the duty if: (1) the securities intermediary acts with respect to the duty as agreed upon by the entitlement holder and the securities intermediary; or (2) in the absence of agreement, the securities intermediary either places the entitlement holder in a position to exercise the rights directly or exercises due care in accordance with reasonable commercial standards to follow the direction of the entitlement holder. Ocial Comment
1. Another of the core elements of the securities account relationships for which the Part 5 rules were designed is that although the intermediary may, by virtue of the structure of the indirect holding system, be the party who has the power to exercise the corporate and other rights that come from holding the security, the intermediary exercises these powers as representative of the entitlement holder rather than at its own discretion. This characteristic is one of the things that distinguishes a securities account from other arrangements where one person holds securities on behalf of another, such as the relationship between a mutual fund and its shareholders or a trustee and its beneciary. 2. The fact that the intermediary exercises the rights of security holding as representative of the entitlement holder does not, of course, preclude the entitlement holder from conferring discretionary authority upon the intermediary. Arrangements are not uncommon in which investors do not wish to have their intermediaries forward proxy materials or other information. Thus, this section provides that the intermediary shall exercise corporate and other rights if directed to do so by the entitlement holder. Moreover, as with the other Part 5 duties, the agreement/due care formulation is used in stating how the intermediary is to perform this duty. This section also provides that the intermediary satises the duty if it places the entitlement holder in a position to exercise the rights directly. This is to take account of the fact that some of the rights attendant upon ownership of the security, such as rights to bring derivative and other litigation, are far removed from the matters that intermediaries are expected to perform. 3. This section, and the two that follow, deal with the aspects of securities holding that are related to investment decisions. For example, one of the rights of holding a particular security that would fall within the purview of this section would be the right to exercise a conversion right for a convertible security. It is quite common for investors to confer discretionary authority upon another person, such as an investment adviser, with respect to these rights and other investment decisions. Because this section, and the other sections of Part 5, all specify that a securities intermediary satises the Part 5 duties if it acts in accordance with the entitlement holder's agreement, there is no inconsistency between the statement of duties of a securities intermediary and these common arrangements. 808

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4. Section 8-509 also applies to the Section 8-506 duty, so that compliance with applicable regulatory requirements constitutes compliance with this duty. This is quite important in this context, since the federal securities laws establish a comprehensive system of regulation of the distribution of proxy materials and exercise of voting rights with respect to securities held through brokers and other intermediaries. By virtue of Section 8-509(a), compliance with such regulatory requirement constitutes compliance with the Section 8-506 duty. Denitional Cross References: Agreement. Section 1-201(3). Entitlement holder. Section 8-102(a)(7). Financial asset. Section 8-102(a)(9). Securities intermediary. Section 8-102(a)(14). Security entitlement. Section 8-102(a)(17).

8-507. Duty of Securities Intermediary to Comply With Entitlement Order. (a) A securities intermediary shall comply with an entitlement order if the entitlement order is originated by the appropriate person, the securities intermediary has had reasonable opportunity to assure itself that the entitlement order is genuine and authorized, and the securities intermediary has had reasonable opportunity to comply with the entitlement order. A securities intermediary satises the duty if: (1) the securities intermediary acts with respect to the duty as agreed upon by the entitlement holder and the securities intermediary; or (2) in the absence of agreement, the securities intermediary exercises due care in accordance with reasonable commercial standards to comply with the entitlement order. (b) If a securities intermediary transfers a nancial asset pursuant to an ineective entitlement order, the securities intermediary shall reestablish a security entitlement in favor of the person entitled to it, and pay or credit any payments or distributions that the person did not receive as a result of the wrongful transfer. If the securities intermediary does not reestablish a security entitlement, the securities intermediary is liable to the entitlement holder for damages. Ocial Comment
1. Subsection (a) of this section states another aspect of duties of securities intermediaries that make up security entitlementsthe securities intermediary's duty to comply with entitlement orders. One of the main reasons for holding securities through securities intermediaries is to enable rapid transfer in settlement of trades. Thus the right to have one's orders for disposition of the security entitlement honored is an inherent part of the relationship. Subsection (b) states the correlative liability of a securities intermediary for transferring a nancial asset from an entitlement holder's account pursuant to an entitlement order that was not eective. 2. The duty to comply with entitlement orders is subject to several qualications. The intermediary has a duty only with respect to an entitlement order that is in fact originated by the appropriate person. Moreover, the intermediary has a duty only if it has had reasonable opportunity to assure itself that the order is genuine and authorized, and reasonable opportunity to comply with the order. The same agreement/due care formula is used in this section as in the other Part 5 sections on the duties of intermediaries, and the rules of Section 8-509 apply to the Section 8-507 duty. 3. Appropriate person is dened in Section 8-107. In the usual case, the appropriate person is the entitlement holder, see Section 8-107(a)(3). Entitlement holder is dened in Section 8-102(a)(7) as the person identied in the records of a securities intermediary as the person having a security entitlement. Thus, the general rule is that an intermediary's 809

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Art. 8

duty with respect to entitlement orders runs only to the person with whom the intermediary has established a relationship. One of the basic principles of the indirect holding system is that securities intermediaries owe duties only to their own customers. See also Section 8-115. The only situation in which a securities intermediary has a duty to comply with entitlement orders originated by a person other than the person with whom the intermediary established a relationship is covered by Section 8-107(a)(4) and (a)(5), which provide that the term appropriate person includes the successor or personal representative of a decedent, or the custodian or guardian of a person who lacks capacity. If the entitlement holder is competent, another person does not fall within the dened term appropriate person merely by virtue of having power to act as an agent for the entitlement holder. Thus, an intermediary is not required to determine at its peril whether a person who purports to be authorized to act for an entitlement holder is in fact authorized to do so. If an entitlement holder wishes to be able to act through agents, the entitlement holder can establish appropriate arrangements in advance with the securities intermediary. One important application of this principle is that if an entitlement holder grants a security interest in its security entitlements to a third-party lender, the intermediary owes no duties to the secured party, unless the intermediary has entered into a control agreement in which it agrees to act on entitlement orders originated by the secured party. See Section 8-106. Even though the security agreement or some other document may give the secured party authority to act as agent for the debtor, that would not make the secured party an appropriate person to whom the security intermediary owes duties. If the entitlement holder and securities intermediary have agreed to such a control arrangement, then the intermediary's action in following instructions from the secured party would satisfy the subsection (a) duty. Although an agent, such as the secured party in this example, is not an appropriate person, an entitlement order is eective if originated by an authorized person. See Section 8-107(a) and (b). Moreover, Section 8-507(a) provides that the intermediary satises its duty if it acts in accordance with the entitlement holder's agreement. 4. Subsection (b) provides that an intermediary is liable for a wrongful transfer if the entitlement order was ineective. Section 8-107 species whether an entitlement order is eective. An eective entitlement order is dierent from an entitlement order originated by an appropriate person. An entitlement order is eective under Section 8-107(b) if it is made by the appropriate person, or by a person who has power to act for the appropriate person under the law of agency, or if the appropriate person has ratied the entitlement order or is precluded from denying its eectiveness. Thus, although a securities intermediary does not have a duty to act on an entitlement order originated by the entitlement holder's agent, the intermediary is not liable for wrongful transfer if it does so. Subsection (b), together with Section 8-107, has the eect of leaving to other law most of the questions of the sort dealt with by Article 4A for wire transfers of funds, such as allocation between the securities intermediary and the entitlement holder of the risk of fraudulent entitlement orders. 5. The term entitlement order does not cover all directions that a customer might give a broker concerning securities held through the broker. Article 8 is not a codication of all of the law of customers and stockbrokers. Article 8 deals with the settlement of securities trades, not the trades. The term entitlement order does not refer to instructions to a broker to make trades, that is, enter into contracts for the purchase or sale of securities. Rather, the entitlement order is the mechanism of transfer for securities held through intermediaries, just as indorsements and instructions are the mechanism for securities held directly. In the ordinary case the customer's direction to the broker to deliver the securities at settlement is implicit in the customer's instruction to the broker to sell. The distinction is, however, signicant in that this section has no application to the relationship between the customer and broker with respect to the trade itself. For example, assertions by a customer that it was damaged by a broker's failure to execute a trading order suciently rapidly or in the proper manner are not governed by this Article. Denitional Cross References: Agreement. Section 1-201(3). Appropriate person. Section 8-107. Eective. Section 8-107. Entitlement holder. Section 8-102(a)(7). Entitlement order. Section 8-102(a)(8). 810

Art. 8

Investment Securities

8-509

Financial asset. Section 8-102(a)(9). Securities intermediary. Section 8-102(a)(14). Security entitlement. Section 8-102(a)(17).

8-508. Duty of Securities Intermediary to Change Entitlement Holder's Position to Other Form of Security Holding. A securities intermediary shall act at the direction of an entitlement holder to change a security entitlement into another available form of holding for which the entitlement holder is eligible, or to cause the nancial asset to be transferred to a securities account of the entitlement holder with another securities intermediary. A securities intermediary satises the duty if: (1) the securities intermediary acts as agreed upon by the entitlement holder and the securities intermediary; or (2) in the absence of agreement, the securities intermediary exercises due care in accordance with reasonable commercial standards to follow the direction of the entitlement holder. Ocial Comment
1. This section states another aspect of the duties of securities intermediaries that make up security entitlementsthe obligation of the securities intermediary to change an entitlement holder's position into any other form of holding for which the entitlement holder is eligible or to transfer the entitlement holder's position to an account at another intermediary. This section does not state unconditionally that the securities intermediary is obligated to turn over a certicate to the customer or to cause the customer to be registered on the books of the issuer, because the customer may not be eligible to hold the security directly. For example, municipal bonds are now commonly issued in book-entry only form, in which the only entity that the issuer will register on its own books is a depository. If security certicates in registered form are issued for the security, and individuals are eligible to have the security registered in their own name, the entitlement holder can request that the intermediary deliver or cause to be delivered to the entitlement holder a certicate registered in the name of the entitlement holder or a certicate indorsed in blank or specially indorsed to the entitlement holder. If security certicates in bearer form are issued for the security, the entitlement holder can request that the intermediary deliver or cause to be delivered a certicate in bearer form. If the security can be held by individuals directly in uncerticated form, the entitlement holder can request that the security be registered in its name. The specication of this duty does not determine the pricing terms of the agreement in which the duty arises. 2. The same agreement/due care formula is used in this section as in the other Part 5 sections on the duties of intermediaries. So too, the rules of Section 8-509 apply to the Section 8-508 duty. Denitional Cross References: Agreement. Section 1-201(3). Entitlement holder. Section 8-102(a)(7). Financial asset. Section 8-102(a)(9). Securities intermediary. Section 8-102(a)(14). Security entitlement. Section 8-102(a)(17).

8-509. Specication of Duties of Securities Intermediary by Other Statute or Regulation; Manner of Performance of Duties of Securities Intermediary and Exercise of Rights of Entitlement Holder. (a) If the substance of a duty imposed upon a securities intermediary by Sections 8-504 through 8-508 is the subject of other statute, regulation, or rule, compliance with that statute, regulation, or rule satises the duty.
811

 8-509

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Art. 8

(b) To the extent that specic standards for the performance of the duties of a securities intermediary or the exercise of the rights of an entitlement holder are not specied by other statute, regulation, or rule or by agreement between the securities intermediary and entitlement holder, the securities intermediary shall perform its duties and the entitlement holder shall exercise its rights in a commercially reasonable manner. (c) The obligation of a securities intermediary to perform the duties imposed by Sections 8-504 through 8-508 is subject to: (1) rights of the securities intermediary arising out of a security interest under a security agreement with the entitlement holder or otherwise; and (2) rights of the securities intermediary under other law, regulation, rule, or agreement to withhold performance of its duties as a result of unfullled obligations of the entitlement holder to the securities intermediary. (d) Sections 8-504 through 8-508 do not require a securities intermediary to take any action that is prohibited by other statute, regulation, or rule. Ocial Comment
This Article is not a comprehensive statement of the law governing the relationship between broker-dealers or other securities intermediaries and their customers. Most of the law governing that relationship is the common law of contract and agency, supplemented or supplanted by regulatory law. This Article deals only with the most basic commercial/ property law principles governing the relationship. Although Sections 8-504 through 8-508 specify certain duties of securities intermediaries to entitlement holders, the point of these sections is to identify what it means to have a security entitlement, not to specify the details of performance of these duties. For many intermediaries, regulatory law species in great detail the intermediary's obligations on such matters as safekeeping of customer property, distribution of proxy materials, and the like. To avoid any conict between the general statement of duties in this Article and the specic statement of intermediaries' obligations in such regulatory schemes, subsection (a) provides that compliance with applicable regulation constitutes compliance with the duties specied in Sections 8-504 through 8-508. Denitional Cross References: Agreement. Section 1-201(3). Entitlement holder. Section 8-102(a)(7). Securities intermediary. Section 8-102(a)(14). Security agreement. Section 9-102(a)(73). Security interest. Section 1-201(37).

8-510. Rights of Purchaser of Security Entitlement from Entitlement Holder. (a) In a case not covered by the priority rules in Article 9 or the rules stated in subsection (c), an action based on an adverse claim to a nancial asset or security entitlement, whether framed in conversion, replevin, constructive trust, equitable lien, or other theory, may not be asserted against a person who purchases a security entitlement, or an interest therein, from an entitlement holder if the purchaser gives value, does not have notice of the adverse claim, and obtains control. (b) If an adverse claim could not have been asserted against an entitlement holder under Section 8-502, the adverse claim cannot be asserted against a person who purchases a security entitlement, or an interest therein, from the entitlement holder.
812

Art. 8

Investment Securities

8-510

(c) In a case not covered by the priority rules in Article 9, a purchaser for value of a security entitlement, or an interest therein, who obtains control has priority over a purchaser of a security entitlement, or an interest therein, who does not obtain control. Except as otherwise provided in subsection (d), purchasers who have control rank according to priority in time of: (1) the purchaser's becoming the person for whom the securities account, in which the security entitlement is carried, is maintained, if the purchaser obtained control under Section 8-106(d)(1); (2) the securities intermediary's agreement to comply with the purchaser's entitlement orders with respect to security entitlements carried or to be carried in the securities account in which the security entitlement is carried, if the purchaser obtained control under Section 8-106(d)(2); or (3) if the purchaser obtained control through another person under Section 8-106(d)(3), the time on which priority would be based under this subsection if the other person were the secured party. (d) A securities intermediary as purchaser has priority over a conicting purchaser who has control unless otherwise agreed by the securities intermediary. As amended in 1999.
See Appendix I contained within revised Article 9 for material relating to changes made in text in 1999.

Ocial Comment
1. This section species certain rules concerning the rights of persons who purchase interests in security entitlements from entitlement holders. The rules of this section are provided to take account of cases where the purchaser's rights are derivative from the rights of another person who is and continues to be the entitlement holder. 2. Subsection (a) provides that no adverse claim can be asserted against a purchaser of an interest in a security entitlement if the purchaser gives value, obtains control, and does not have notice of the adverse claim. The primary purpose of this rule is to give adverse claim protection to persons who take security interests in security entitlements and obtain control, but do not themselves become entitlement holders. The following examples illustrate subsection (a): Example 1. X steals a certicated bearer bond from Owner. X delivers the certicate to Able & Co. for credit to X's securities account. Later, X borrows from Bank and grants bank a security interest in the security entitlement. Bank obtains control under Section 8-106(d)(2) by virtue of an agreement in which Able agrees to comply with entitlement orders originated by Bank. X absconds. Example 2. Same facts as in Example 1, except that Bank does not obtain a control agreement. Instead, Bank perfects by ling a nancing statement. In both of these examples, when X deposited the bonds X acquired a security entitlement under Section 8-501. Under other law, Owner may be able to have a constructive trust imposed on the security entitlement as the traceable product of the bonds that X misappropriated. X granted a security interest in that entitlement to Bank. Bank was a purchaser of an interest in the security entitlement from X. In Example 1, although Bank was not a person who acquired a security entitlement from the intermediary, Bank did obtain control. If Bank did not have notice of Owner's claim, Section 8-510(a) precludes Owner from asserting an adverse claim against Bank. In Example 2, Bank had a perfected security interest, but did not obtain control. Accordingly, Section 8-510(a) does not preclude Owner from asserting its adverse claim against Bank. 3. Subsection (b) applies to the indirect holding system a limited version of the shelter principle. The following example illustrates the relatively limited class of cases for which 813

 8-510

Uniform Commercial Code

Art. 8

it may be needed: Example 3. Thief steals a certicated bearer bond from Owner. Thief delivers the certicate to Able & Co. for credit to Thief's securities account. Able forwards the certicate to a clearing corporation for credit to Able's account. Later Thief instructs Able to sell the positions in the bonds. Able sells to Baker & Co., acting as broker for Buyer. The trade is settled by book-entries in the accounts of Able and Baker at the clearing corporation, and in the accounts of Thief and Buyer at Able and Baker respectively. Owner may be able to reconstruct the trade records to show that settlement occurred in such fashion that the same bonds that were carried in Thief's account at Able are traceable into Buyer's account at Baker. Buyer later decides to donate the bonds to Alma Mater University and executes an assignment of its rights as entitlement holder to Alma Mater. Buyer had a position in the bonds, which Buyer held in the form of a security entitlement against Baker. Buyer then made a gift of the position to Alma Mater. Although Alma Mater is a purchaser, Section 1-201(33), it did not give value. Thus, Alma Mater is a person who purchased a security entitlement, or an interest therein, from an entitlement holder (Buyer). Buyer was protected against Owner's adverse claim by the Section 8-502 rule. Thus, by virtue of Section 8-510(b), Owner is also precluded from asserting an adverse claim against Alma Mater. 4. Subsection (c) species a priority rule for cases where an entitlement holder transfers conicting interests in the same security entitlement to dierent purchasers. It follows the same principle as the Article 9 priority rule for investment property, that is, control trumps non-control. Indeed, the most signicant category of conicting purchasers may be secured parties. Priority questions for security interests, however, are governed by the rules in Article 9. Subsection (c) applies only to cases not covered by the Article 9 rules. It is intended primarily for disputes over conicting claims arising out of repurchase agreement transactions that are not covered by the other rules set out in Articles 8 and 9. The following example illustrates subsection (c): Example 4. Dealer holds securities through an account at Alpha Bank. Alpha Bank in turns holds through a clearing corporation account. Dealer transfers securities to RP1 in a hold in custody repo transaction. Dealer then transfers the same securities to RP2 in another repo transaction. The repo to RP2 is implemented by transferring the securities from Dealer's regular account at Alpha Bank to a special account maintained by Alpha Bank for Dealer and RP2. The agreement among Dealer, RP2, and Alpha Bank provides that Dealer can make substitutions for the securities but RP2 can direct Alpha Bank to sell any securities held in the special account. Dealer becomes insolvent. RP1 claims a prior interest in the securities transferred to RP2. In this example Dealer remained the entitlement holder but agreed that RP2 could initiate entitlement orders to Dealer's security intermediary, Alpha Bank. If RP2 had become the entitlement holder, the adverse claim rule of Section 8-502 would apply. Even if RP2 does not become the entitlement holder, the arrangement among Dealer, Alpha Bank, and RP2 does suce to give RP2 control. Thus, under Section 8-510(c), RP2 has priority over RP1, because RP2 is a purchaser who obtained control, and RP1 is a purchaser who did not obtain control. The same result could be reached under Section 8-510(a) which provides that RP1's earlier in time interest cannot be asserted as an adverse claim against RP2. The same result would follow under the Article 9 priority rules if the interests of RP1 and RP2 are characterized as security interests, see Section 9-328(1). The main point of the rules of Section 8-510(c) is to ensure that there will be clear rules to cover the conicting claims of RP1 and RP2 without characterizing their interests as Article 9 security interests. The priority rules in Article 9 for conicting security interests also include a default temporal priority rule for cases where multiple secured parties have obtained control but omitted to specify their respective rights by agreement. See Section 9-328(2) and Comment 5 to Section 9-328. Because the purchaser priority rule in Section 8-510(c) is intended to track the Article 9 priority rules, it too has a temporal priority rule for cases where multiple non-secured party purchasers have obtained control but omitted to specify their respective rights by agreement. The rule is patterned on Section 9-328(2). 5. If a securities intermediary itself is a purchaser, subsection (d) provides that it has priority over the interest of another purchaser who has control. Article 9 contains a similar rule. See Section 9-328(3). Denitional Cross References: 814

Art. 8

Investment Securities

8-511

Adverse claim. Section 8-102(a)(1). Control. Section 8-106. Entitlement holder. Section 8-102(a)(7). Notice of adverse claim. Section 8-105. Purchase. Section 1-201(32). Purchaser. Sections 1-201(33) & 8-116. Securities intermediary. Section 8-102(a)(14). Security entitlement. Section 8-102(a)(17). Value. Sections 1-201(44) & 8-116.

As amended in 1999.
See Appendix I contained within revised Article 9 for material relating to changes made in Ocial Comment in 1999.

8-511. Priority Among Security Interests and Entitlement Holders. (a) Except as otherwise provided in subsections (b) and (c), if a securities intermediary does not have sucient interests in a particular nancial asset to satisfy both its obligations to entitlement holders who have security entitlements to that nancial asset and its obligation to a creditor of the securities intermediary who has a security interest in that nancial asset, the claims of entitlement holders, other than the creditor, have priority over the claim of the creditor. (b) A claim of a creditor of a securities intermediary who has a security interest in a nancial asset held by a securities intermediary has priority over claims of the securities intermediary's entitlement holders who have security entitlements with respect to that nancial asset if the creditor has control over the nancial asset. (c) If a clearing corporation does not have sucient nancial assets to satisfy both its obligations to entitlement holders who have security entitlements with respect to a nancial asset and its obligation to a creditor of the clearing corporation who has a security interest in that nancial asset, the claim of the creditor has priority over the claims of entitlement holders. Ocial Comment
1. This section sets out priority rules for circumstances in which a securities intermediary fails leaving an insucient quantity of securities or other nancial assets to satisfy the claims of its entitlement holders and the claims of creditors to whom it has granted security interests in nancial assets held by it. Subsection (a) provides that entitlement holders' claims have priority except as otherwise provided in subsection (b), and subsection (b) provides that the secured creditor's claim has priority if the secured creditor obtains control, as dened in Section 8-106. The following examples illustrate the operation of these rules. Example 1. Able & Co., a broker, borrows from Alpha Bank and grants Alpha Bank a security interest pursuant to a written agreement which identies certain securities that are to be collateral for the loan, either specically or by category. Able holds these securities in a clearing corporation account. Able becomes insolvent and it is discovered that Able holds insucient securities to satisfy the claims of customers who have paid for securities that they held in accounts with Able and the collateral claims of Alpha Bank. Alpha Bank's security interest in the security entitlements that Able holds through the clearing corporation account may be perfected under the automatic perfection rule of Section 9-309(10), but Alpha Bank did not obtain control under Section 8-106. Thus, under Section 8-511(a) the entitlement holders' claims have priority over Alpha Bank's claim. Example 2. Able & Co., a broker, borrows from Beta Bank and grants Beta Bank a se815

 8-511

Uniform Commercial Code

Art. 8

curity interest in securities that Able holds in a clearing corporation account. Pursuant to the security agreement, the securities are debited from Alpha's account and credited to Beta's account in the clearing corporation account. Able becomes insolvent and it is discovered that Able holds insucient securities to satisfy the claims of customers who have paid for securities that they held in accounts with Able and the collateral claims of Alpha Bank. Although the transaction between Able and Beta took the form of an outright transfer on the clearing corporation's books, as between Able and Beta, Able remains the owner and Beta has a security interest. In that respect the situation is no dierent than if Able had delivered bearer bonds to Beta in pledge to secure a loan. Beta's security interest is perfected, and Beta obtained control. See Sections 8-106 and 9-314. Under Section 8-511(b), Beta Bank's security interest has priority over claims of Able's customers. The result in Example 2 is an application to this particular setting of the general principle expressed in Section 8-503, and explained in the Comments thereto, that the entitlement holders of a securities intermediary cannot assert rights against third parties to whom the intermediary has wrongfully transferred interests, except in extremely unusual circumstances where the third party was itself a participant in the transferor's wrongdoing. Under subsection (b) the claim of a secured creditor of a securities intermediary has priority over the claims of entitlement holders if the secured creditor has obtained control. If, however, the secured creditor acted in collusion with the intermediary in violating the intermediary's obligation to its entitlement holders, then under Section 8-503(e), the entitlement holders, through their representative in insolvency proceedings, could recover the interest from the secured creditor, that is, set aside the security interest. 2. The risk that investors who hold through an intermediary will suer a loss as a result of a wrongful pledge by the intermediary is no dierent than the risk that the intermediary might fail and not have the securities that it was supposed to be holding on behalf of its customers, either because the securities were never acquired by the intermediary or because the intermediary wrongfully sold securities that should have been kept to satisfy customers' claims. Investors are protected against that risk by the regulatory regimes under which securities intermediaries operate. Intermediaries are required to maintain custody, through clearing corporation accounts or in other approved locations, of their customers' securities and are prohibited from using customers' securities in their own business activities. Securities rms who are carrying both customer and proprietary positions are not permitted to grant blanket liens to lenders covering all securities which they hold, for their own account or for their customers. Rather, securities rms designate specically which positions they are pledging. Under SEC Rules 8c-1 and 15c2-1, customers' securities can be pledged only to fund loans to customers, and only with the consent of the customers. Customers' securities cannot be pledged for loans for the rm's proprietary business; only proprietary positions can be pledged for proprietary loans. SEC Rule 15c3-3 implements these prohibitions in a fashion tailored to modern securities rm accounting systems by requiring brokers to maintain a sucient inventory of securities, free from any liens, to satisfy the claims of all of their customers for fully paid and excess margin securities. Revised Article 8 mirrors that requirement, specifying in Section 8-504 that a securities intermediary must maintain a sucient quantity of investment property to satisfy all security entitlements, and may not grant security interests in the positions it is required to hold for customers, except as authorized by the customers. If a failed brokerage has violated the customer protection regulations and does not have sucient securities to satisfy customers' claims, its customers are protected against loss from a shortfall by the Securities Investor Protection Act (SIPA). Securities rms required to register as brokers or dealers are also required to become members of the Securities Investor Protection Corporation (SIPC), which provides their customers with protection somewhat similar to that provided by FDIC and other deposit insurance programs for bank depositors. When a member rm fails, SIPC is authorized to initiate a liquidation proceeding under the provisions of SIPA. If the assets of the securities rm are insucient to satisfy all customer claims, SIPA makes contributions to the estate from a fund nanced by assessments on its members to protect customers against losses up to $500,000 for cash and securities held at member rms. Article 8 is premised on the view that the important policy of protecting investors against the risk of wrongful conduct by their intermediaries is suciently treated by other law. 3. Subsection (c) sets out a special rule for secured nancing provided to enable clearing 816

Art. 8

Investment Securities

8-603

corporations to complete settlement. In order to permit clearing corporations to establish liquidity facilities where necessary to ensure completion of settlement, subsection (c) provides a priority for secured lenders to such clearing corporations. Subsection (c) does not turn on control because the clearing corporation may be the top tier securities intermediary for the securities pledged, so that there may be no practicable method for conferring control on the lender. Denitional Cross References: Clearing corporation. Section 8-102(a)(5). Control. Section 8-106. Entitlement holder. Section 8-102(a)(7). Financial asset. Section 8-102(a)(9). Securities intermediary. Section 8-102(a)(14). Security entitlement. Section 8-102(a)(17). Security interest. Section 1-201(37). Value. Sections 1-201(44) & 8-116.

PART 6. TRANSITION PROVISIONS FOR REVISED ARTICLE 8

8-601. Eective Date. This [Act] takes eect . . .. 8-602. Repeals. This [Act] repeals . . .. Ocial Comment
If the State has adopted the Uniform Act for the Simplication of Fiduciary Security Transfers, or similar legislation, it should be repealed.

8-603. Savings Clause. (a) This [Act] does not aect an action or proceeding commenced before this [Act] takes eect. (b) If a security interest in a security is perfected at the date this [Act] takes eect, and the action by which the security interest was perfected would suce to perfect a security interest under this [Act], no further action is required to continue perfection. If a security interest in a security is perfected at the date this [Act] takes eect but the action by which the security interest was perfected would not suce to perfect a security interest under this [Act], the security interest remains perfected for a period of four months after the eective date and continues perfected thereafter if appropriate action to perfect under this [Act] is taken within that period. If a security interest is perfected at the date this [Act] takes eect and the security interest can be perfected by ling under this [Act], a nancing statement signed by the secured party instead of the debtor may be led within that period to continue perfection or thereafter to perfect. Ocial Comment
The revision of Article 8 should present few signicant transition problems. Although the revision involves signicant changes in terminology and analysis, the substantive rules are, in large measure, based upon the current practices and are consistent with results that could be reached, albeit at times with some struggle, by proper interpretation of the rules of present law. Thus, the new rules can be applied, without signicant dislocations, to transactions and events that occurred prior to enactment. The enacting provisions should not, whether by applicability, transition, or savings 817

 8-603

Uniform Commercial Code

Art. 8

clause language, attempt to provide that old Article 8 continues to apply to transactions, events, rights, duties, liabilities, or the like that occurred or accrued before the eective date and that new Article 8 applies to those that occur or accrue after the eective date. The reason for revising Article 8 and corresponding provisions of Article 9 is the concern that the provisions of old Article 8 could be interpreted or misinterpreted to yield results that impede the safe and ecient operation of the national system for the clearance and settlement of securities transactions. Accordingly, it is not the case that any eort should be made to preserve the applicability of old Article 8 to transactions and events that occurred before the eective date. Only two circumstances seem to warrant continued application of rules of old Article 8. First, to avoid disruption in the conduct of litigation, it may make sense to provide for continued application of the old Article 8 rules to lawsuits pending before the eective date. Second, there are some limited circumstances in which prior law permitted perfection of security interests by methods that are not provided for in the revised version. Section 8-313(1) (h) (1978) permitted perfection of security interests in securities held through intermediaries by notice to the intermediary. Under Revised Articles 8 and 9, security interests can be perfected in such cases by control, which requires the agreement of the intermediary, or by ling. It is likely that secured parties who relied strongly on such collateral under prior law did not simply send notices but obtained agreements from the intermediaries that would suce for control under the new rules. However, it seems appropriate to include a provision that gives a secured creditor some opportunity after the eective date to perfect in this or any other case in which there is doubt whether the method of perfection used under prior law would be sucient under the new version. CONFORMING AMENDMENTS TO ARTICLES 1, 3, 4, 5, 9, AND 10 See Appendix K, infra.

818

ARTICLE 9. SECURED TRANSACTIONS*

PART 1. GENERAL PROVISIONS
[SUBPART 1. SHORT TITLE, DEFINITIONS, AND GENERAL CONCEPTS]
9-101. Short Title. 9-102. Denitions and Index of Denitions. 9-103. Purchase-Money Security Interest; Application of Payments; Burden of Establishing. 9-104. Control of Deposit Account. 9-105. Control of Electronic Chattel Paper. 9-106. Control of Investment Property. 9-107. Control of Letter-of-Credit Right. 9-108. Suciency of Description.

[SUBPART 2. APPLICABILITY OF ARTICLE]

9-109. Scope. 9-110. Security Interests Arising Under Article 2 or 2A.

PART 2. EFFECTIVENESS OF SECURITY AGREEMENT; ATTACHMENT OF SECURITY INTEREST; RIGHTS OF PARTIES TO SECURITY AGREEMENT
[SUBPART 1. EFFECTIVENESS AND ATTACHMENT]
9-201. General Eectiveness of Security Agreement. 9-202. Title to Collateral Immaterial. 9-203. Attachment and Enforceability of Security Interest; Proceeds; Supporting Obligations; Formal Requisites. 9-204. After-Acquired Property; Future Advances. 9-205. Use or Disposition of Collateral Permissible. 9-206. Security Interest Arising in Purchase or Delivery of Financial Asset.

[SUBPART 2. RIGHTS AND DUTIES]

9-207. Rights and Duties of Secured Party Having Possession or Control of Collateral. 9-208. Additional Duties of Secured Party Having Control of Collateral. 9-209. Duties of Secured Party if Account Debtor Has Been Notied of Assignment.
*(With Conforming Amendments to Articles 1, 2, 2A, 4, 5, 6, 7, and 8) Revised Article 9 became eective July 1, 2001. Pre-revision Article 9 may be found in Appendix O.

819

Uniform Commercial Code 9-210. Request for Accounting; Request Regarding List of Collateral or Statement of Account.

Art. 9

PART 3. PERFECTION AND PRIORITY

[SUBPART 1. LAW GOVERNING PERFECTION AND PRIORITY]
9-301. Law Governing Perfection and Priority 9-302. Law Governing Perfection and Priority 9-303. Law Governing Perfection and Priority Covered by a Certicate of Title. 9-304. Law Governing Perfection and Priority Accounts. 9-305. Law Governing Perfection and Priority Investment Property. 9-306. Law Governing Perfection and Priority of-Credit Rights. 9-307. Location of Debtor. of Security Interests. of Agricultural Liens. of Security Interests in Goods of Security Interests in Deposit of Security Interests in of Security Interests in Letter-

[SUBPART 2. PERFECTION]
9-308. When Security Interest or Agricultural Lien Is Perfected; Continuity of Perfection. 9-309. Security Interest Perfected Upon Attachment. 9-310. When Filing Required to Perfect Security Interest or Agricultural Lien; Security Interests and Agricultural Liens to Which Filing Provisions Do Not Apply. 9-311. Perfection of Security Interests in Property Subject to Certain Statutes, Regulations, and Treaties. 9-312. Perfection of Security Interests in Chattel Paper, Deposit Accounts, Documents, Goods Covered by Documents, Instruments, Investment Property, Letter-of-Credit Rights, and Money; Perfection by Permissive Filing; Temporary Perfection Without Filing or Transfer of Possession. 9-313. When Possession by or Delivery to Secured Party Perfects Security Interest Without Filing. 9-314. Perfection by Control. 9-315. Secured Party's Rights on Disposition of Collateral and in Proceeds. 9-316. Continued Perfection of Security Interest Following Change in Governing Law.

[SUBPART 3. PRIORITY]
9-317. Interests That Take Priority Over or Take Free of Security Interest or Agricultural Lien. 9-318. No Interest Retained in Right to Payment That Is Sold; Rights and Title of Seller of Account or Chattel Paper With Respect to Creditors and Purchasers. 9-319. Rights and Title of Consignee With Respect to Creditors and Purchasers. 9-320. Buyer of Goods. 9-321. Licensee of General Intangible and Lessee of Goods in Ordinary Course of Business. 9-322. Priorities Among Conicting Security Interests in and Agricultural Liens on Same Collateral. 9-323. Future Advances.
820

Art. 9 9-324. 9-325. 9-326. 9-327. 9-328. 9-329. 9-330. 9-331. 9-332. 9-333. 9-334. 9-335. 9-336. 9-337. 9-338.

Secured Transactions Priority of Purchase-Money Security Interests. Priority of Security Interests in Transferred Collateral. Priority of Security Interests Created by New Debtor. Priority of Security Interests in Deposit Account. Priority of Security Interests in Investment Property. Priority of Security Interests in Letter-of-Credit Right. Priority of Purchaser of Chattel Paper or Instrument. Priority of Rights of Purchasers of Instruments, Documents, and Securities Under Other Articles; Priority of Interests in Financial Assets and Security Entitlements Under Article 8. Transfer of Money; Transfer of Funds From Deposit Account. Priority of Certain Liens Arising by Operation of Law. Priority of Security Interests in Fixtures and Crops. Accessions. Commingled Goods. Priority of Security Interests in Goods Covered by Certicate of Title. Priority of Security Interest or Agricultural Lien Perfected by Filed Financing Statement Providing Certain Incorrect Information. Priority Subject to Subordination.

9-339.

[SUBPART 4. RIGHTS OF BANK]

9-340. Eectiveness of Right of Recoupment or Set-O Against Deposit Account. 9-341. Bank's Rights and Duties With Respect to Deposit Account. 9-342. Bank's Right to Refuse to Enter Into or Disclose Existence of Control Agreement.

PART 4. RIGHTS OF THIRD PARTIES

Alienability of Debtor's Rights. Secured Party Not Obligated on Contract of Debtor or in Tort. Agreement Not to Assert Defenses Against Assignee. Rights Acquired by Assignee; Claims and Defenses Against Assignee. Modication of Assigned Contract. Discharge of Account Debtor; Notication of Assignment; Identication and Proof of Assignment; Restrictions on Assignment of Accounts, Chattel Paper, Payment Intangibles, and Promissory Notes Ineective. 9-407. Restrictions on Creation or Enforcement of Security Interest in Leasehold Interest or in Lessor's Residual Interest. 9-408. Restrictions on Assignment of Promissory Notes, Health-Care-Insurance Receivables, and Certain General Intangibles Ineective. 9-409. Restrictions on Assignment of Letter-of-Credit Rights Ineective. 9-401. 9-402. 9-403. 9-404. 9-405. 9-406.

PART 5. FILING
[SUBPART 1. FILING OFFICE; CONTENTS AND EFFECTIVENESS OF FINANCING STATEMENT]
9-501. Filing Oce. 9-502. Contents of Financing Statement; Record of Mortgage as Financing Statement; Time of Filing Financing Statement. 9-503. Name of Debtor and Secured Party.
821

Uniform Commercial Code

Art. 9

9-504. Indication of Collateral. 9-505. Filing and Compliance With Other Statutes and Treaties for Consignments, Leases, Other Bailments, and Other Transactions. 9-506. Eect of Errors or Omissions. 9-507. Eect of Certain Events on Eectiveness of Financing Statement. 9-508. Eectiveness of Financing Statement if New Debtor Becomes Bound by Security Agreement. 9-509. Persons Entitled to File a Record. 9-510. Eectiveness of Filed Record. 9-511. Secured Party of Record. 9-512. Amendment of Financing Statement. 9-513. Termination Statement. 9-514. Assignment of Powers of Secured Party of Record. 9-515. Duration and Eectiveness of Financing Statement; Eect of Lapsed Financing Statement. 9-516. What Constitutes Filing; Eectiveness of Filing. 9-517. Eect of Indexing Errors. 9-518. Claim Concerning Inaccurate or Wrongfully Filed Record.

[SUBPART 2. DUTIES AND OPERATION OF FILING OFFICE]

9-519. Numbering, Maintaining, and Indexing Records; Communicating Information Provided in Records. 9-520. Acceptance and Refusal to Accept Record. 9-521. Uniform Form of Written Financing Statement and Amendment. 9-522. Maintenance and Destruction of Records. 9-523. Information From Filing Oce; Sale or License of Records. 9-524. Delay by Filing Oce. 9-525. Fees. 9-526. Filng-Oce Rules. 9-527. Duty to Report.

PART 6. DEFAULT
[SUBPART 1. DEFAULT AND ENFORCEMENT OF SECURITY INTEREST]
9-601. Rights After Default; Judicial Enforcement; Consignor or Buyer of Accounts, Chattel Paper, Payment Intangibles, or Promissory Notes. 9-602. Waiver and Variance of Rights and Duties. 9-603. Agreement on Standards Concerning Rights and Duties. 9-604. Procedure if Security Agreement Covers Real Property or Fixtures. 9-605. Unknown Debtor or Secondary Obligor. 9-606. Time of Default for Agricultural Lien. 9-607. Collection and Enforcement by Secured Party. 9-608. Application of Proceeds of Collection or Enforcement; Liability for Deciency and Right to Surplus. 9-609. Secured Party's Right to Take Possession After Default. 9-610. Disposition of Collateral After Default. 9-611. Notication Before Disposition of Collateral. 9-612. Timeliness of Notication Before Disposition of Collateral. 9-613. Contents and Form of Notication Before Disposition of Collateral: General.
822

Art. 9

Secured Transactions

9-614. Contents and Form of Notication Before Disposition of Collateral: Consumer-Goods Transaction. 9-615. Application of Proceeds of Disposition; Liability for Deciency and Right to Surplus. 9-616. Explanation of Calculation of Surplus or Deciency. 9-617. Rights of Transferee of Collateral. 9-618. Rights and Duties of Certain Secondary Obligors. 9-619. Transfer of Record or Legal Title. 9-620. Acceptance of Collateral in Full or Partial Satisfaction of Obligation; Compulsory Disposition of Collateral. 9-621. Notication of Proposal to Accept Collateral. 9-622. Eect of Acceptance of Collateral. 9-623. Right to Redeem Collateral. 9-624. Waiver.

[SUBPART 2. NONCOMPLIANCE WITH ARTICLE]

9-625. 9-626. 9-627. 9-628. Remedies for Secured Party's Failure to Comply With Article. Action in Which Deciency or Surplus Is in Issue. Determination of Whether Conduct Was Commercially Reasonable. Nonliability and Limitation on Liability of Secured Party; Liability of Secondary Obligor.

PART 7. TRANSITION
Eective Date. Savings Clause. Security Interest Perfected Before Eective Date. Security Interest Unperfected Before Eective Date. Eectiveness of Action Taken Before Eective Date. When Initial Financing Statement Suces to Continue Eectiveness of Financing Statement. 9-707. Amendment of Pre-Eective-Date Financing Statement. 9-708. Persons Entitled to File Initial Financing Statement or Continuation Statement. 9-709. Priority. 9-701. 9-702. 9-703. 9-704. 9-705. 9-706.

APPENDIX I. CONFORMING AMENDMENTS TO OTHER ARTICLES APPENDIX II. MODEL PROVISIONS FOR PRODUCTIONMONEY PRIORITY APPENDIX III. PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE APPENDIX IV. PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE

823

NATIONAL CONFERENCE OF COMMISSIONERS ON UNIFORM STATE LAWS

DRAFTING COMMITTEE TO REVISE UNIFORM COMMERCIAL CODE ARTICLE 9SECURED TRANSACTIONS William M. Burke, 20th Floor, Standard Chartered Bank Building, 4 Des Voeux Road, Hong Kong, China, Chair Marion W. Benfield, Jr., University of Texas, School of Law, 10 Overlook Circle, New Braunfels, TX 78132 Neil B. Cohen, Brooklyn Law School, Room 904A, 250 Joralemon Street, Brooklyn, NY 11201, The American Law Institute Representative Dale G. Higer, Suite 1900, 101 S. Capitol Boulevard, Boise, ID 83702-5958 William C. Hillman, U.S. Bankruptcy Court, Room 1101, 10 Causeway Street, Boston, MA 02222 Michael Houghton, P.O. Box 1347, 18th Floor, 1201 N. Market Street, Wilmington, DE 19899 Randal C. Picker, University of Chicago Law School, 1111 E. 60th Street, Chicago, IL 60637 Donald J. Rapson, Room 3338, 650 CIT Drive, Livingston, NJ 07039-0491, The American Law Institute Representative Harry C. Sigman, P.O. Box 67E08, Los Angeles, CA 90067, The American Law Institute Representative Bradley Y. Smith, 20th Floor, 450 Lexington Avenue, New York, NY 10017, The American Law Institute Representative Edwin E. Smith, 15th Floor, 150 Federal Street, Boston, MA 02110 Sandra S. Stern, 509 Madison Avenue, Suite 612, New York, NY 10022 Steven L. Harris, Chicago-Kent College of Law, 565 W. Adams Street, Chicago, IL 606613691, Co-Reporter Charles W. Mooney, Jr., University of Pennsylvania, School of Law, 3400 Chestnut Street, Philadelphia, PA 19104, Co-Reporter EX OFFICIO Gene N. Lebrun, P.O. Box 8250, 9th Floor, 909 St. Joseph Street, Rapid City, SD 57709, President Henry M. Kittleson, P.O. Box 32092, 92 Lake Wire Drive, Lakeland, FL 33802-2092, Division Chair AMERICAN BAR ASSOCIATION ADVISORS Robert Bauer, 1300 N. 17th Street, #1800, Arlington, VA 22209, Intellectual Property Law Section Advisor Richard E. Cherin, 1 Riverfront Plaza, Newark, NJ 07102, Business Law Section Advisor Richard R. Goldberg, 51st Floor, 1735 Market Street, Philadelphia, PA 19103, Real Property, Probate & Trust Law Section Advisor Lawrence A. Manzanares, City & County Building, 1437 Bannock Street, Courtroom 303W, Denver, CO 80202, Judicial Administration Division, National Conference of Special Court Judges Advisor Steven O. Weise, 40th Floor, 601 S. Figueroa Street, Los Angeles, CA 90017, Advisor EXECUTIVE DIRECTOR Fred H. Miller, University of Oklahoma, College of Law, 300 Timberdell Road, Norman, OK 73019, Executive Director William J. Pierce, 1505 Roxbury Road, Ann Arbor, MI 48104, Executive Director Emeritus 824

Art. 9

Secured Transactions

TABLE OF DISPOSITION OF SECTIONS IN FORMER ARTICLE 9 AND OTHER CODE SECTIONS

Old Article 9 9-101 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-102 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-103(1)(a), (b); (c) omitted . . . . . . . . . . . . . 9-103(1)(d) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-103(2)(a), (b); (c) omitted . . . . . . . . . . . . . 9-103(2)(d) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-103(3)(a), (b); (c) omitted . . . . . . . . . . . . . 9-103(3)(d) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-103(3)(e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-103(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-103(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-103(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-104 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-105 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-106 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-107 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-108 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-109 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-110 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-111 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-112 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-113 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-114 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-115(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-115(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-115(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-115(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-115(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-115(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-115(e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-116 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-201 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-202 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-203(1)(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-203(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-204 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-205 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-206 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-207 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-208 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-301(1)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-301(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-301(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-302(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-302(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . New Article 9 9-101 9-109 9-301 9-316 9-303, 9-316 9-337 9-301 9-307 9-316 9-301 9-301 9-304, 9-305, 9-306 9-109 9-102 9-102 9-103 Omitted as no longer needed 9-102 9-108 Deleted as unnecessary Omittedsee 9-102(a)(28) 9-110 Omittedsee 9-103 and 9-324 9-102, 9-106 9-203, 9-308 9-108 9-309, 9-312, 9-314 9-327, 9-328, 9-329 9-203, 9-313 9-106 9-206, 9-309 9-201 9-202 9-203 9-201 9-204 9-205 9-403 9-207 9-210 9-317 9-102 9-323 9-309, 9-310 9-310 825

Uniform Commercial Code

Old Article 9 9-302(3), (4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-303 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-304 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-305 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-306 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-307(1)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-307(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-308 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-309 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-310 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-311 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-312(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-312(2) omitted . . . . . . . . . . . . . . . . . . . . . . . . 9-312(3), (4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-312(5), (6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-312(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-313(1)(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-313(8) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-314 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-315 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-316 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-317 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-318(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-318(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-318(3), (4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-401 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-402(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-402(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-402(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-402(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-402(5), (6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-402(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-402(8) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-403(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-403(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-403(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-403(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-403(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-403(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-403(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-404 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-405 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-406 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-407 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-408 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-501(1), (2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-501(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . New Article 9 9-311 9-308 9-312 9-306, 9-313 9-315 9-320 9-323 9-330 9-331 9-333 9-401 9-322 See Appendix B 9-324 9-322 9-323 9-334 9-604 9-335 9-336 9-339 9-402 9-404 9-405 9-406 9-501 9-504, 9-502 Omitted as unnecessary 9-521 9-512 9-502 9-503(a)(4), 9-507 9-506 9-516(a) 9-515 9-515, 9-522 9-519 9-525 9-515 9-519 9-513 9-514, 9-519 9-512 9-523 9-505 9-601 9-602, 9-603

Art. 9

826

Art. 9

Secured Transactions
New Article 9 9-604 9-601 9-607, 9-608 9-609 9-610, 9-615 9-615 9-610, 9-611, 9-624 9-617 9-618 9-620, 9-621, 9-624 9-623, 9-624 9-625, 9-627 New Article 9 9-102 9-407 9-317 9-321 9-323

Old Article 9 9-501(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-501 (5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-502 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-503 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-504(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-504(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-504(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-504(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-504(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-505 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-506 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-507 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Code Sections 2-326(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-303(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-307(2)(b) and (c) . . . . . . . . . . . . . . . . . . . . 2A-307(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2A-307(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Table Indicating Sources Or Derivations Of New Article 9 Sections And Conforming Amendments
New Article 9 Sections (Note: many sections contain some new coverage) 9-101 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-102 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-103 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-104 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-105 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-106 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-107 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-108 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-109 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-110 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-201 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-202 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-203 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-204 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-205 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-206 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-207 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-208 (New) 9-209 (New) 9-210 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Primary Old Article 9 and Other Code Sections 9-101 9-105, 9-106, 9-109, 9-301(3), 9-306 (1), 9-115, 2-326(3) 9-107 Derived from 8-106 Derived from 8-106 8-106 and 9-115(e) Derived from 8-106 9-110, 9-115(3) 9-102, 9-104 9-113 9-201, 9-203(4) 9-202 9-203, 9-115(2), (6) 9-204 9-205 9-116 9-207

9-208 827

Uniform Commercial Code

New Article 9 Sections (Note: many sections contain some new coverage) 9-301 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-302 (New) 9-303 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-304 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-305 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-306 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-307 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-308 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-309 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-310 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-311 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-312 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-313 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-314 (New in part) . . . . . . . . . . . . . . . . . . . . . 9-315 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-316 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-317 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-318 (New) 9-319 (New) 9-320 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-321 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-322 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-323 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-324 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-325 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-326 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-327 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-328 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-329 (New) 9-330 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-331 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-332 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-333 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-334 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-335 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-336 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-337 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-338 (New) 9-339 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-340 (New) 9-341 (New) 9-342 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-401 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 828 Primary Old Article 9 and Other Code Sections

Art. 9

9-103(1)(a), (b), 9-103(3)(a), (b), 9-103(4), 9-103(5) substantially modied 9-103(2)(a), (b), substantially revised Derived from 8-110(e) and former 9-103(6) 9-103(6) Derived in part from 8-110(e) and 9-305 and former 9-103(6) 9-103(3)(d), as substantially revised 9-303, 9-115(2) 9-302(1), 9-115(4)(c), (d), 9-116 9-302(1), (2) 9-302(3), (4) 9-115(4) and 9-304, with additions and some changes 9-305, 9-115(6) 9-115(4) and derived from 8-106 9-306 9-103(1)(d), (2)(b), (3)(e), as modied 9-301, 2A-307(2)

9-307 2A-103(1)(o), 2A-307(3) 9-312(5), (6) 9-312(7), 9-301(4), 9-307(3), 2A-307(4) 9-312(3), (4) But see 9-402(7) But see 9-402(7) Derived from 9-115(5) 9-115(5) Loosely modeled after former 9-115(5). See also 5-114 and 5-118 9-308 9-309 But see Comment 2(c) to 9-306 9-310 9-313 Section replaces former 9-314 Section replaces former 9-315 Derived from 9-103(2)(d) 9-316

Derived from 8-106(g) 9-311

Art. 9

Secured Transactions
Primary Old Article 9 and Other Code Sections 9-317 9-206 9-318(1) 9-318(2) 9-318(3), (4) 2A-303 See also 5-114 Derived from former 9-401 9-402(1), (5), (6) Subsection (a)(4),(b) and (c) derive from former 9-402(7); otherwise, new 9-402(1) 9-408 9-402(8) 9-402(7) But see 9-402(7)

New Article 9 Sections (Note: many sections contain some new coverage) 9-402 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-403 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-404 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-405 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-406 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-407 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-408 (New) 9-409 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-501 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-502 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-503 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-504 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-505 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-506 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-507 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-508 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-509 (New) 9-510 (New) 9-511 (New) 9-512 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-513 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-514 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-515 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-516 (Basically New). . . . . . . . . . . . . . . . . . . 9-517 (New) 9-518 (New) 9-519 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-520 (New) 9-521 (New) 9-522 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-523 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-524 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-525 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-526 (New) 9-527 (New) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-601 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-602 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-603 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-604 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-605 (New) 9-606 (New) 9-607 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9-402(4) 9-404 9-405 9-403(2), (3), (6) Subsection (a) is former 9-403(1); the remainder is new

9-403(4), (7); 9-405(2)

9-403(3), revised substantially 9-407; subsections (d) and (e) are new Derived from 4-109 Various sections of former Part 4 Subsection (b) derives in part from the Uniform Consumer Credit Code (1974) Derived in part from the Uniform Consumer Credit Code (1974) 9-501(1), (2), (5) 9-501(3) 9-501(3) 9-501(4), 9-313(8)

9-502, subsections (b), (d), and (e) are new

829

Uniform Commercial Code

New Article 9 Sections (Note: many sections contain some new coverage) 9-608 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-609 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-610 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-611 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-612 (New) 9-613 (New) 9-614 (New) 9-615 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-616 (New) 9-617 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-618 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-619 (New) 9-620 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-621 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-622 (New) 9-623 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-624 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-625 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-626 (New) 9-627 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-628 (New) 9-701 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-702 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-703 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-704 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-705 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-706 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-707 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-708 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-709 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Primary Old Article 9 and Other Code Sections

Art. 9

Subsection (a) is new. Subsection (b) derives from former 9-502(2) 9-503 9-504(1), (3) 9-504(3)

9-504(1), (2) 9-504(4) 9-504(5) 9-505 9-505 9-506 9-504(3), 9-505, 9-506 9-507 9-507(2) No comparable provision (See Article 10) No comparable provision (See Article 10) No comparable provision (See Article 10) No comparable provision (See Article 10) No comparable provision (See Article 10) No comparable provision (See Article 10) No comparable provision (See Article 10) No comparable provision (See Article 10) No comparable provision (See Article 10) in Article 9 in Article 9 in Article 9 in Article 9 in Article 9 in Article 9 in Article 9 in Article 9 in Article 9

Conforming Amendments to Other Code Sections and Comments 1-105(2) 1-201(9), (32), (37) 830

Art. 9

Secured Transactions
2-103(3) 2-210; New subsection (3) added 2-312; Comment 2-326(3) 2-502 (1) and (2) 2-716(3) 2A-103(3) 2A-303 2A-307 2A-309 4-210 5-118 (New) Article 6 (unless repealed) 7-503 8-102 Comment 8-103 (f) 8-106 and Comment 8-110 8-301 (3) 8-302 (a) 8-502 Comment 8-510

9-101

PART 1. GENERAL PROVISIONS

[SUBPART 1. SHORT TITLE, DEFINITIONS, AND GENERAL CONCEPTS] 9-101. Short Title. This article may be cited as Uniform Commercial CodeSecured Transactions. Ocial Comment
1. Source. This Article supersedes former Uniform Commercial Code (UCC) Article 9. As did its predecessor, it provides a comprehensive scheme for the regulation of security interests in personal property and xtures. For the most part this Article follows the general approach and retains much of the terminology of former Article 9. In addition to describing many aspects of the operation and interpretation of this Article, these Comments explain the material changes that this Article makes to former Article 9. Former Article 9 superseded the wide variety of pre-UCC security devices. Unlike the Comments to former Article 9, however, these Comments dwell very little on the pre-UCC state of the law. For that reason, the Comments to former Article 9 will remain of substantial historical value and interest. They also will remain useful in understanding the background and general conceptual approach of this Article. Citations to Bankruptcy Code Section in these Comments are to Title 11 of the United States Code as in eect on December 31, 1998. 2. Background and History. In 1990, the Permanent Editorial Board for the UCC with the support of its sponsors, The American Law Institute and the National Conference of Commissioners on Uniform State Laws, established a committee to study Article 9 of the UCC. The study committee issued its report as of December 1, 1992, recommending the creation of a drafting committee for the revision of Article 9 and also recommending numerous specic changes to Article 9. Organized in 1993, a drafting committee met fteen times 831

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Art. 9

from 1993 to 1998. This Article was approved by its sponsors in 1998. 3. Reorganization and Renumbering; Captions; Style. This Article reects a substantial reorganization of former Article 9 and renumbering of most sections. New Part 4 deals with several aspects of third-party rights and duties that are unrelated to perfection and priority. Some of these were covered by Part 3 of former Article 9. Part 5 deals with ling (covered by former Part 4) and Part 6 deals with default and enforcement (covered by former Part 5). Appendix I contains conforming revisions to other articles of the UCC, and Appendix II contains model provisions for production-money priority. This Article also includes headings for the subsections as an aid to readers. Unlike section captions, which are part of the UCC, see Section 1-109, subsection headings are not a part of the ocial text itself and have not been approved by the sponsors. Each jurisdiction in which this Article is introduced may consider whether to adopt the headings as a part of the statute and whether to adopt a provision clarifying the eect, if any, to be given to the headings. This Article also has been conformed to current style conventions. 4. Summary of Revisions. Following is a brief summary of some of the more signicant revisions of Article 9 that are included in this Article. a. Scope of Article 9. This Article expands the scope of Article 9 in several respects. Deposit accounts. Section 9-109 includes within this Article's scope deposit accounts as original collateral, except in consumer transactions. Former Article 9 dealt with deposit accounts only as proceeds of other collateral. Sales of payment intangibles and promissory notes. Section 9-109 also includes within the scope of this Article most sales of payment intangibles (dened in Section 9-102 as general intangibles under which an account debtor's principal obligation is monetary) and promissory notes (also dened in Section 9-102). Former Article 9 included sales of accounts and chattel paper, but not sales of payment intangibles or promissory notes. In its inclusion of sales of payment intangibles and promissory notes, this Article continues the drafting convention found in former Article 9; it provides that the sale of accounts, chattel paper, payment intangibles, or promissory notes creates a security interest. The denition of account in Section 9-102 also has been expanded to include various rights to payment that were general intangibles under former Article 9. Health-care-insurance receivables. Section 9-109 narrows Article 9's exclusion of transfers of interests in insurance policies by carving out of the exclusion health-care-insurance receivables (dened in Section 9-102). A health-care-insurance receivable is included within the denition of account in Section 9-102. Nonpossessory statutory agricultural liens. Section 9-109 also brings nonpossessory statutory agricultural liens within the scope of Article 9. Consignments. Section 9-109 provides that true consignments-bailments for the purpose of sale by the bailee are security interests covered by Article 9, with certain exceptions. See Section 9-102 (dening consignment). Currently, many consignments are subject to Article 9's ling requirements by operation of former Section 2-326. Supporting obligations and property securing rights to payment. This Article also addresses explicitly (i) obligations, such as guaranties and letters of credit, that support payment or performance of collateral such as accounts, chattel paper, and payment intangibles, and (ii) any property (including real property) that secures a right to payment or performance that is subject to an Article 9 security interest. See Sections 9-203, 9-308. Commercial tort claims. Section 9-109 expands the scope of Article 9 to include the assignment of commercial tort claims by narrowing the exclusion of tort claims generally. However, this Article continues to exclude tort claims for bodily injury and other nonbusiness tort claims of a natural person. See Section 9-102 (dening commercial tort claim). Transfers by States and governmental units of States. Section 9-109 narrows the exclusion of transfers by States and their governmental units. It excludes only transfers covered by another statute (other than a statute generally applicable to security interests) to the extent the statute governs the creation, perfection, priority, or enforcement of security interests. Nonassignable general intangibles, promissory notes, health-care-insurance receivables, and letter-of-credit rights. This Article enables a security interest to attach to letter-ofcredit rights, health-care-insurance receivables, promissory notes, and general intangibles, including contracts, permits, licenses, and franchises, notwithstanding a contractual or 832

Art. 9

Secured Transactions

9-101

statutory prohibition against or limitation on assignment. This Article explicitly protects third parties against any adverse eect of the creation or attempted enforcement of the security interest. See Sections 9-408, 9-409. Subject to Sections 9-408 and 9-409 and two other exceptions (Sections 9406, concerning accounts, chattel paper, and payment intangibles, and 9407, concerning interests in leased goods), Section 9-401 establishes a baseline rule that the inclusion of transactions and collateral within the scope of Article 9 has no eect on non-Article 9 law dealing with the alienability or inalienability of property. For example, if a commercial tort claim is nonassignable under other applicable law, the fact that a security interest in the claim is within the scope of Article 9 does not override the other applicable law's eective prohibition of assignment. b. Duties of Secured Party. This Article provides for expanded duties of secured parties. Release of control. Section 9-208 imposes upon a secured party having control of a deposit account, investment property, or a letter-of-credit right the duty to release control when there is no secured obligation and no commitment to give value. Section 9-209 contains analogous provisions when an account debtor has been notied to pay a secured party. Information. Section 9-210 expands a secured party's duties to provide the debtor with information concerning collateral and the obligations that it secures. Default and enforcement. Part 6 also includes some additional duties of secured parties in connection with default and enforcement. See, e.g., Section 9-616 (duty to explain calculation of deciency or surplus in a consumer-goods transaction). c. Choice of Law. The choice-of-law rules for the law governing perfection, the eect of perfection or nonperfection, and priority are found in Part 3, Subpart 1 (Sections 9-301 through 9-307). See also Section 9-316. Where to le: Location of debtor. This Article changes the choice-of-law rule governing perfection (i.e., where to le) for most collateral to the law of the jurisdiction where the debtor is located. See Section 9-301. Under former Article 9, the jurisdiction of the debtor's location governed only perfection and priority of a security interest in accounts, general intangibles, mobile goods, and, for purposes of perfection by ling, chattel paper and investment property. Determining debtor's location. As a baseline rule, Section 9-307 follows former Section 9-103, under which the location of the debtor is the debtor's place of business (or chief executive oce, if the debtor has more than one place of business). Section 9-307 contains three major exceptions. First, a registered organization, such as a corporation or limited liability company, is located in the State under whose law the debtor is organized, e.g., a corporate debtor's State of incorporation. Second, an individual debtor is located at his or her principal residence. Third, there are special rules for determining the location of the United States and registered organizations organized under the law of the United States. Location of non-U.S. debtors. If, applying the foregoing rules, a debtor is located in a jurisdiction whose law does not require public notice as a condition of perfection of a nonpossessory security interest, the entity is deemed located in the District of Columbia. See Section 9307. Thus, to the extent that this Article applies to non-U.S. debtors, perfection could be accomplished in many cases by a domestic ling. Priority. For tangible collateral such as goods and instruments, Section 9-301 provides that the law applicable to priority and the eect of perfection or nonperfection will remain the law of the jurisdiction where the collateral is located, as under former Section 9-103 (but without the confusing last event test). For intangible collateral, such as accounts, the applicable law for priority will be that of the jurisdiction in which the debtor is located. Possessory security interests; agricultural liens. Perfection, the eect of perfection or nonperfection, and priority of a possessory security interest or an agricultural lien are governed by the law of the jurisdiction where the collateral subject to the security interest or lien is located. See Sections 9-301, 9302. Goods covered by certicates of title; deposit accounts; letter-of-credit rights; investment property. This Article includes several renements to the treatment of choice-of-law matters for goods covered by certicates of title. See Section 9-303. It also provides special choice-of-law rules, similar to those for investment property under current Articles 8 and 9, for deposit accounts (Section 9-304), investment property (Section 9-305), and letter-ofcredit rights (Section 9306). 833

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Art. 9

Change in applicable law. Section 9-316 addresses perfection following a change in applicable law. d. Perfection. The rules governing perfection of security interests and agricultural liens are found in Part 3, Subpart 2 (Sections 9-308 through 9-316). Deposit accounts; letter-of-credit rights. With certain exceptions, this Article provides that a security interest in a deposit account or a letter-of-credit right may be perfected only by the secured party's acquiring control of the deposit account or letter-of-credit right. See Sections 9-312, 9-314. Under Section 9-104, a secured party has control of a deposit account when, with the consent of the debtor, the secured party obtains the depositary bank's agreement to act on the secured party's instructions (including when the secured party becomes the account holder) or when the secured party is itself the depositary bank. The control requirements are patterned on Section 8106, which species the requirements for control of investment property. Under Section 9-107, control of a letter-of-credit right occurs when the issuer or nominated person consents to an assignment of proceeds under Section 5114. Electronic chattel paper. Section 9-102 includes a new dened term: electronic chattel paper. Electronic chattel paper is a record or records consisting of information stored in an electronic medium (i.e., it is not written). Perfection of a security interest in electronic chattel paper may be by control or ling. See Sections 9-105 (sui generis denition of control of electronic chattel paper), 9312 (perfection by ling), 9314 (perfection by control). Investment property. The perfection requirements for investment property (dened in Section 9-102), including perfection by control under Section 9-106, remain substantially unchanged. However, a new provision in Section 9-314 is designed to ensure that a secured party retains control in repledge transactions that are typical in the securities markets. Instruments, agricultural liens, and commercial tort claims. This Article expands the types of collateral in which a security interest may be perfected by ling to include instruments. See Section 9-312. Agricultural liens and security interests in commercial tort claims also are perfected by ling, under this Article. See Sections 9-308, 9-310. Sales of payment intangibles and promissory notes. Although former Article 9 covered the outright sale of accounts and chattel paper, sales of most other types of receivables also are nancing transactions to which Article 9 should apply. Accordingly, Section 9-102 expands the denition of account to include many types of receivables (including health-careinsurance receivables, dened in Section 9-102) that former Article 9 classied as general intangibles. It thereby subjects to Article 9's ling system sales of more types of receivables than did former Article 9. Certain sales of payment intangibles-primarily bank loan participation transactions-should not be subject to the Article 9 ling rules. These transactions fall in a residual category of collateral, payment intangibles (general intangibles under which the account debtor's principal obligation is monetary), the sale of which is exempt from the ling requirements of Article 9. See Sections 9-102, 9-109, 9-309 (perfection upon attachment). The perfection rules for sales of promissory notes are the same as those for sales of payment intangibles. Possessory security interests. Several provisions of this Article address aspects of security interests involving a secured party or a third party who is in possession of the collateral. In particular, Section 9-313 resolves a number of uncertainties under former Section 9-305. It provides that a security interest in collateral in the possession of a third party is perfected when the third party acknowledges in an authenticated record that it holds for the secured party's benet. Section 9-313 also provides that a third party need not so acknowledge and that its acknowledgment does not impose any duties on it, unless it otherwise agrees. A special rule in Section 9-313 provides that if a secured party already is in possession of collateral, its security interest remains perfected by possession if it delivers the collateral to a third party and the collateral is accompanied by instructions to hold it for the secured party or to redeliver it to the secured party. Section 9-313 also claries the limited circumstances under which a security interest in goods covered by a certicate of title may be perfected by the secured party's taking possession. Automatic perfection. Section 9-309 lists various types of security interests as to which no public-notice step is required for perfection (e.g., purchase-money security interests in consumer goods other than automobiles). This automatic perfection also extends to a transfer of a health-care-insurance receivable to a health-care provider. Those transfers normally will be made by natural persons who receive health-care services; there is little 834

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value in requiring ling for perfection in that context. Automatic perfection also applies to security interests created by sales of payment intangibles and promissory notes. Section 9-308 provides that a perfected security interest in collateral supported by a supporting obligation (such as an account supported by a guaranty) also is a perfected security interest in the supporting obligation, and that a perfected security interest in an obligation secured by a security interest or lien on property (e.g., a real-property mortgage) also is a perfected security interest in the security interest or lien. e. Priority; Special Rules for Banks and Deposit Accounts. The rules governing priority of security interests and agricultural liens are found in Part 3, Subpart 3 (Sections 9-317 through 9-342). This Article includes several new priority rules and some special rules relating to banks and deposit accounts (Sections 9-340 through 9-342). Purchase-money security interests: General; consumer-goods transactions; inventory. Section 9-103 substantially rewrites the denition of purchase-money security interest (PMSI) (although the term is not formally dened). The substantive changes, however, apply only to non-consumer-goods transactions. (Consumer transactions and consumergoods transactions are discussed below in Comment 4.j.) For non-consumer-goods transactions, Section 9-103 makes clear that a security interest in collateral may be (to some extent) both a PMSI as well as a non-PMSI, in accord with the dual status rule applied by some courts under former Article 9 (thereby rejecting the transformation rule). The denition provides an even broader conception of a PMSI in inventory, yielding a result that accords with private agreements entered into in response to the uncertainty under former Article 9. It also treats consignments as purchase-money security interests in inventory. Section 9-324 revises the PMSI priority rules, but for the most part without material change in substance. Section 9-324 also claries the priority rules for competing PMSIs in the same collateral. Purchase-money security interests in livestock; agricultural liens. Section 9-324 provides a special PMSI priority, similar to the inventory PMSI priority rule, for livestock. Section 9-322 (which contains the baseline rst-to-le-or-perfect priority rule) also recognizes special non-Article 9 priority rules for agricultural liens, which can override the baseline rst-in-time rule. Purchase-money security interests in software. Section 9-324 contains a new priority rule for a software purchase-money security interest. (Section 9-102 includes a denition of software.) Under Section 9-103, a software PMSI includes a PMSI in software that is used in goods that are also subject to a PMSI. (Note also that the denition of chattel paper has been expanded to include records that evidence a monetary obligation and a security interest in specic goods and software used in the goods.) Investment property. The priority rules for investment property are substantially similar to the priority rules found in former Section 9-115, which was added in conjunction with the 1994 revisions to UCC Article 8. Under Section 9-328, if a secured party has control of investment property (Sections 8106, 9106), its security interest is senior to a security interest perfected in another manner (e.g., by ling). Also under Section 9328, security interests perfected by control generally rank according to the time that control is obtained or, in the case of a security entitlement or a commodity contract carried in a commodity account, the time when the control arrangement is entered into. This is a change from former Section 9-115, under which the security interests ranked equally. However, as between a securities intermediary's security interest in a security entitlement that it maintains for the debtor and a security interest held by another secured party, the securities intermediary's security interest is senior. Deposit accounts. This Article's priority rules applicable to deposit accounts are found in Section 9-327. They are patterned on and are similar to those for investment property in former Section 9-115 and Section 9-328 of this Article. Under Section 9-327, if a secured party has control of a deposit account, its security interest is senior to a security interest perfected in another manner (i.e., as cash proceeds). Also under Section 9327, security interests perfected by control rank according to the time that control is obtained, but as between a depositary bank's security interest and one held by another secured party, the depositary bank's security interest is senior. A corresponding rule in Section 9-340 makes a depositary bank's right of set-o generally senior to a security interest held by another secured party. However, if the other secured party becomes the depositary bank's customer with respect to the deposit account, then its security interest is senior to the depositary bank's security interest and right of set-o. Sections 9-327, 9-340. 835

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Letter-of-credit rights. The priority rules for security interests in letter-of-credit rights are found in Section 9-329. They are somewhat analogous to those for deposit accounts. A security interest perfected by control has priority over one perfected in another manner (i.e., as a supporting obligation for the collateral in which a security interest is perfected). Security interests in a letter-of-credit right perfected by control rank according to the time that control is obtained. However, the rights of a transferee beneciary or a nominated person are independent and superior to the extent provided in Section 5-114. See Section 9-109(c)(4). Chattel paper and instruments. Section 9-330 is the successor to former Section 9-308. As under former Section 9-308, diering priority rules apply to purchasers of chattel paper who give new value and take possession (or, in the case of electronic chattel paper, obtain control) of the collateral depending on whether a conicting security interest in the collateral is claimed merely as proceeds. The principal change relates to the role of knowledge and the eect of an indication of a previous assignment of the collateral. Section 9-330 also aords priority to purchasers of instruments who take possession in good faith and without knowledge that the purchase violates the rights of the competing secured party. In addition, to qualify for priority, purchasers of chattel paper, but not of instruments, must purchase in the ordinary course of business. Proceeds. Section 9-322 contains new priority rules that clarify when a special priority of a security interest in collateral continues or does not continue with respect to proceeds of the collateral. Other renements to the priority rules for proceeds are included in Sections 9-324 (purchase-money security interest priority) and 9-330 (priority of certain purchasers of chattel paper and instruments). Miscellaneous priority provisions. This Article also includes (i) clarications of selected good-faith-purchase and similar issues (Sections 9-317, 9-331); (ii) new priority rules to deal with the double debtor problem arising when a debtor creates a security interest in collateral acquired by the debtor subject to a security interest created by another person (Section 9-325); (iii) new priority rules to deal with the problems created when a change in corporate structure or the like results in a new entity that has become bound by the original debtor's after-acquired property agreement (Section 9-326); (iv) a provision enabling most transferees of funds from a deposit account or money to take free of a security interest (Section 9-332); (v) substantially rewritten and rened priority rules dealing with accessions and commingled goods (Sections 9-335, 9-336); (vi) revised priority rules for security interests in goods covered by a certicate of title (Section 9-337); and (vii) provisions designed to ensure that security interests in deposit accounts will not extend to most transferees of funds on deposit or payees from deposit accounts and will not otherwise clog the payments system (Sections 9-341, 9-342). Model provisions relating to production-money security interests. Appendix II to this Article contains model denitions and priority rules relating to production-money security interests held by secured parties who give new value used in the production of crops. Because no consensus emerged on the wisdom of these provisions during the drafting process, the sponsors make no recommendation on whether these model provisions should be enacted. f. Proceeds. Section 9-102 contains an expanded denition of proceeds of collateral which includes additional rights and property that arise out of collateral, such as distributions on account of collateral and claims arising out of the loss or nonconformity of, defects in, or damage to collateral. The term also includes collections on account of supporting obligations, such as guarantees. g. Part 4: Additional Provisions Relating to Third-Party Rights. New Part 4 contains several provisions relating to the relationships between certain third parties and the parties to secured transactions. It contains new Sections 9-401 (replacing former Section 9-311) (alienability of debtor's rights), 9-402 (replacing former Section 9-317) (secured party not obligated on debtor's contracts), 9-403 (replacing former Section 9-206) (agreement not to assert defenses against assignee), 9-404, 9-405, and 9-406 (replacing former Section 9-318) (rights acquired by assignee, modication of assigned contract, discharge of account debtor, restrictions on assignment of account, chattel paper, promissory note, or payment intangible ineective), 9-407 (replacing some provisions of former Section 2A-303) (restrictions on creation or enforcement of security interest in leasehold interest or lessor's residual interest ineective). It also contains new Sections 9-408 (restrictions on assignment of promissory notes, health-care-insurance receivables ineective, and certain general 836

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intangibles ineective) and 9-409 (restrictions on assignment of letter-of-credit rights ineffective), which are discussed above. h. Filing. Part 5 (formerly Part 4) of Article 9 has been substantially rewritten to simplify the statutory text and to deal with numerous problems of interpretation and implementation that have arisen over the years. Medium-neutrality. This Article is medium-neutral; that is, it makes clear that parties may le and otherwise communicate with a ling oce by means of records communicated and stored in media other than on paper. Identity of person who les a record; authorization. Part 5 is largely indierent as to the person who eects a ling. Instead, it addresses whose authorization is necessary for a person to le a record with a ling oce. The ling scheme does not contemplate that the identity of a ler will be a part of the searchable records. This approach is consistent with, and a necessary aspect of, eliminating signatures or other evidence of authorization from the system (except to the extent that ling oces may choose to employ authentication procedures in connection with electronic communications). As long as the appropriate person authorizes the ling, or, in the case of a termination statement, the debtor is entitled to the termination, it is largely insignicant whether the secured party or another person les any given record. Section 9-509 collects in one place most of the rules that determine when a record may be led. In general, the debtor's authorization is required for the ling of an initial nancing statement or an amendment that adds collateral. With one further exception, a secured party of record's authorization is required for the ling of other amendments. The exception arises if a secured party has failed to provide a termination statement that is required because there is no outstanding secured obligation or commitment to give value. In that situation, a debtor is authorized to le a termination statement indicating that it has been led by the debtor. Financing statement formal requisites. The formal requisites for a nancing statement are set out in Section 9-502. A nancing statement must provide the name of the debtor and the secured party and an indication of the collateral that it covers. Sections 9-503 and 9-506 address the suciency of a name provided on a nancing statement and clarify when a debtor's name is correct and when an incorrect name is insucient. Section 9-504 addresses the indication of collateral covered. Under Section 9-504, a super-generic description (e.g.,all assets or all personal property) in a nancing statement is a sucient indication of the collateral. (Note, however, that a super-generic description is inadequate for purposes of a security agreement. See Sections 9-108, 9-203.) To facilitate electronic ling, this Article does not require that the debtor's signature or other authorization appear on a nancing statement. Instead, it prohibits the ling of unauthorized nancing statements and imposes liability upon those who violate the prohibition. See Sections 9-509, 9-626. Filing-oce operations. Part 5 contains several provisions governing ling operations. First, it prohibits the ling oce from rejecting an initial nancing statement or other record for a reason other than one of the few that are specied. See Sections 9-520, 9-516. Second, the ling oce is obliged to link all subsequent records (e.g., assignments, continuation statements, etc.) to the initial nancing statement to which they relate. See Section 9-519. Third, the ling oce may delete a nancing statement and related records from the les no earlier than one year after lapse (lapse normally is ve years after the ling date), and then only if a continuation statement has not been led. See Sections 9-515, 9-519, 9-522. Thus, a nancing statement and related records would be discovered by a search of the les even after the ling of a termination statement. This approach helps eliminate ling-oce discretion and also eases problems associated with multiple secured parties and multiple partial assignments. Fourth, Part 5 mandates performance standards for ling oces. See Sections 9-519, 9-520, 9-523. Fifth, it provides for the promulgation of lingoce rules to deal with details best left out of the statute and requires the ling oce to submit periodic reports. See Sections 9-526, 9-527. Correction of records: Defaulting or missing secured parties and fraudulent lings. In some areas of the country, serious problems have arisen from fraudulent nancing statements that are led against public ocials and other persons. This Article addresses the fraud problem by providing the opportunity for a debtor to le a termination statement when a secured party wrongfully refuses or fails to provide a termination statement. See 837

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Section 9-509. This opportunity also addresses the problem of secured parties that simply disappear through mergers or liquidations. In addition, Section 9-518 aords a statutory method by which a debtor who believes that a led record is inaccurate or was wrongfully led may indicate that fact in the les by ling a correction statement, albeit without affecting the ecacy, if any, of the challenged record. Extended period of eectiveness for certain nancing statements. Section 9-515 contains an exception to the usual rule that nancing statements are eective for ve years unless a continuation statement is led to continue the eectiveness for another ve years. Under that section, an initial nancing statement led in connection with a public-nance transaction or a manufactured-home transaction (terms dened in Section 9-102) is eective for 30 years. National form of nancing statement and related forms. Section 9-521 provides for uniform, national written forms of nancing statements and related written records that must be accepted by a ling oce that accepts written records. i. Default and Enforcement. Part 6 of Article 9 extensively revises former Part 5. Provisions relating to enforcement of consumer-goods transactions and consumer transactions are discussed in Comment 4.j. Debtor, secondary obligor; waiver. Section 9-602 claries the identity of persons who have rights and persons to whom a secured party owes specied duties under Part 6. Under that section, the rights and duties are enjoyed by and run to the debtor, dened in Section 9-102 to mean any person with a non-lien property interest in collateral, and to any obligor. However, with one exception (Section 9-616, as it relates to a consumer obligor), the rights and duties concerned aect non-debtor obligors only if they are secondary obligors. Secondary obligor is dened in Section 9-102 to include one who is secondarily obligated on the secured obligation, e.g., a guarantor, or one who has a right of recourse against the debtor or another obligor with respect to an obligation secured by collateral. However, under Section 9-628, the secured party is relieved from any duty or liability to any person unless the secured party knows that the person is a debtor or obligor. Resolving an issue on which courts disagreed under former Article 9, this Article generally prohibits waiver by a secondary obligor of its rights and a secured party's duties under Part 6. See Section 9-602. However, Section 9-624 permits a secondary obligor or debtor to waive the right to notication of disposition of collateral and, in a non-consumer transaction, the right to redeem collateral, if the secondary obligor or debtor agrees to do so after default. Rights of collection and enforcement of collateral. Section 9-607 explains in greater detail than former 9-502 the rights of a secured party who seeks to collect or enforce collateral, including accounts, chattel paper, and payment intangibles. It also sets forth the enforcement rights of a depositary bank holding a security interest in a deposit account maintained with the depositary bank. Section 9-607 relates solely to the rights of a secured party vis-avis a debtor with respect to collections and enforcement. It does not aect the rights or duties of third parties, such as account debtors on collateral, which are addressed elsewhere (e.g., Section 9-406). Section 9-608 claries the manner in which proceeds of collection or enforcement are to be applied. Disposition of collateral: Warranties of title. Section 9-610 imposes on a secured party who disposes of collateral the warranties of title, quiet possession, and the like that are otherwise applicable under other law. It also provides rules for the exclusion or modication of those warranties. Disposition of collateral: Notication, application of proceeds, surplus and deciency, other eects. Section 9-611 requires a secured party to give notication of a disposition of collateral to other secured parties and lienholders who have led nancing statements against the debtor covering the collateral. (That duty was eliminated by the 1972 revisions to Article 9.) However, that section relieves the secured party from that duty when the secured party undertakes a search of the records and a report of the results is unreasonably delayed. Section 9-613, which applies only to non-consumer transactions, species the contents of a sucient notication of disposition and provides that a notication sent 10 days or more before the earliest time for disposition is sent within a reasonable time. Section 9-615 addresses the application of proceeds of disposition, the entitlement of a debtor to any surplus, and the liability of an obligor for any deciency. Section 9-619 claries the eects of a disposition by a secured party, including the rights of transferees of the collateral. 838

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Rights and duties of secondary obligor. Section 9-618 provides that a secondary obligor obtains the rights and assumes the duties of a secured party if the secondary obligor receives an assignment of a secured obligation, agrees to assume the secured party's rights and duties upon a transfer to it of collateral, or becomes subrogated to the rights of the secured party with respect to the collateral. The assumption, transfer, or subrogation is not a disposition of collateral under Section 9-610, but it does relieve the former secured party of further duties. Former Section 9-504(5) did not address whether a secured party was relieved of its duties in this situation. Transfer of record or legal title. Section 9-619 contains a new provision making clear that a transfer of record or legal title to a secured party is not of itself a disposition under Part 6. This rule applies regardless of the circumstances under which the transfer of title occurs. Strict foreclosure. Section 9-620, unlike former Section 9-505, permits a secured party to accept collateral in partial satisfaction, as well as full satisfaction, of the obligations secured. This right of strict foreclosure extends to intangible as well as tangible property. Section 9-622 claries the eects of an acceptance of collateral on the rights of junior claimants. It rejects the approach taken by some courts-deeming a secured party to have constructively retained collateral in satisfaction of the secured obligations-in the case of a secured party's unreasonable delay in the disposition of collateral. Instead, unreasonable delay is relevant when determining whether a disposition under Section 9-610 is commercially reasonable. Eect of noncompliance: Rebuttable presumption test. Section 9-626 adopts the rebuttable presumption test for the failure of a secured party to proceed in accordance with certain provisions of Part 6. (As discussed in Comment 4.j., the test does not necessarily apply to consumer transactions.) Under this approach, the deciency claim of a noncomplying secured party is calculated by crediting the obligor with the greater of the actual net proceeds of a disposition and the amount of net proceeds that would have been realized if the disposition had been conducted in accordance with Part 6 (e.g., in a commercially reasonable manner). For non-consumer transactions, Section 9-626 rejects the absolute bar test that some courts have imposed; that approach bars a noncomplying secured party from recovering any deciency, regardless of the loss (if any) the debtor suered as a consequence of the noncompliance. Low-price dispositions: Calculation of deciency and surplus. Section 9-615(f) addresses the problem of procedurally regular dispositions that fetch a low price. Subsection (f) provides a special method for calculating a deciency if the proceeds of a disposition of collateral to a secured party, a person related to the secured party, or a secondary obligor are signicantly below the range of proceeds that a complying disposition to a person other than the secured party, a person related to the secured party, or a secondary obligor would have brought. (Person related to is dened in Section 9-102.) In these situations there is reason to suspect that there may be inadequate incentives to obtain a better price. Consequently, instead of calculating a deciency (or surplus) based on the actual net proceeds, the deciency (or surplus) would be calculated based on the proceeds that would have been received in a disposition to a person other than the secured party, a person related to the secured party, or a secondary obligor. j. Consumer Goods, Consumer-Goods Transactions, and Consumer Transactions. This Article (including the accompanying conforming revisions (see Appendix I)) includes several special rules for consumer goods, consumer transactions, and consumer-goods transactions. Each term is dened in Section 9-102. (i) Revised Sections 2-502 and 2-716 provide a buyer of consumer goods with enhanced rights to possession of the goods, thereby accelerating the opportunity to achieve buyer in ordinary course of business status under Section 1-201. (ii) Section 9-103(e) (allocation of payments for determining extent of purchase-money status), (f) (purchase-money status not aected by cross-collateralization, renancing, restructuring, or the like), and (g) (secured party has burden of establishing extent of purchase-money status) do not apply to consumer-goods transactions. Sections 9-103 also provides that the limitation of those provisions to transactions other than consumer-goods transactions leaves to the courts the proper rules for consumer-goods transactions and prohibits the courts from drawing inferences from that limitation. (iii) Section 9-108 provides that in a consumer transaction a description of consumer goods, a security entitlement, securities account, or commodity account only by [UCC839

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dened] type of collateral is not a sucient collateral description in a security agreement. (iv) Sections 9-403 and 9-404 make eective the Federal Trade Commission's anti-holderin-due-course rule (when applicable), 16 C.F.R. Part 433, even in the absence of the required legend. (v) The 10-day safe-harbor for notication of a disposition provided by Section 9-612 does not apply in a consumer transaction. (vi) Section 9-613 (contents and form of notice of disposition) does not apply to a consumer-goods transaction. (vii) Section 9-614 contains special requirements for the contents of a notication of disposition and a safe-harbor, plain English form of notication, for consumer-goods transactions. (viii) Section 9-616 requires a secured party in a consumer-goods transaction to provide a debtor with a notication of how it calculated a deciency at the time it rst undertakes to collect a deciency. (ix) Section 9-620 prohibits partial strict foreclosure with respect to consumer goods collateral and, unless the debtor agrees to waive the requirement in an authenticated record after default, in certain cases requires the secured party to dispose of consumer goods collateral which has been repossessed. (x) Section 9-626 (rebuttable presumption rule) does not apply to a consumer transaction. Section 9-626 also provides that its limitation to transactions other than consumer transactions leaves to the courts the proper rules for consumer transactions and prohibits the courts from drawing inferences from that limitation. k. Good Faith. Section 9-102 contains a new denition of good faith that includes not only honesty in fact but also the observance of reasonable commercial standards of fair dealing. The denition is similar to the ones adopted in connection with other, recently completed revisions of the UCC. l. Transition Provisions. Part 7 (Sections 9-701 through 9-709) contains transition provisions. Transition from former Article 9 to this Article will be particularly challenging in view of its expanded scope, its modication of choice-of-law rules for perfection and priority, and its expansion of the methods of perfection. m. Conforming and Related Amendments to Other UCC Articles. Appendix I contains several proposed revisions to the provisions and Comments of other UCC articles. For the most part the revisions are explained in the Comments to the proposed revisions. Cross-references in other UCC articles to sections of Article 9 also have been revised. Article 1. Revised Section 1-201 contains revisions to the denitions of buyer in ordinary course of business, purchaser, and security interest. Articles 2 and 2A. Sections 2-210, 2-326, 2-502, 2-716, 2A-303, and 2A-307 have been revised to address the intersection between Articles 2 and 2A and Article 9. Article 5. New Section 5-118 is patterned on Section 4-210. It provides for a security interest in documents presented under a letter of credit in favor of the issuer and a nominated person on the letter of credit. Article 8. Revisions to Section 8-106, which deals with control of securities and security entitlements, conform it to Section 8-302, which deals with delivery. Revisions to Section 8-110, which deals with a securities intermediary's jurisdiction, conform it to the revised treatment of a commodity intermediary's jurisdiction in Section 9-305. Sections 8-301 and 8-302 have been revised for clarication. Section 8-510 has been revised to conform it to the revised priority rules of Section 9-328. Several Comments in Article 8 also have been revised.

9-102. Denitions and Index of Denitions. (a) [Article 9 denitions.] In this article: (1) Accession means goods that are physically united with other goods in such a manner that the identity of the original goods is not lost. (2) Account, except as used in account for, means a right to payment of a monetary obligation, whether or not earned by performance, (i) for property that has been or is to be sold, leased, licensed, assigned, or otherwise disposed of, (ii) for services rendered or to be rendered, (iii)
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for a policy of insurance issued or to be issued, (iv) for a secondary obligation incurred or to be incurred, (v) for energy provided or to be provided, (vi) for the use or hire of a vessel under a charter or other contract, (vii) arising out of the use of a credit or charge card or information contained on or for use with the card, or (viii) as winnings in a lottery or other game of chance operated or sponsored by a State, governmental unit of a State, or person licensed or authorized to operate the game by a State or governmental unit of a State. The term includes health-care-insurance receivables. The term does not include (i) rights to payment evidenced by chattel paper or an instrument, (ii) commercial tort claims, (iii) deposit accounts, (iv) investment property, (v) letter-ofcredit rights or letters of credit, or (vi) rights to payment for money or funds advanced or sold, other than rights arising out of the use of a credit or charge card or information contained on or for use with the card. (3) Account debtor means a person obligated on an account, chattel paper, or general intangible. The term does not include persons obligated to pay a negotiable instrument, even if the instrument constitutes part of chattel paper. (4) Accounting, except as used in accounting for, means a record: (A) authenticated by a secured party; (B) indicating the aggregate unpaid secured obligations as of a date not more than 35 days earlier or 35 days later than the date of the record; and (C) identifying the components of the obligations in reasonable detail. (5) Agricultural lien means an interest in farm products: (A) which secures payment or performance of an obligation for: (i) goods or services furnished in connection with a debtor's farming operation; or (ii) rent on real property leased by a debtor in connection with its farming operation; (B) which is created by statute in favor of a person that: (i) in the ordinary course of its business furnished goods or services to a debtor in connection with a debtor's farming operation; or (ii) leased real property to a debtor in connection with the debtor's farming operation; and (C) whose eectiveness does not depend on the person's possession of the personal property. (6) As-extracted collateral means: (A) oil, gas, or other minerals that are subject to a security interest that: (i) is created by a debtor having an interest in the minerals before extraction; and (ii) attaches to the minerals as extracted; or (B) accounts arising out of the sale at the wellhead or minehead of oil, gas, or other minerals in which the debtor had an interest before extraction.
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(7) Authenticate means: (A) to sign; or (B) to execute or otherwise adopt a symbol, or encrypt or similarly process a record in whole or in part, with the present intent of the authenticating person to identify the person and adopt or accept a record. (8) Bank means an organization that is engaged in the business of banking. The term includes savings banks, savings and loan associations, credit unions, and trust companies. (9) Cash proceeds means proceeds that are money, checks, deposit accounts, or the like. (10) Certicate of title means a certicate of title with respect to which a statute provides for the security interest in question to be indicated on the certicate as a condition or result of the security interest's obtaining priority over the rights of a lien creditor with respect to the collateral. (11) Chattel paper means a record or records that evidence both a monetary obligation and a security interest in specic goods, a security interest in specic goods and software used in the goods, a security interest in specic goods and license of software used in the goods, a lease of specic goods, or a lease of specic goods and license of software used in the goods. In this paragraph, monetary obligation means a monetary obligation secured by the goods or owed under a lease of the goods and includes a monetary obligation with respect to software used in the goods. The term does not include (i) charters or other contracts involving the use or hire of a vessel or (ii) records that evidence a right to payment arising out of the use of a credit or charge card or information contained on or for use with the card. If a transaction is evidenced by records that include an instrument or series of instruments, the group of records taken together constitutes chattel paper. (12) Collateral means the property subject to a security interest or agricultural lien. The term includes: (A) proceeds to which a security interest attaches; (B) accounts, chattel paper, payment intangibles, and promissory notes that have been sold; and (C) goods that are the subject of a consignment. (13) Commercial tort claim means a claim arising in tort with respect to which: (A) the claimant is an organization; or (B) the claimant is an individual and the claim: (i) arose in the course of the claimant's business or profession; and (ii) does not include damages arising out of personal injury to or the death of an individual. (14) Commodity account means an account maintained by a commodity intermediary in which a commodity contract is carried for a commodity customer. (15) Commodity contract means a commodity futures contract, an
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option on a commodity futures contract, a commodity option, or another contract if the contract or option is: (A) traded on or subject to the rules of a board of trade that has been designated as a contract market for such a contract pursuant to federal commodities laws; or (B) traded on a foreign commodity board of trade, exchange, or market, and is carried on the books of a commodity intermediary for a commodity customer. (16) Commodity customer means a person for which a commodity intermediary carries a commodity contract on its books. (17) Commodity intermediary means a person that: (A) is registered as a futures commission merchant under federal commodities law; or (B) in the ordinary course of its business provides clearance or settlement services for a board of trade that has been designated as a contract market pursuant to federal commodities law. (18) Communicate means: (A) to send a written or other tangible record; (B) to transmit a record by any means agreed upon by the persons sending and receiving the record; or (C) in the case of transmission of a record to or by a ling oce, to transmit a record by any means prescribed by ling-oce rule. (19) Consignee means a merchant to which goods are delivered in a consignment. (20) Consignment means a transaction, regardless of its form, in which a person delivers goods to a merchant for the purpose of sale and: (A) the merchant: (i) deals in goods of that kind under a name other than the name of the person making delivery; (ii) is not an auctioneer; and (iii) is not generally known by its creditors to be substantially engaged in selling the goods of others; (B) with respect to each delivery, the aggregate value of the goods is $1,000 or more at the time of delivery; (C) the goods are not consumer goods immediately before delivery; and (D) the transaction does not create a security interest that secures an obligation. (21) Consignor means a person that delivers goods to a consignee in a consignment. (22) Consumer debtor means a debtor in a consumer transaction. (23) Consumer goods means goods that are used or bought for use primarily for personal, family, or household purposes. (24) Consumer-goods transaction means a consumer transaction in which: (A) an individual incurs an obligation primarily for personal, family, or household purposes; and
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(B) a security interest in consumer goods secures the obligation. (25) Consumer obligor means an obligor who is an individual and who incurred the obligation as part of a transaction entered into primarily for personal, family, or household purposes. (26) Consumer transaction means a transaction in which (i) an individual incurs an obligation primarily for personal, family, or household purposes, (ii) a security interest secures the obligation, and (iii) the collateral is held or acquired primarily for personal, family, or household purposes. The term includes consumer-goods transactions. (27) Continuation statement means an amendment of a nancing statement which: (A) identies, by its le number, the initial nancing statement to which it relates; and (B) indicates that it is a continuation statement for, or that it is led to continue the eectiveness of, the identied nancing statement. (28) Debtor means: (A) a person having an interest, other than a security interest or other lien, in the collateral, whether or not the person is an obligor; (B) a seller of accounts, chattel paper, payment intangibles, or promissory notes; or (C) a consignee. (29) Deposit account means a demand, time, savings, passbook, or similar account maintained with a bank. The term does not include investment property or accounts evidenced by an instrument. (30) Document means a document of title or a receipt of the type described in Section 7-201(b). (31) Electronic chattel paper means chattel paper evidenced by a record or records consisting of information stored in an electronic medium. (32) Encumbrance means a right, other than an ownership interest, in real property. The term includes mortgages and other liens on real property. (33) Equipment means goods other than inventory, farm products, or consumer goods. (34) Farm products means goods, other than standing timber, with respect to which the debtor is engaged in a farming operation and which are: (A) crops grown, growing, or to be grown, including: (i) crops produced on trees, vines, and bushes; and (ii) aquatic goods produced in aquacultural operations; (B) livestock, born or unborn, including aquatic goods produced in aquacultural operations; (C) supplies used or produced in a farming operation; or (D) products of crops or livestock in their unmanufactured states. (35) Farming operation means raising, cultivating, propagating, fattening, grazing, or any other farming, livestock, or aquacultural operation.
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(36) File number means the number assigned to an initial nancing statement pursuant to Section 9-519(a). (37) Filing oce means an oce designated in Section 9-501 as the place to le a nancing statement. (38) Filing-oce rule means a rule adopted pursuant to Section 9-526. (39) Financing statement means a record or records composed of an initial nancing statement and any led record relating to the initial nancing statement. (40) Fixture ling means the ling of a nancing statement covering goods that are or are to become xtures and satisfying Section 9-502(a) and (b). The term includes the ling of a nancing statement covering goods of a transmitting utility which are or are to become xtures. (41) Fixtures means goods that have become so related to particular real property that an interest in them arises under real property law. (42) General intangible means any personal property, including things in action, other than accounts, chattel paper, commercial tort claims, deposit accounts, documents, goods, instruments, investment property, letter-of-credit rights, letters of credit, money, and oil, gas, or other minerals before extraction. The term includes payment intangibles and software. (43) [reserved] (44) Goods means all things that are movable when a security interest attaches. The term includes (i) xtures, (ii) standing timber that is to be cut and removed under a conveyance or contract for sale, (iii) the unborn young of animals, (iv) crops grown, growing, or to be grown, even if the crops are produced on trees, vines, or bushes, and (v) manufactured homes. The term also includes a computer program embedded in goods and any supporting information provided in connection with a transaction relating to the program if (i) the program is associated with the goods in such a manner that it customarily is considered part of the goods, or (ii) by becoming the owner of the goods, a person acquires a right to use the program in connection with the goods. The term does not include a computer program embedded in goods that consist solely of the medium in which the program is embedded. The term also does not include accounts, chattel paper, commercial tort claims, deposit accounts, documents, general intangibles, instruments, investment property, letter-of-credit rights, letters of credit, money, or oil, gas, or other minerals before extraction. (45) Governmental unit means a subdivision, agency, department, county, parish, municipality, or other unit of the government of the United States, a State, or a foreign country. The term includes an organization having a separate corporate existence if the organization is eligible to issue debt on which interest is exempt from income taxation under the laws of the United States. (46) Health-care-insurance receivable means an interest in or claim under a policy of insurance which is a right to payment of a monetary obligation for health-care goods or services provided or to be provided. (47) Instrument means a negotiable instrument or any other writing
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that evidences a right to the payment of a monetary obligation, is not itself a security agreement or lease, and is of a type that in ordinary course of business is transferred by delivery with any necessary indorsement or assignment. The term does not include (i) investment property, (ii) letters of credit, or (iii) writings that evidence a right to payment arising out of the use of a credit or charge card or information contained on or for use with the card. (48) Inventory means goods, other than farm products, which: (A) are leased by a person as lessor; (B) are held by a person for sale or lease or to be furnished under a contract of service; (C) are furnished by a person under a contract of service; or (D) consist of raw materials, work in process, or materials used or consumed in a business. (49) Investment property means a security, whether certicated or uncerticated, security entitlement, securities account, commodity contract, or commodity account. (50) Jurisdiction of organization, with respect to a registered organization, means the jurisdiction under whose law the organization is organized. (51) Letter-of-credit right means a right to payment or performance under a letter of credit, whether or not the beneciary has demanded or is at the time entitled to demand payment or performance. The term does not include the right of a beneciary to demand payment or performance under a letter of credit. (52) Lien creditor means: (A) a creditor that has acquired a lien on the property involved by attachment, levy, or the like; (B) an assignee for benet of creditors from the time of assignment; (C) a trustee in bankruptcy from the date of the ling of the petition; or (D) a receiver in equity from the time of appointment. (53) Manufactured home means a structure, transportable in one or more sections, which, in the traveling mode, is eight body feet or more in width or 40 body feet or more in length, or, when erected on site, is 320 or more square feet, and which is built on a permanent chassis and designed to be used as a dwelling with or without a permanent foundation when connected to the required utilities, and includes the plumbing, heating, air-conditioning, and electrical systems contained therein. The term includes any structure that meets all of the requirements of this paragraph except the size requirements and with respect to which the manufacturer voluntarily les a certication required by the United States Secretary of Housing and Urban Development and complies with the standards established under Title 42 of the United States Code. (54) Manufactured-home transaction means a secured transaction: (A) that creates a purchase-money security interest in a manufactured home, other than a manufactured home held as inventory; or (B) in which a manufactured home, other than a manufactured home held as inventory, is the primary collateral.
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(55) Mortgage means a consensual interest in real property, including xtures, which secures payment or performance of an obligation. (56) New debtor means a person that becomes bound as debtor under Section 9-203(d) by a security agreement previously entered into by another person. (57) New value means (i) money, (ii) money's worth in property, services, or new credit, or (iii) release by a transferee of an interest in property previously transferred to the transferee. The term does not include an obligation substituted for another obligation. (58) Noncash proceeds means proceeds other than cash proceeds. (59) Obligor means a person that, with respect to an obligation secured by a security interest in or an agricultural lien on the collateral, (i) owes payment or other performance of the obligation, (ii) has provided property other than the collateral to secure payment or other performance of the obligation, or (iii) is otherwise accountable in whole or in part for payment or other performance of the obligation. The term does not include issuers or nominated persons under a letter of credit. (60) Original debtor, except as used in Section 9-310(c), means a person that, as debtor, entered into a security agreement to which a new debtor has become bound under Section 9-203(d). (61) Payment intangible means a general intangible under which the account debtor's principal obligation is a monetary obligation. (62) Person related to, with respect to an individual, means: (A) the spouse of the individual; (B) a brother, brother-in-law, sister, or sister-in-law of the individual; (C) an ancestor or lineal descendant of the individual or the individual's spouse; or (D) any other relative, by blood or marriage, of the individual or the individual's spouse who shares the same home with the individual. (63) Person related to, with respect to an organization, means: (A) a person directly or indirectly controlling, controlled by, or under common control with the organization; (B) an ocer or director of, or a person performing similar functions with respect to, the organization; (C) an ocer or director of, or a person performing similar functions with respect to, a person described in subparagraph (A); (D) the spouse of an individual described in subparagraph (A), (B), or (C); or (E) an individual who is related by blood or marriage to an individual described in subparagraph (A), (B), (C), or (D) and shares the same home with the individual. (64) Proceeds, except as used in Section 9-609(b), means the following property: (A) whatever is acquired upon the sale, lease, license, exchange, or other disposition of collateral; (B) whatever is collected on, or distributed on account of, collateral;
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(C) rights arising out of collateral; (D) to the extent of the value of collateral, claims arising out of the loss, nonconformity, or interference with the use of, defects or infringement of rights in, or damage to, the collateral; or (E) to the extent of the value of collateral and to the extent payable to the debtor or the secured party, insurance payable by reason of the loss or nonconformity of, defects or infringement of rights in, or damage to, the collateral. (65) Promissory note means an instrument that evidences a promise to pay a monetary obligation, does not evidence an order to pay, and does not contain an acknowledgment by a bank that the bank has received for deposit a sum of money or funds. (66) Proposal means a record authenticated by a secured party which includes the terms on which the secured party is willing to accept collateral in full or partial satisfaction of the obligation it secures pursuant to Sections 9-620, 9-621, and 9-622. (67) Public-nance transaction means a secured transaction in connection with which: (A) debt securities are issued; (B) all or a portion of the securities issued have an initial stated maturity of at least 20 years; and (C) the debtor, obligor, secured party, account debtor or other person obligated on collateral, assignor or assignee of a secured obligation, or assignor or assignee of a security interest is a State or a governmental unit of a State. (68) Pursuant to commitment, with respect to an advance made or other value given by a secured party, means pursuant to the secured party's obligation, whether or not a subsequent event of default or other event not within the secured party's control has relieved or may relieve the secured party from its obligation. (69) Record, except as used in for record, of record, record or legal title, and record owner, means information that is inscribed on a tangible medium or which is stored in an electronic or other medium and is retrievable in perceivable form. (70) Registered organization means an organization organized solely under the law of a single State or the United States and as to which the State or the United States must maintain a public record showing the organization to have been organized. (71) Secondary obligor means an obligor to the extent that: (A) the obligor's obligation is secondary; or (B) the obligor has a right of recourse with respect to an obligation secured by collateral against the debtor, another obligor, or property of either. (72) Secured party means: (A) a person in whose favor a security interest is created or provided for under a security agreement, whether or not any obligation to be secured is outstanding; (B) a person that holds an agricultural lien;
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(C) a consignor; (D) a person to which accounts, chattel paper, payment intangibles, or promissory notes have been sold; (E) a trustee, indenture trustee, agent, collateral agent, or other representative in whose favor a security interest or agricultural lien is created or provided for; or (F) a person that holds a security interest arising under Section 2-401, 2-505, 2-711(3), 2A-508(5), 4-210, or 5-118. (73) Security agreement means an agreement that creates or provides for a security interest. (74) Send, in connection with a record or notication, means: (A) to deposit in the mail, deliver for transmission, or transmit by any other usual means of communication, with postage or cost of transmission provided for, addressed to any address reasonable under the circumstances; or (B) to cause the record or notication to be received within the time that it would have been received if properly sent under subparagraph (A). (75) Software means a computer program and any supporting information provided in connection with a transaction relating to the program. The term does not include a computer program that is included in the denition of goods. (76) State means a State of the United States, the District of Columbia, Puerto Rico, the United States Virgin Islands, or any territory or insular possession subject to the jurisdiction of the United States. (77) Supporting obligation means a letter-of-credit right or secondary obligation that supports the payment or performance of an account, chattel paper, a document, a general intangible, an instrument, or investment property. (78) Tangible chattel paper means chattel paper evidenced by a record or records consisting of information that is inscribed on a tangible medium. (79) Termination statement means an amendment of a nancing statement which: (A) identies, by its le number, the initial nancing statement to which it relates; and (B) indicates either that it is a termination statement or that the identied nancing statement is no longer eective. (80) Transmitting utility means a person primarily engaged in the business of: (A) operating a railroad, subway, street railway, or trolley bus; (B) transmitting communications electrically, electromagnetically, or by light; (C) transmitting goods by pipeline or sewer; or (D) transmitting or producing and transmitting electricity, steam, gas, or water. (b) [Denitions in other articles.] Control as provided in Section 7-106 and the following denitions in other articles apply to this article:
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Applicant. Beneciary. Broker. Certicated security. Check. Clearing corporation. Contract for sale. Customer. Entitlement holder. Financial asset. Holder in due course. Issuer (with respect to a letter of credit or letter-of-credit right). Issuer (with respect to a security). Issuer (with respect to documents of title). Lease. Lease agreement. Lease contract. Leasehold interest. Lessee. Lessee in ordinary course of business. Lessor. Lessor's residual interest. Letter of credit. Merchant. Negotiable instrument. Nominated person. Note. Proceeds of a letter of credit. Prove. Sale. Securities account. Securities intermediary. Security. Security certicate. Security entitlement. Uncerticated security.

Section Section Section Section Section Section Section Section Section Section Section Section

5-102. 5-102. 8-102. 8-102. 3-104. 8-102. 2-106. 4-104. 8-102. 8-102. 3-302. 5-102.

Section 8-201. Section 7-102. Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section Section 2A-103. 2A-103. 2A-103. 2A-103. 2A-103. 2A-103. 2A-103. 2A-103. 5-102. 2-104. 3-104. 5-102. 3-104. 5-114. 3-103. 2-106. 8-501. 8-102. 8-102. 8-102. 8-102. 8-102.

(c) [Article 1 denitions and principles.] Article 1 contains general denitions and principles of construction and interpretation applicable throughout this article. As amended in 1999, 2000, 2001 and 2003.
See Appendix P for material relating to changes made in text in 1999 and 2000.
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See Appendix I contained within revised Article 1 for material relating to changes made in text in 2001. See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Source. All terms that are dened in Article 9 and used in more than one section are consolidated in this section. Note that the denition of security interest is found in Section 1-201, not in this Article, and has been revised. See Appendix I. Many of the denitions in this section are new; many others derive from those in former Section 9-105. The following Comments also indicate other sections of former Article 9 that dened (or explained) terms. 2. Parties to Secured Transactions. a. Debtor; Obligor; Secondary Obligor. Determining whether a person was a debtor under former Section 9-105(1)(d) required a close examination of the context in which the term was used. To reduce the need for this examination, this Article redenes debtor and adds new dened terms, secondary obligor and obligor. In the context of Part 6 (default and enforcement), these denitions distinguish among three classes of persons: (i) those persons who may have a stake in the proper enforcement of a security interest by virtue of their non-lien property interest (typically, an ownership interest) in the collateral, (ii) those persons who may have a stake in the proper enforcement of the security interest because of their obligation to pay the secured debt, and (iii) those persons who have an obligation to pay the secured debt but have no stake in the proper enforcement of the security interest. Persons in the rst class are debtors. Persons in the second class are secondary obligors if any portion of the obligation is secondary or if the obligor has a right of recourse against the debtor or another obligor with respect to an obligation secured by collateral. One must consult the law of suretyship to determine whether an obligation is secondary. The Restatement (3d), Suretyship and Guaranty 1 (1996), contains a useful explanation of the concept. Obligors in the third class are neither debtors nor secondary obligors. With one exception (Section 9-616, as it relates to a consumer obligor), the rights and duties provided by Part 6 aect non-debtor obligors only if they are secondary obligors. By including in the denition of debtor all persons with a property interest (other than a security interest in or other lien on collateral), the denition includes transferees of collateral, whether or not the secured party knows of the transfer or the transferee's identity. Exculpatory provisions in Part 6 protect the secured party in that circumstance. See Sections 9-605 and 9-628. The denition renders unnecessary former Section 9-112, which governed situations in which collateral was not owned by the debtor. The denition also includes a consignee, as dened in this section, as well as a seller of accounts, chattel paper, payment intangibles, or promissory notes. Secured parties and other lienholders are excluded from the denition of debtor because the interests of those parties normally derive from and encumber a debtor's interest. However, if in a separate secured transaction a secured party grants, as debtor, a security interest in its own interest (i.e., its security interest and any obligation that it secures), the secured party is a debtor in that transaction. This typically occurs when a secured party with a security interest in specic goods assigns chattel paper. Consider the following examples:
Example 1: Behnfeldt borrows money and grants a security interest in her Miata to secure the debt. Behnfeldt is a debtor and an obligor. Example 2: Behnfeldt borrows money and grants a security interest in her Miata to secure the debt. Bruno co-signs a negotiable note as maker. As before, Behnfeldt is the debtor and an obligor. As an accommodation party (see Section 3-419), Bruno is a secondary obligor. Bruno has this status even if the note states that her obligation is a primary obligation and that she waives all suretyship defenses. Example 3: Behnfeldt borrows money on an unsecured basis. Bruno co-signs the note and grants a security interest in her Honda to secure her obligation. Inasmuch as Behnfeldt does not have a property interest in the Honda, Behnfeldt is not a debtor. Having granted the security interest, Bruno is the debtor. Because Behnfeldt is a principal obligor, she is not a secondary obligor. Whatever the outcome of enforcement of the security interest against the Honda or Bruno's secondary obligation, Bruno will look to Behnfeldt for her losses. The enforcement will not aect Behnfeldt's aggregate obligations.

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When the principal obligor (borrower) and the secondary obligor (surety) each has granted a security interest in dierent collateral, the status of each is determined by the collateral involved.
Example 4: Behnfeldt borrows money and grants a security interest in her Miata to secure the debt. Bruno co-signs the note and grants a security interest in her Honda to secure her obligation. When the secured party enforces the security interest in Behnfeldt's Miata, Behnfeldt is the debtor, and Bruno is a secondary obligor. When the secured party enforces the security interest in the Honda, Bruno is the debtor. As in Example 3, Behnfeldt is an obligor, but not a secondary obligor.

b. Secured Party. The secured party is the person in whose favor the security interest has been created, as determined by reference to the security agreement. This denition controls, among other things, which person has the duties and potential liability that Part 6 imposes upon a secured party. The denition of secured party also includes a consignor, a person to which accounts, chattel paper, payment intangibles, or promissory notes have been sold, and the holder of an agricultural lien. The denition of secured party claries the status of various types of representatives. Consider, for example, a multi-bank facility under which Bank A, Bank B, and Bank C are lenders and Bank A serves as the collateral agent. If the security interest is granted to the banks, then they are the secured parties. If the security interest is granted to Bank A as collateral agent, then Bank A is the secured party. c. Other Parties. A consumer obligor is dened as the obligor in a consumer transaction. Denitions of new debtor and original debtor are used in the special rules found in Sections 9-326 and 9-508. 3. Denitions Relating to Creation of a Security Interest. a. Collateral. As under former Section 9-105, collateral is the property subject to a security interest and includes accounts and chattel paper that have been sold. It has been expanded in this Article. The term now explicitly includes proceeds subject to a security interest. It also reects the broadened scope of the Article. It includes property subject to an agricultural lien as well as payment intangibles and promissory notes that have been sold. b. Security Agreement. The denition of security agreement is substantially the same as under former Section 9-105an agreement that creates or provides for a security interest. However, the term frequently was used colloquially in former Article 9 to refer to the document or writing that contained a debtor's security agreement. This Article eliminates that usage, reserving the term for the more precise meaning specied in the denition. Whether an agreement creates a security interest depends not on whether the parties intend that the law characterize the transaction as a security interest but rather on whether the transaction falls within the denition of security interest in Section 1-201. Thus, an agreement that the parties characterize as a lease of goods may be a security agreement, notwithstanding the parties' stated intention that the law treat the transaction as a lease and not as a secured transaction. See Section 1-203. 4. Goods-Related Denitions. a. Goods; Consumer Goods; Equipment; Farm Products; Farming Operation; Inventory. The denition of goods is substantially the same as the denition in former Section 9-105. This Article also retains the four mutually-exclusive types of collateral that consist of goods: consumer goods, equipment, farm products, and inventory. The revisions are primarily for clarication. The classes of goods are mutually exclusive. For example, the same property cannot simultaneously be both equipment and inventory. In borderline casesa physician's car or a farmer's truck that might be either consumer goods or equipmentthe principal use to which the property is put is determinative. Goods can fall into dierent classes at dierent times. For example, a radio may be inventory in the hands of a dealer and consumer goods in the hands of a consumer. As under former Article 9, goods are equipment if they do not fall into another category. The denition of consumer goods follows former Section 9-109. The classication turns on whether the debtor uses or bought the goods for use primarily for personal, family, or household purposes. Goods are inventory if they are leased by a lessor or held by a person for sale or lease. The revised denition of inventory makes clear that the term includes goods leased by the 852

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debtor to others as well as goods held for lease. (The same result should have obtained under the former denition.) Goods to be furnished or furnished under a service contract, raw materials, and work in process also are inventory. Implicit in the denition is the criterion that the sales or leases are or will be in the ordinary course of business. For example, machinery used in manufacturing is equipment, not inventory, even though it is the policy of the debtor to sell machinery when it becomes obsolete or worn. Inventory also includes goods that are consumed in a business (e.g., fuel used in operations). In general, goods used in a business are equipment if they are xed assets or have, as identiable units, a relatively long period of use, but are inventory, even though not held for sale or lease, if they are used up or consumed in a short period of time in producing a product or providing a service. Goods are farm products if the debtor is engaged in farming operations with respect to the goods. Animals in a herd of livestock are covered whether the debtor acquires them by purchase or as a result of natural increase. Products of crops or livestock remain farm products as long as they have not been subjected to a manufacturing process. The terms crops and livestock are not dened. The new denition of farming operations is for clarication only. Crops, livestock, and their products cease to be farm products when the debtor ceases to be engaged in farming operations with respect to them. If, for example, they come into the possession of a marketing agency for sale or distribution or of a manufacturer or processor as raw materials, they become inventory. Products of crops or livestock, even though they remain in the possession of a person engaged in farming operations, lose their status as farm products if they are subjected to a manufacturing process. What is and what is not a manufacturing operation is not specied in this Article. At one end of the spectrum, some processes are so closely connected with farmingsuch as pasteurizing milk or boiling sap to produce maple syrup or sugarthat they would not constitute manufacturing. On the other hand an extensive canning operation would be manufacturing. Once farm products have been subjected to a manufacturing operation, they normally become inventory. The revised denition of farm products claries the distinction between crops and standing timber and makes clear that aquatic goods produced in aquacultural operations may be either crops or livestock. Although aquatic goods that are vegetable in nature often would be crops and those that are animal would be livestock, this Article leaves the courts free to classify the goods on a case-by-case basis. See Section 9-324, Comment 11. The denitions of goods and software are also mutually exclusive. Computer programs usually constitute software, and, as such, are not goods as this Article uses the terms. However, under the circumstances specied in the denition of goods, computer programs embedded in goods are part of the goods and are not software. b. Accession; Manufactured Home; Manufactured-Home Transaction. Other specialized denitions of goods include accession (see the special priority and enforcement rules in Section 9-335), and manufactured home (see Section 9-515, permitting a nancing statement in a manufactured-home transaction to be eective for 30 years). The denition of manufactured home borrows from the federal Manufactured Housing Act, 42 U.S.C. 5401 et seq., and is intended to have the same meaning. c. As-Extracted Collateral. Under this Article, oil, gas, and other minerals that have not been extracted from the ground are treated as real property, to which this Article does not apply. Upon extraction, minerals become personal property (goods) and eligible to be collateral under this Article. See the denition of goods, which excludes oil, gas, and other minerals before extraction. To take account of nancing practices reecting the shift from real to personal property, this Article contains special rules for perfecting security interests in minerals which attach upon extraction and in accounts resulting from the sale of minerals at the wellhead or minehead. See, e.g., Sections 9-301(4) (law governing perfection and priority); 9-501 (place of ling), 9-502 (contents of nancing statement), 9-519 (indexing of records). The new term, as-extracted collateral, refers to the minerals and related accounts to which the special rules apply. The term at the wellhead encompasses arrangements based on a sale of the produce at the moment that it issues from the ground and is measured, without technical distinctions as to whether title passes at the Christmas tree of a well, the far side of a gathering tank, or at some other point. The term at . . . the minehead is comparable. The following examples explain the operation of these provisions. 853

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Example 5: Debtor owns an interest in oil that is to be extracted. To secure Debtor's obligations to Lender, Debtor enters into an authenticated agreement granting Lender an interest in the oil. Although Lender may acquire an interest in the oil under real-property law, Lender does not acquire a security interest under this Article until the oil becomes personal property, i.e., until is extracted and becomes goods to which this Article applies. Because Debtor had an interest in the oil before extraction and Lender's security interest attached to the oil as extracted, the oil is asextracted collateral. Example 6: Debtor owns an interest in oil that is to be extracted and contracts to sell the oil to Buyer at the wellhead. In an authenticated agreement, Debtor agrees to sell to Lender the right to payment from Buyer. This right to payment is an account that constitutes as-extracted collateral. If Lender then resells the account to Financer, Financer acquires a security interest. However, inasmuch as the debtor-seller in that transaction, Lender, had no interest in the oil before extraction, Financer's collateral (the account it owns) is not as-extracted collateral. Example 7: Under the facts of Example 6, before extraction, Buyer grants a security interest in the oil to Bank. Although Bank's security interest attaches when the oil is extracted, Bank's security interest is not in as-extracted collateral, inasmuch as its debtor, Buyer, did not have an interest in the oil before extraction.

5. Receivables-related Denitions. a. Account; Health-Care-Insurance Receivable; As-Extracted Collateral. The denition of account has been expanded and reformulated. It is no longer limited to rights to payment relating to goods or services. Many categories of rights to payment that were classied as general intangibles under former Article 9 are accounts under this Article. Thus, if they are sold, a nancing statement must be led to perfect the buyer's interest in them. Among the types of property that are expressly excluded from the denition is a right to payment for money or funds advanced or sold. As dened in Section 1-201, money is limited essentially to currency. As used in the exclusion from the denition of account, however, funds is a broader concept (although the term is not dened). For example, when a bank-lender credits a borrower's deposit account for the amount of a loan, the bank's advance of funds is not a transaction giving rise to an account. The denition of health-care-insurance receivable is new. It is a subset of the denition of account. However, the rules generally applicable to account debtors on accounts do not apply to insurers obligated on health-care-insurance receivables. See Sections 9-404(e), 9-405(d), 9-406(i). Note that certain accounts also are as-extracted collateral. See Comment 4.c., Examples 6 and 7. b. Chattel Paper; Electronic Chattel Paper; Tangible Chattel Paper. Chattel paper consists of a monetary obligation together with a security interest in or a lease of specic goods if the obligation and security interest or lease are evidenced by a record or records. The denition has been expanded from that found in former Article 9 to include records that evidence a monetary obligation and a security interest in specic goods and software used in the goods, a security interest in specic goods and license of software used in the goods, or a lease of specic goods and license of software used in the goods. The expanded denition covers transactions in which the debtor's or lessee's monetary obligation includes amounts owed with respect to software used in the goods. The monetary obligation with respect to the software need not be owed under a license from the secured party or lessor, and the secured party or lessor need not be a party to the license transaction itself. Among the types of monetary obligations that are included in chattel paper are amounts that have been advanced by the secured party or lessor to enable the debtor or lessee to acquire or obtain nancing for a license of the software used in the goods.* The denition also makes clear that rights to payment arising out of credit-card transactions are not chattel paper. Charters of vessels are expressly excluded from the denition of chattel paper; they are accounts. The term charter as used in this section includes bareboat charters, time charters, successive voyage charters, contracts of areightment, contracts of carriage, and all other arrangements for the use of vessels. Under former Section 9-105, only if the evidence of an obligation consisted of a writing or writings could an obligation qualify as chattel paper. In this Article, traditional, written chattel paper is included in the denition [Section 9-102] *Amendments in italics approved by 854 the Permanent Editorial Board for Uniform Commercial Code October 20, 1999.

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of tangible chattel paper. Electronic chattel paper is chattel paper that is stored in an electronic medium instead of in tangible form. The concept of an electronic medium should be construed liberally to include electrical, digital, magnetic, optical, electromagnetic, or any other current or similar emerging technologies. The denition of electronic chattel paper does not dictate that it be created in any particular fashion. For example, a record consisting of a tangible writing may be converted to electronic form (e.g., by creating electronic images of a signed writing). Or, records may be initially created and executed in electronic form (e.g., a lessee might authenticate an electronic record of a lease that is then stored in electronic form). In either case the resulting records are electronic chattel paper. c. Instrument; Promissory Note. The denition of instrument includes a negotiable instrument. As under former Section 9-105, it also includes any other right to payment of a monetary obligation that is evidenced by a writing of a type that in ordinary course of business is transferred by delivery (and, if necessary, an indorsement or assignment). Except in the case of chattel paper, the fact that an instrument is secured by a security interest or encumbrance on property does not change the character of the instrument as such or convert the combination of the instrument and collateral into a separate classication of personal property. The denition makes clear that rights to payment arising out of credit-card transactions are not instruments. The denition of promissory note is new, necessitated by the inclusion of sales of promissory notes within the scope of Article 9. It explicitly excludes obligations arising out of orders to pay (e.g., checks) as opposed to promises to pay. See Section 3-104. d. General Intangible; Payment Intangible. General intangible is the residual category of personal property, including things in action, that is not included in the other dened types of collateral. Examples are various categories of intellectual property and the right to payment of a loan of funds that is not evidenced by chattel paper or an instrument. As used in the denition of general intangible, things in action includes rights that arise under a license of intellectual property, including the right to exploit the intellectual property without liability for infringement. The denition has been revised to exclude commercial tort claims, deposit accounts, and letter-of-credit rights. Each of the three is a separate type of collateral. One important consequence of this exclusion is that tortfeasors (commercial tort claims), banks (deposit accounts), and persons obligated on letters of credit (letter-of-credit rights) are not account debtors having the rights and obligations set forth in Sections 9-404, 9-405, and 9-406. In particular, tortfeasors, banks, and persons obligated on letters of credit are not obligated to pay an assignee (secured party) upon receipt of the notication described in Section 9-404(a). See Comment 5.h. Another important consequence relates to the adequacy of the description in the security agreement. See Section 9-108. Payment intangible is a subset of the denition of general intangible. The sale of a payment intangible is subject to this Article. See Section 9-109(a)(3). Virtually any intangible right could give rise to a right to payment of money once one hypothesizes, for example, that the account debtor is in breach of its obligation. The term payment intangible, however, embraces only those general intangibles under which the account debtor's principal obligation is a monetary obligation. (Emphasis added.) In classifying intangible collateral, a court should begin by identifying the particular rights that have been assigned. The account debtor (promisor) under a particular contract may owe several types of monetary obligations as well as other, nonmonetary obligations. If the promisee's right to payment of money is assigned separately, the right is an account or payment intangible, depending on how the account debtor's obligation arose. When all the promisee's rights are assigned together, an account, a payment intangible, and a general intangible all may be involved, depending on the nature of the rights. A right to the payment of money is frequently buttressed by ancillary covenants, such as covenants in a purchase agreement, note, or mortgage requiring insurance on the collateral or forbidding removal of the collateral, or covenants to preserve the creditworthiness of the promisor, such as covenants restricting dividends and the like. This Article does not treat these ancillary rights separately from the rights to payment to which they relate. For example, attachment and perfection of an assignment of a right to payment of a monetary obligation, whether it be an account or payment intangible, also carries these ancillary rights. Every payment intangible is also a general intangible. Likewise, software is a gen855

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eral intangible for purposes of this Article. See Comment 25. Accordingly, except as otherwise provided, statutory provisions applicable to general intangibles apply to payment intangibles and software. e. Letter-of-Credit Right. The term letter-of-credit right embraces the rights to payment and performance under a letter of credit (dened in Section 5-102). However, it does not include a beneciary's right to demand payment or performance. Transfer of those rights to a transferee beneciary is governed by Article 5. See Sections 9-107, Comment 4, and 9-329, Comments 3 and 4. f. Supporting Obligation. This new term covers the most common types of credit enhancementssuretyship obligations (including guarantees) and letter-of-credit rights that support one of the types of collateral specied in the denition. As explained in Comment 2.a., suretyship law determines whether an obligation is secondary for purposes of this denition. Section 9-109 generally excludes from this Article transfers of interests in insurance policies. However, the regulation of a secondary obligation as an insurance product does not necessarily mean that it is a policy of insurance for purposes of the exclusion in Section 9-109. Thus, this Article may cover a secondary obligation (as a supporting obligation), even if the obligation is issued by a regulated insurance company and the obligation is subject to regulation as an insurance product. This Article contains rules explicitly governing attachment, perfection, and priority of security interests in supporting obligations. See Sections 9-203, 9-308, 9-310, and 9-322. These provisions reect the principle that a supporting obligation is an incident of the collateral it supports. Collections of or other distributions under a supporting obligation are proceeds of the supported collateral as well as proceeds of the supporting obligation itself. See Section 9-102 (dening proceeds) and Comment 13.b. As such, the collections and distributions are subject to the priority rules applicable to proceeds generally. See Section 9-322. However, under the special rule governing security interests in a letter-of-credit right, a secured party's failure to obtain control (Section 9-107) of a letter-of-credit right supporting collateral may leave its security interest exposed to a priming interest of a party who does take control. See Section 9-329 (security interest in a letter-of-credit right perfected by control has priority over a conicting security interest). g. Commercial Tort Claim. This term is new. A tort claim may serve as original collateral under this Article only if it is a commercial tort claim. See Section 9-109(d). Although security interests in commercial tort claims are within its scope, this Article does not override other applicable law restricting the assignability of a tort claim. See Section 9-401. A security interest in a tort claim also may exist under this Article if the claim is proceeds of other collateral. h. Account Debtor. An account debtor is a person obligated on an account, chattel paper, or general intangible. The account debtor's obligation often is a monetary obligation; however, this is not always the case. For example, if a franchisee uses its rights under a franchise agreement (a general intangible) as collateral, then the franchisor is an account debtor. As a general matter, Article 3, and not Article 9, governs obligations on negotiable instruments. Accordingly, the denition of account debtor excludes obligors on negotiable instruments constituting part of chattel paper. The principal eect of this change from the denition in former Article 9 is that the rules in Sections 9-403, 9-404, 9-405, and 9-406, dealing with the rights of an assignee and duties of an account debtor, do not apply to an assignment of chattel paper in which the obligation to pay is evidenced by a negotiable instrument. (Section 9-406(d), however, does apply to promissory notes, including negotiable promissory notes.) Rather, the assignee's rights are governed by Article 3. Similarly, the duties of an obligor on a nonnegotiable instrument are governed by non-Article 9 law unless the nonnegotiable instrument is a part of chattel paper, in which case the obligor is an account debtor. i. Receivables Under Government Entitlement Programs. This Article does not contain a dened term that encompasses specically rights to payment or performance under the many and varied government entitlement programs. Depending on the nature of a right under a program, it could be an account, a payment intangible, a general intangible other than a payment intangible, or another type of collateral. The right also might be proceeds of collateral (e.g., crops). 6. Investment-Property-Related Denitions: Commodity Account; Commodity 856

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Contract; Commodity Customer; Commodity Intermediary; Investment Property. These denitions are substantially the same as the corresponding denitions in former Section 9-115. Investment property includes securities, both certicated and uncerticated, securities accounts, security entitlements, commodity accounts, and commodity contracts. The term investment property includes a securities account in order to facilitate transactions in which a debtor wishes to create a security interest in all of the investment positions held through a particular account rather than in particular positions carried in the account. Former Section 9-115 was added in conjunction with Revised Article 8 and contained a variety of rules applicable to security interests in investment property. These rules have been relocated to the appropriate sections of Article 9. See, e.g., Sections 9-203 (attachment), 9-314 (perfection by control), 9-328 (priority). The terms security, security entitlement, and related terms are dened in Section 8-102, and the term securities account is dened in Section 8-501. The terms commodity account, commodity contract, commodity customer, and commodity intermediary are dened in this section. Commodity contracts are not securities or nancial assets under Article 8. See Section 8-103(f). Thus, the relationship between commodity intermediaries and commodity customers is not governed by the indirect-holding-system rules of Part 5 of Article 8. For securities, Article 9 contains rules on security interests, and Article 8 contains rules on the rights of transferees, including secured parties, on such matters as the rights of a transferee if the transfer was itself wrongful and gives rise to an adverse claim. For commodity contracts, Article 9 establishes rules on security interests, but questions of the sort dealt with in Article 8 for securities are left to other law. The indirect-holding-system rules of Article 8 are suciently exible to be applied to new developments in the securities and nancial markets, where that is appropriate. Accordingly, the denition of commodity contract is narrowly drafted to ensure that it does not operate as an obstacle to the application of the Article 8 indirect-holding-system rules to new products. The term commodity contract covers those contracts that are traded on or subject to the rules of a designated contract market and foreign commodity contracts that are carried on the books of American commodity intermediaries. The eect of this denition is that the category of commodity contracts that are excluded from Article 8 but governed by Article 9 is essentially the same as the category of contracts that fall within the exclusive regulatory jurisdiction of the federal Commodity Futures Trading Commission. Commodity contracts are dierent from securities or other nancial assets. A person who enters into a commodity futures contract is not buying an asset having a certain value and holding it in anticipation of increase in value. Rather the person is entering into a contract to buy or sell a commodity at set price for delivery at a future time. That contract may become advantageous or disadvantageous as the price of the commodity uctuates during the term of the contract. The rules of the commodity exchanges require that the contracts be marked to market on a daily basis; that is, the customer pays or receives any increment attributable to that day's price change. Because commodity customers may incur obligations on their contracts, they are required to provide collateral at the outset, known as original margin, and may be required to provide additional amounts, known as variation margin, during the term of the contract. The most likely setting in which a person would want to take a security interest in a commodity contract is where a lender who is advancing funds to nance an inventory of a physical commodity requires the borrower to enter into a commodity contract as a hedge against the risk of decline in the value of the commodity. The lender will want to take a security interest in both the commodity itself and the hedging commodity contract. Typically, such arrangements are structured as security interests in the entire commodity account in which the borrower carries the hedging contracts, rather than in individual contracts. One important eect of including commodity contracts and commodity accounts in Article 9 is to provide a clearer legal structure for the analysis of the rights of commodity clearing organizations against their participants and futures commission merchants against their customers. The rules and agreements of commodity clearing organizations generally provide that the clearing organization has the right to liquidate any participant's positions in order to satisfy obligations of the participant to the clearing corporation. Similarly, agreements between futures commission merchants and their customers generally provide that the futures commission merchant has the right to liquidate a customer's positions in order to satisfy obligations of the customer to the futures commission merchant. The main property that a commodity intermediary holds as collateral for the obligations 857

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that the commodity customer may incur under its commodity contracts is not other commodity contracts carried by the customer but the other property that the customer has posted as margin. Typically, this property will be securities. The commodity intermediary's security interest in such securities is governed by the rules of this Article on security interests in securities, not the rules on security interests in commodity contracts or commodity accounts. Although there are signicant analytic and regulatory dierences between commodities and securities, the development of commodity contracts on nancial products in the past few decades has resulted in a system in which the commodity markets and securities markets are closely linked. The rules on security interests in commodity contracts and commodity accounts provide a structure that may be essential in times of stress in the nancial markets. Suppose, for example that a rm has a position in a securities market that is hedged by a position in a commodity market, so that payments that the rm is obligated to make with respect to the securities position will be covered by the receipt of funds from the commodity position. Depending upon the settlement cycles of the dierent markets, it is possible that the rm could nd itself in a position where it is obligated to make the payment with respect to the securities position before it receives the matching funds from the commodity position. If cross-margining arrangements have not been developed between the two markets, the rm may need to borrow funds temporarily to make the earlier payment. The rules on security interests in investment property would facilitate the use of positions in one market as collateral for loans needed to cover obligations in the other market. 7. Consumer-Related Denitions: Consumer Debtor; Consumer Goods; Consumer-goods transaction; Consumer Obligor; Consumer Transaction. The denition of consumer goods (discussed above) is substantially the same as the denition in former Section 9-109. The denitions of consumer debtor, consumer obligor, consumer-goods transaction, and consumer transaction have been added in connection with various new (and old) consumer-related provisions and to designate certain provisions that are inapplicable in consumer transactions. Consumer-goods transaction is a subset of consumer transaction. Under each denition, both the obligation secured and the collateral must have a personal, family, or household purpose. However, mixed business and personal transactions also may be characterized as a consumer-goods transaction or consumer transaction. Subparagraph (A) of the denition of consumer-goods transactions and clause (i) of the denition of consumer transaction are primary purposes tests. Under these tests, it is necessary to determine the primary purpose of the obligation or obligations secured. Subparagraph (B) and clause (iii) of these denitions are satised if any of the collateral is consumer goods, in the case of a consumer-goods transaction, or is held or acquired primarily for personal, family, or household purposes, in the case of a consumer transaction. The fact that some of the obligations secured or some of the collateral for the obligation does not satisfy the tests (e.g., some of the collateral is acquired for a business purpose) does not prevent a transaction from being a consumer transaction or consumer-goods transaction. 8. Filing-Related Denitions: Continuation Statement; File Number; Filing Oce; Filing-oce Rule; Financing Statement; Fixture Filing; Manufactured-Home Transaction; New Debtor; Original Debtor; PublicFinance Transaction; Termination Statement; Transmitting Utility. These denitions are used exclusively or primarily in the ling-related provisions in Part 5. Most are self-explanatory and are discussed in the Comments to Part 5. A nancing statement led in a manufactured-home transaction or a public-nance transaction may remain eective for 30 years instead of the 5 years applicable to other nancing statements. See Section 9-515(b). The denitions relating to medium neutrality also are signicant for the ling provisions. See Comment 9. The denition of transmitting utility has been revised to embrace the business of transmitting communications generally to take account of new and future types of communications technology. The term designates a special class of debtors for whom separate ling rules are provided in Part 5, thereby obviating the many local xture lings that would be necessary under the rules of Section 9-501 for a far-ung public-utility debtor. A transmitting utility will not necessarily be regulated by or operating as such in a jurisdiction where xtures are located. For example, a utility might own transmission lines in a jurisdiction, although the utility generates no power and has no customers in the jurisdiction. 9. Denitions Relating to Medium Neutrality. 858

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a. Record. In many, but not all, instances, the term record replaces the term writing and written. A record includes information that is in intangible form (e.g., electronically stored) as well as tangible form (e.g., written on paper). Given the rapid development and commercial adoption of modern communication and storage technologies, requirements that documents or communications be written, in writing, or otherwise in tangible form do not necessarily reect or aid commercial practices. A record need not be permanent or indestructible, but the term does not include any oral or other communication that is not stored or preserved by any means. The information must be stored on paper or in some other medium. Information that has not been retained other than through human memory does not qualify as a record. Examples of current technologies commercially used to communicate or store information include, but are not limited to, magnetic media, optical discs, digital voice messaging systems, electronic mail, audio tapes, and photographic media, as well as paper. Record is an inclusive term that includes all of these methods of storing or communicating information. Any writing is a record. A record may be authenticated. See Comment 9.b. A record may be created without the knowledge or intent of a particular person. Like the terms written or in writing, the term record does not establish the purposes, permitted uses, or legal eect that a record may have under any particular provision of law. Whatever is led in the Article 9 ling system, including nancing statements, continuation statements, and termination statements, whether transmitted in tangible or intangible form, would fall within the denition. However, in some instances, statutes or ling-oce rules may require that a paper record be led. In such cases, even if this Article permits the ling of an electronic record, compliance with those statutes or rules is necessary. Similarly, a ler must comply with a statute or rule that requires a particular type of encoding or formatting for an electronic record. This Article sometimes uses the terms for record, of record, record or legal title, and record owner. Some of these are terms traditionally used in real-property law. The denition of record in this Article now explicitly excepts these usages from the dened term. Also, this Article refers to a record that is led or recorded in real-property recording systems to record a mortgage as a record of a mortgage. This usage recognizes that the dened term mortgage means an interest in real property; it does not mean the record that evidences, or is led or recorded with respect to, the mortgage. b. Authenticate; Communicate; Send. The terms authenticate and authenticated generally replace sign and signed. Authenticated replaces and broadens the definition of signed, in Section 1-201, to encompass authentication of all records, not just writings. (References to authentication of, e.g., an agreement, demand, or notication mean, of course, authentication of a record containing an agreement, demand, or notication.) The terms communicate and send also contemplate the possibility of communication by nonwritten media. These denitions include the act of transmitting both tangible and intangible records. The denition of send replaces, for purposes of this Article, the corresponding term in Section 1-201. The reference to usual means of communication in that denition contemplates an inquiry into the appropriateness of the method of transmission used in the particular circumstances involved. 10. Scope-Related Denitions. a. Expanded Scope of Article: Agricultural Lien; Consignment; Payment Intangible; Promissory Note. These new denitions reect the expanded scope of Article 9, as provided in Section 9-109(a). b. Reduced Scope of Exclusions: Governmental Unit; Health-Care-Insurance Receivable; Commercial Tort Claims. These new denitions reect the reduced scope of the exclusions, provided in Section 9-109(c) and (d), of transfers by governmental debtors and assignments of interests in insurance policies and commercial tort claims. 11. Choice-of-Law-Related Denitions: Certicate of Title; Governmental Unit; Jurisdiction of Organization; Registered Organization; State. These new denitions reect the changes in the law governing perfection and priority of security interests and agricultural liens provided in Part 3, Subpart 1. Not every organization that may provide information about itself in the public records is a registered organization. For example, a general partnership is not a registered organization, even if it les a statement of partnership authority under Section 303 of the Uniform Partnership Act (1994) or an assumed name (dba) certicate. This is because the 859

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State under whose law the partnership is organized is not required to maintain a public record showing that the partnership has been organized. In contrast, corporations, limited liability companies, and limited partnerships are registered organizations. 12. Deposit-Account-Related Denitions: Deposit Account; Bank. The revised denition of deposit account incorporates the denition of bank, which is new. The denition derives from the denitions of bank in Sections 4-105(1) and 4A-105(a)(2), which focus on whether the organization is engaged in the business of banking. Deposit accounts evidenced by Article 9 instruments are excluded from the term deposit account. In contrast, former Section 9-105 excluded from the former denition an account evidenced by a certicate of deposit. The revised denition claries the proper treatment of nonnegotiable or uncerticated certicates of deposit. Under the denition, an uncerticated certicate of deposit would be a deposit account (assuming there is no writing evidencing the bank's obligation to pay) whereas a nonnegotiable certicate of deposit would be a deposit account only if it is not an instrument as dened in this section (a question that turns on whether the nonnegotiable certicate of deposit is of a type that in ordinary course of business is transferred by delivery with any necessary indorsement or assignment.) A deposit account evidenced by an instrument is subject to the rules applicable to instruments generally. As a consequence, a security interest in such an instrument cannot be perfected by control (see Section 9-104), and the special priority rules applicable to deposit accounts (see Sections 9-327 and 9-340) do not apply. The term deposit account does not include investment property, such as securities and security entitlements. Thus, the term also does not include shares in a money-market mutual fund, even if the shares are redeemable by check. 13. Proceeds-Related Denitions: Cash Proceeds; Noncash Proceeds; Proceeds. The revised denition of proceeds expands the denition beyond that contained in former Section 9-306 and resolves ambiguities in the former section. a. Distributions on Account of Collateral. The phrase whatever is collected on, or distributed on account of, collateral, in subparagraph (B), is broad enough to cover cash or stock dividends distributed on account of securities or other investment property that is original collateral. Compare former Section 9-306 (Any payments or distributions made with respect to investment property collateral are proceeds.). This section rejects the holding of FDIC v. Hastie, 2 F.3d 1042 (10th Cir. 1993) (postpetition cash dividends on stock subject to a prepetition pledge are not proceeds under Bankruptcy Code Section 552(b)), to the extent the holding relies on the Article 9 denition of proceeds. b. Distributions on Account of Supporting Obligations. Under subparagraph (B), collections on and distributions on account of collateral consisting of various credit-support arrangements (supporting obligations, as dened in Section 9-102) also are proceeds. Consequently, they are aorded treatment identical to proceeds collected from or distributed by the obligor on the underlying (supported) right to payment or other collateral. Proceeds of supporting obligations also are proceeds of the underlying rights to payment or other collateral. c. Proceeds of Proceeds. The denition of proceeds no longer provides that proceeds of proceeds are themselves proceeds. That idea is expressed in the revised denition of collateral in Section 9-102. No change in meaning is intended. d. Proceeds Received by Person Who Did Not Create Security Interest. When collateral is sold subject to a security interest and the buyer then resells the collateral, a question arose under former Article 9 concerning whether the debtor had received what the buyer received on resale and, therefore, whether those receipts were proceeds under former Section 9-306(2). This Article contains no requirement that property be received by the debtor for the property to qualify as proceeds. It is necessary only that the property be traceable, directly or indirectly, to the original collateral. e. Cash Proceeds and Noncash Proceeds. The denition of cash proceeds is substantially the same as the corresponding denition in former Section 9-306. The phrase and the like covers property that is functionally equivalent to money, checks, or deposit accounts, such as some money-market accounts that are securities or part of securities entitlements. Proceeds other than cash proceeds are noncash proceeds. 14. Consignment-Related Denitions: Consignee; Consignment; Consignor. The denition of consignment excludes, in subparagraphs (B) and (C), transactions for 860

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which ling would be inappropriate or of insucient benet to justify the costs. A consignment excluded from the application of this Article by one of those subparagraphs may still be a true consignment; however, it is governed by non-Article 9 law. The denition also excludes, in subparagraph (D), what have been called consignments intended for security. These consignments are not bailments but secured transactions. Accordingly, all of Article 9 applies to them. See Sections 1-201(b)(35), 9-109(a)(1). The consignor is the person who delivers goods to the consignee in a consignment. The denition of consignment requires that the goods be delivered to a merchant for the purpose of sale. If the goods are delivered for another purpose as well, such as milling or processing, the transaction is a consignment nonetheless because a purpose of the delivery is sale. On the other hand, if a merchant-processor-bailee will not be selling the goods itself but will be delivering to buyers to which the owner-bailor agreed to sell the goods, the transaction would not be a consignment. 15. Accounting. This denition describes the record and information that a debtor is entitled to request under Section 9-210. 16. Document. The denition of document incorporates both tangible and electronic documents of title. See Section 1-201(15)[1-201(b)16] and Comment 15 [16]. Legislative Note: Former Article 1 dened document of title in section 1-201(15) and accompanying comment 15. Revised Article 1 denes document of title in Section 1-201(b)(16) and accompanying comment 16. Cross references should be adapted depending upon which version of Article 1 is in force in the jurisdiction. 18. Fixtures. This denition is unchanged in substance from the corresponding denition in former Section 9-313. See Section 9-334 (priority of security interests in xtures and crops). 19. Good Faith. This Article expands the denition of good faith to include the observance of reasonable commercial standards of fair dealing. The denition in this section applies when the term is used in this Article, and the same concept applies in the context of this Article for purposes of the obligation of good faith imposed by Section 1-203. See subsection (c). 20. Lien Creditor This denition is unchanged in substance from the corresponding denition in former Section 9-301. 21. New Value. This Article deletes former Section 9-108. Its broad formulation of new value, which embraced the taking of after-acquired collateral for a pre-existing claim, was unnecessary, counterintuitive, and ineective for its original purpose of sheltering afteracquired collateral from attack as a voidable preference in bankruptcy. The new denition derives from Bankruptcy Code Section 547(a). The term is used with respect to temporary perfection of security interests in instruments, certicated securities, or negotiable documents under Section 9-312(e) and with respect to chattel paper priority in Section 9-330. 22. Person Related To. Section 9-615 provides a special method for calculating a deciency or surplus when the secured party, a person related to the secured party, or a secondary obligor acquires the collateral at a foreclosure disposition. Separate denitions of the term are provided with respect to an individual secured party and with respect to a secured party that is an organization. The denitions are patterned on the corresponding denition in Section 1.301(32) of the Uniform Consumer Credit Code (1974). 23. Proposal. This denition describes a record that is sucient to propose to retain collateral in full or partial satisfaction of a secured obligation. See Sections 9-620, 9-621, 9-622. 24. Pursuant to Commitment. This denition is unchanged in substance from the corresponding denition in former Section 9-105. It is used in connection with special priority rules applicable to future advances. See Section 9-323. 25. Software. The denition of software is used in connection with the priority rules applicable to purchase-money security interests. See Sections 9-103, 9-324. Software, like a payment intangible, is a type of general intangible for purposes of this Article. See Comment 4.a., above, regarding the distinction between goods and software. 26. Terminology: Assignment and Transfer. In numerous provisions, this Article refers to the assignment or the transfer of property interests. These terms and their derivatives are not dened. This Article generally follows common usage by using the terms assignment and assign to refer to transfers of rights to payment, claims, and liens and other security interests. It generally uses the term transfer to refer to other 861

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transfers of interests in property. Except when used in connection with a letter-of-credit transaction (see Section 9-107, Comment 4), no signicance should be placed on the use of one term or the other. Depending on the context, each term may refer to the assignment or transfer of an outright ownership interest or to the assignment or transfer of a limited interest, such as a security interest.

As amended in 1999, 2000, 2001 and 2003.

See Appendix P for material relating to changes made in Ocial Comment in 1999 and 2000. See Appendix I contained within revised Article 1 for material relating to changes made in Ocial Comment in 2001. See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

9-103. Purchase-Money Security Interest; Application of Payments; Burden of Establishing. (a) [Denitions.] In this section: (1) purchase-money collateral means goods or software that secures a purchase-money obligation incurred with respect to that collateral; and (2) purchase-money obligation means an obligation of an obligor incurred as all or part of the price of the collateral or for value given to enable the debtor to acquire rights in or the use of the collateral if the value is in fact so used. (b) [Purchase-money security interest in goods.] A security interest in goods is a purchase-money security interest: (1) to the extent that the goods are purchase-money collateral with respect to that security interest; (2) if the security interest is in inventory that is or was purchasemoney collateral, also to the extent that the security interest secures a purchase-money obligation incurred with respect to other inventory in which the secured party holds or held a purchase-money security interest; and (3) also to the extent that the security interest secures a purchasemoney obligation incurred with respect to software in which the secured party holds or held a purchase-money security interest. (c) [Purchase-money security interest in software.] A security interest in software is a purchase-money security interest to the extent that the security interest also secures a purchase-money obligation incurred with respect to goods in which the secured party holds or held a purchasemoney security interest if: (1) the debtor acquired its interest in the software in an integrated transaction in which it acquired an interest in the goods; and (2) the debtor acquired its interest in the software for the principal purpose of using the software in the goods. (d) [Consignor's inventory purchase-money security interest.] The security interest of a consignor in goods that are the subject of a consignment is a purchase-money security interest in inventory. (e) [Application of payment in non-consumer-goods transaction.] In a transaction other than a consumer-goods transaction, if the extent to
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which a security interest is a purchase-money security interest depends on the application of a payment to a particular obligation, the payment must be applied: (1) in accordance with any reasonable method of application to which the parties agree; (2) in the absence of the parties' agreement to a reasonable method, in accordance with any intention of the obligor manifested at or before the time of payment; or (3) in the absence of an agreement to a reasonable method and a timely manifestation of the obligor's intention, in the following order: (A) to obligations that are not secured; and (B) if more than one obligation is secured, to obligations secured by purchase-money security interests in the order in which those obligations were incurred. (f) [No loss of status of purchase-money security interest in nonconsumer-goods transaction.] In a transaction other than a consumergoods transaction, a purchase-money security interest does not lose its status as such, even if: (1) the purchase-money collateral also secures an obligation that is not a purchase-money obligation; (2) collateral that is not purchase-money collateral also secures the purchase-money obligation; or (3) the purchase-money obligation has been renewed, renanced, consolidated, or restructured. (g) [Burden of proof in non-consumer-goods transaction.] In a transaction other than a consumer-goods transaction, a secured party claiming a purchase-money security interest has the burden of establishing the extent to which the security interest is a purchase-money security interest. (h) [Non-consumer-goods transactions; no inference.] The limitation of the rules in subsections (e), (f), and (g) to transactions other than consumer-goods transactions is intended to leave to the court the determination of the proper rules in consumer-goods transactions. The court may not infer from that limitation the nature of the proper rule in consumergoods transactions and may continue to apply established approaches. Ocial Comment
1. Source. Former Section 9-107. 2. Scope of This Section. Under Section 9-309(1), a purchase-money security interest in consumer goods is perfected when it attaches. Sections 9-317 and 9-324 provide special priority rules for purchase-money security interests in a variety of contexts. This section explains when a security interest enjoys purchase-money status. 3. Purchase-Money Collateral; Purchase-Money Obligation; PurchaseMoney Security Interest. Subsection (a) denes purchase-money collateral and purchase-money obligation. These terms are essential to the description of what constitutes a purchase-money security interest under subsection (b). As used in subsection (a)(2), the denition of purchase-money obligation, the price of collateral or the value given to enable includes obligations for expenses incurred in connection with acquiring rights in the collateral, sales taxes, duties, nance charges, interest, freight charges, costs of storage in transit, demurrage, administrative charges, expenses of collection and enforcement, attorney's fees, and other similar obligations. 863

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The concept of purchase-money security interest requires a close nexus between the acquisition of collateral and the secured obligation. Thus, a security interest does not qualify as a purchase-money security interest if a debtor acquires property on unsecured credit and subsequently creates the security interest to secure the purchase price. 4. Cross-Collateralization of Purchase-Money Security Interests in Inventory. Subsection (b)(2) deals with the problem of cross-collateralized purchase-money security interests in inventory. Consider a simple example: Example: Seller (S) sells an item of inventory (Item-1) to Debtor (D), retaining a security interest in Item-1 to secure Item-1's price and all other obligations, existing and future, of D to S. S then sells another item of inventory to D (Item-2), again retaining a security interest in Item-2 to secure Item-2's price as well as all other obligations of D to S. D then pays to S Item-1's price. D then sells Item-2 to a buyer in ordinary course of business, who takes Item-2 free of S's security interest. Under subsection (b)(2), S's security interest in Item-1 securing Item-2's unpaid price would be a purchase-money security interest. This is so because S has a purchase-money security interest in Item-1, Item-1 secures the price of (a purchase-money obligation incurred with respect to) Item-2 (other inventory), and Item-2 itself was subject to a purchase-money security interest. Note that, to the extent Item-1 secures the price of Item-2, S's security interest in Item-1 would not be a purchase-money security interest under subsection (b)(1). The security interest in Item-1 is a purchase-money security interest under subsection (b)(1) only to the extent that Item-1 is purchase-money collateral, i.e., only to the extent that Item-1 secures a purchase-money obligation incurred with respect to that collateral (i.e., Item-1). See subsection (a)(1). 5. Purchase-Money Security Interests in Goods and Software. Subsections (b) and (c) limit purchase-money security interests to security interests in goods, including xtures, and software. Otherwise, no change in meaning from former Section 9-107 is intended. The second sentence of former Section 9-115(5)(f) made the purchase-money priority rule (former Section 9-312(4)) inapplicable to investment property. This section's limitation makes that provision unnecessary. Subsection (c) describes the limited circumstances under which a security interest in goods may be accompanied by a purchase-money security interest in software. The software must be acquired by the debtor in a transaction integrated with the transaction in which the debtor acquired the goods, and the debtor must acquire the software for the principal purpose of using the software in the goods. Software is dened in Section 9-102. 6. Consignments. Under former Section 9-114, the priority of the consignor's interest is similar to that of a purchase-money security interest. Subsection (d) achieves this result more directly, by dening the interest of a consignor, dened in Section 9-102, to be a purchase-money security interest in inventory for purposes of this Article. This drafting convention obviates any need to set forth special priority rules applicable to the interest of a consignor. Rather, the priority of the consignor's interest as against the rights of lien creditors of the consignee, competing secured parties, and purchasers of the goods from the consignee can be determined by reference to the priority rules generally applicable to inventory, such as Sections 9-317, 9-320, 9-322, and 9-324. For other purposes, including the rights and duties of the consignor and consignee as between themselves, the consignor would remain the owner of goods under a bailment arrangement with the consignee. See Section 9-319. 7. Provisions Applicable Only to Non-Consumer-Goods Transactions. a. Dual-Status Rule. For transactions other than consumer-goods transactions, this Article approves what some cases have called the dual-status rule, under which a security interest may be a purchase-money security interest to some extent and a non-purchasemoney security interest to some extent. (Concerning consumer-goods transactions, see subsection (h) and Comment 8.) Some courts have found this rule to be explicit or implicit in the words to the extent, found in former Section 9-107 and continued in subsections (b)(1) and (b)(2). The rule is made explicit in subsection (e). For non-consumer-goods transactions, this Article rejects the transformation rule adopted by some cases, under which any cross-collateralization, renancing, or the like destroys the purchase-money status entirely. Consider, for example, what happens when a $10,000 loan secured by a purchase-money security interest is renanced by the original lender, and, as part of the transaction, the 864

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debtor borrows an additional $2,000 secured by the collateral. Subsection (f) resolves any doubt that the security interest remains a purchase-money security interest. Under subsection (b), however, it enjoys purchase-money status only to the extent of $10,000. b. Allocation of Payments. Continuing with the example, if the debtor makes a $1,000 payment on the $12,000 obligation, then one must determine the extent to which the security interest remains a purchase-money security interest$9,000 or $10,000. Subsection (e)(1) expresses the overriding principle, applicable in cases other than consumer-goods transactions, for determining the extent to which a security interest is a purchase-money security interest under these circumstances: freedom of contract, as limited by principle of reasonableness. An unconscionable method of application, for example, is not a reasonable one and so would not be given eect under subsection (e)(1). In the absence of agreement, subsection (e)(2) permits the obligor to determine how payments should be allocated. If the obligor fails to manifest its intention, obligations that are not secured will be paid rst. (As used in this Article, the concept of obligations that are not secured means obligations for which the debtor has not created a security interest. This concept is dierent from and should not be confused with the concept of an unsecured claim as it appears in Bankruptcy Code Section 506(a).) The obligor may prefer this approach, because unsecured debt is likely to carry a higher interest rate than secured debt. A creditor who would prefer to be secured rather than unsecured also would prefer this approach. After the unsecured debt is paid, payments are to be applied rst toward the obligations secured by purchase-money security interests. In the event that there is more than one such obligation, payments rst received are to be applied to obligations rst incurred. See subsection (e)(3). Once these obligations are paid, there are no purchase-money security interests and no additional allocation rules are needed. Subsection (f) buttresses the dual-status rule by making it clear that (in a transaction other than a consumer-goods transaction) cross-collateralization and renewals, renancings, and restructurings do not cause a purchase-money security interest to lose its status as such. The statutory terms renewed, renanced, and restructured are not dened. Whether the terms encompass a particular transaction depends upon whether, under the particular facts, the purchase-money character of the security interest fairly can be said to survive. Each term contemplates that an identiable portion of the purchase-money obligation could be traced to the new obligation resulting from a renewal, renancing, or restructuring. c. Burden of Proof. As is the case when the extent of a security interest is in issue, under subsection (g) the secured party claiming a purchase-money security interest in a transaction other than a consumer-goods transaction has the burden of establishing whether the security interest retains its purchase-money status. This is so whether the determination is to be made following a renewal, renancing, or restructuring or otherwise. 8. Consumer-Goods Transactions; Characterization Under Other Law. Under subsection (h), the limitation of subsections (e), (f), and (g) to transactions other than consumer-goods transactions leaves to the court the determination of the proper rules in consumer-goods transactions. Subsection (h) also instructs the court not to draw any inference from this limitation as to the proper rules for consumer-goods transactions and leaves the court free to continue to apply established approaches to those transactions. This section addresses only whether a security interest is a purchase-money security interest under this Article, primarily for purposes of perfection and priority. See, e.g., Sections 9-317, 9-324. In particular, its adoption of the dual-status rule, allocation of payments rules, and burden of proof standards for non-consumer-goods transactions is not intended to aect or inuence characterizations under other statutes. Whether a security interest is a purchase-money security interest under other law is determined by that law. For example, decisions under Bankruptcy Code Section 522(f) have applied both the dualstatus and the transformation rules. The Bankruptcy Code does not expressly adopt the state law denition of purchase-money security interest. Where federal law does not defer to this Article, this Article does not, and could not, determine a question of federal law.

9-104. Control of Deposit Account. (a) [Requirements for control.] A secured party has control of a deposit account if: (1) the secured party is the bank with which the deposit account is maintained;
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(2) the debtor, secured party, and bank have agreed in an authenticated record that the bank will comply with instructions originated by the secured party directing disposition of the funds in the deposit account without further consent by the debtor; or (3) the secured party becomes the bank's customer with respect to the deposit account. (b) [Debtor's right to direct disposition.] A secured party that has satised subsection (a) has control, even if the debtor retains the right to direct the disposition of funds from the deposit account. Ocial Comment
1. Source. New; derived from Section 8-106. 2. Why Control Matters. This section explains the concept of control of a deposit account. Control under this section may serve two functions. First, control . . . pursuant to the debtor's agreement may substitute for an authenticated security agreement as an element of attachment. See Section 9-203(b)(3)(D). Second, when a deposit account is taken as original collateral, the only method of perfection is obtaining control under this section. See Section 9-312(b)(1). 3. Requirements for Control. This section derives from Section 8-106 of Revised Article 8, which denes control of securities and certain other investment property. Under subsection (a)(1), the bank with which the deposit account is maintained has control. The eect of this provision is to aord the bank automatic perfection. No other form of public notice is necessary; all actual and potential creditors of the debtor are always on notice that the bank with which the debtor's deposit account is maintained may assert a claim against the deposit account. Under subsection (a)(2), a secured party may obtain control by obtaining the bank's authenticated agreement that it will comply with the secured party's instructions without further consent by the debtor. The analogous provision in Section 8-106 does not require that the agreement be authenticated. An agreement to comply with the secured party's instructions suces for control of a deposit account under this section even if the bank's agreement is subject to specied conditions, e.g., that the secured party's instructions are accompanied by a certication that the debtor is in default. (Of course, if the condition is the debtor's further consent, the statute explicitly provides that the agreement would not confer control.) See revised Section 8-106, Comment 7. Under subsection (a)(3), a secured party may obtain control by becoming the bank's customer, as dened in Section 4-104. As the customer, the secured party would enjoy the right (but not necessarily the exclusive right) to withdraw funds from, or close, the deposit account. See Sections 4-401(a), 4-403(a). Although the arrangements giving rise to control may themselves prevent, or may enable the secured party at its discretion to prevent, the debtor from reaching the funds on deposit, subsection (b) makes clear that the debtor's ability to reach the funds is not inconsistent with control. Perfection by control is not available for bank accounts evidenced by an instrument (e.g., certain certicates of deposit), which by denition are instruments and not deposit accounts. See Section 9-102 (dening deposit account and instrument).

9-105. Control of Electronic Chattel Paper. A secured party has control of electronic chattel paper if the record or records comprising the chattel paper are created, stored, and assigned in such a manner that: (1) a single authoritative copy of the record or records exists which is unique, identiable and, except as otherwise provided in paragraphs (4), (5), and (6), unalterable; (2) the authoritative copy identies the secured party as the assignee of the record or records;
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(3) the authoritative copy is communicated to and maintained by the secured party or its designated custodian; (4) copies or revisions that add or change an identied assignee of the authoritative copy can be made only with the participation of the secured party; (5) each copy of the authoritative copy and any copy of a copy is readily identiable as a copy that is not the authoritative copy; and (6) any revision of the authoritative copy is readily identiable as an authorized or unauthorized revision. Ocial Comment
1. Source. New. 2. Control of Electronic Chattel Paper. This Article covers security interests in electronic chattel paper, a new term dened in Section 9-102. This section governs how control of electronic chattel paper may be obtained. A secured party's control of electronic chattel paper (i) may substitute for an authenticated security agreement for purposes of attachment under Section 9-203, (ii) is a method of perfection under Section 9-314, and (iii) is a condition for obtaining special, non-temporal priority under Section 9-330. Because electronic chattel paper cannot be transferred, assigned, or possessed in the same manner as tangible chattel paper, a special denition of control is necessary. In descriptive terms, this section provides that control of electronic chattel paper is the functional equivalent of possession of tangible chattel paper (a term also dened in Section 9-102). 3. Authoritative Copy of Electronic Chattel Paper. One requirement for establishing control is that a particular copy be an authoritative copy. Although other copies may exist, they must be distinguished from the authoritative copy. This may be achieved, for example, through the methods of authentication that are used or by business practices involving the marking of any additional copies. When tangible chattel paper is converted to electronic chattel paper, in order to establish that a copy of the electronic chattel paper is the authoritative copy it may be necessary to show that the tangible chattel paper no longer exists or has been permanently marked to indicate that it is not the authoritative copy. 4. Development of Control Systems. This Article leaves to the marketplace the development of systems and procedures, through a combination of suitable technologies and business practices, for dealing with control of electronic chattel paper in a commercial context. However, achieving control under this section requires more than the agreement of interested persons that the elements of control are satised. For example, paragraph (4) contemplates that control requires that it be a physical impossibility (or suciently unlikely or implausible so as to approach practical impossibility) to add or change an identied assignee without the participation of the secured party (or its authorized representative). It would not be enough for the assignor merely to agree that it will not change the identied assignee without the assignee-secured party's consent. However, the standards applied to determine whether a party is in control of electronic chattel paper should not be more stringent than the standards now applied to determine whether a party is in possession of tangible chattel paper. Control of electronic chattel paper contemplates systems or procedures such that the secured party must take some action (either directly or through its designated custodian) to eect a change or addition to the authoritative copy. But just as a secured party does not lose possession of tangible chattel paper merely by virtue of the possibility that a person acting on its behalf could wrongfully redeliver the chattel paper to the debtor, so control of electronic chattel paper would not be defeated by the possibility that the secured party's interest could be subverted by the wrongful conduct of a person (such as a custodian) acting on its behalf. Systems that evolve for control of electronic chattel paper may or may not involve a third party custodian of the relevant records. However, this section and the concept of control of electronic chattel paper are not based on the same concepts as are control of deposit accounts (Section 9-104), security entitlements, a type of investment property (Section 9-106), and letter-of-credit rights (Section 9-107). The rules for control of that collateral are based on existing market practices and legal and regulatory regimes for institutions such as banks and securities intermediaries. Analogous practices for electronic chattel paper are developing nonetheless. The exible approach adopted by this section, moreover, should not 867

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impede the development of these practices and, eventually, legal and regulatory regimes, which may become analogous to those for, e.g., investment property.

9-106. Control of Investment Property. (a) [Control under Section 8-106.] A person has control of a certicated security, uncerticated security, or security entitlement as provided in Section 8-106. (b) [Control of commodity contract.] A secured party has control of a commodity contract if: (1) the secured party is the commodity intermediary with which the commodity contract is carried; or (2) the commodity customer, secured party, and commodity intermediary have agreed that the commodity intermediary will apply any value distributed on account of the commodity contract as directed by the secured party without further consent by the commodity customer. (c) [Eect of control of securities account or commodity account.] A secured party having control of all security entitlements or commodity contracts carried in a securities account or commodity account has control over the securities account or commodity account. Ocial Comment
1. Source. Former Section 9-115(e). 2. Control Under Article 8. For an explanation of control of securities and certain other investment property, see Section 8-106, Comments 4 and 7. 3. Control of Commodity Contracts. This section, as did former Section 9-115(1)(e), contains provisions relating to control of commodity contracts which are analogous to those in Section 8-106 for other types of investment property. 4. Securities Accounts and Commodity Accounts. For drafting convenience, control with respect to a securities account or commodity account is dened in terms of obtaining control over the security entitlements or commodity contracts. Of course, an agreement that provides that (without further consent of the debtor) the securities intermediary or commodity intermediary will honor instructions from the secured party concerning a securities account or commodity account described as such is sucient. Such an agreement necessarily implies that the intermediary will honor instructions concerning all security entitlements or commodity contracts carried in the account and thus aords the secured party control of all the security entitlements or commodity contracts.

9-107. Control of Letter-of-Credit Right. A secured party has control of a letter-of-credit right to the extent of any right to payment or performance by the issuer or any nominated person if the issuer or nominated person has consented to an assignment of proceeds of the letter of credit under Section 5-114(c) or otherwise applicable law or practice. Ocial Comment
1. Source. New. 2. Control of Letter-of-Credit Right. Whether a secured party has control of a letter-of-credit right may determine the secured party's priority as against competing secured parties. See Section 9-329. This section provides that a secured party acquires control of a letter-of-credit right by receiving an assignment if the secured party obtains the consent of the issuer or any nominated person, such as a conrmer or negotiating bank, under Section 5-114 or other applicable law or practice. Because both issuers and nominated persons may give or be obligated to give value under a letter of credit, this section contemplates that a secured party obtains control of a letter-of-credit right with respect to the issuer or a particular nominated person only to the extent that the issuer or that 868

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nominated person consents to the assignment. For example, if a secured party obtains control to the extent of an issuer's obligation but fails to obtain the consent of a nominated person, the secured party does not have control to the extent that the nominated person gives value. In many cases the person or persons who will give value under a letter of credit will be clear from its terms. In other cases, prudence may suggest obtaining consent from more than one person. The details of the consenting issuer's or nominated person's duties to pay or otherwise render performance to the secured party are left to the agreement of the parties. 3. Proceeds of a Letter of Credit. Section 5-114 follows traditional banking terminology by referring to a letter of credit beneciary's assignment of its right to receive payment thereunder as an assignment of the proceeds of a letter of credit. However, as the seller of goods can assign its right to receive payment (an account) before it has been earned by delivering the goods to the buyer, so the beneciary of a letter of credit can assign its contingent right to payment before the letter of credit has been honored. See Section 5-114(b). If the assignment creates a security interest, the security interest can be perfected at the time it is created. An assignment of, including the creation of a security interest in, a letter-of-credit right is an assignment of a present interest. 4. Transfer vs. Assignment. Letter-of-credit law and practice distinguish the transfer of a letter of credit from an assignment. Under a transfer, the transferee itself becomes the beneciary and acquires the right to draw. Whether a new, substitute credit is issued or the issuer advises the transferee of its status as such, the transfer constitutes a novation under which the transferee is the new, substituted beneciary (but only to the extent of the transfer, in the case of a partial transfer). Section 5-114(e) provides that the rights of a transferee beneciary or nominated person are independent of the beneciary's assignment of the proceeds of a letter of credit and are superior to the assignee's right to the proceeds. For this reason, transfer does not appear in this Article as a means of control or perfection. Section 9-109(c)(4) recognizes the independent and superior rights of a transferee beneciary under Section 5-114(e); this Article does not apply to the rights of a transferee beneciary or nominated person to the extent that those rights are independent and superior under Section 5-114. 5. Supporting Obligation: Automatic Attachment and Perfection. A letter-of-credit right is a type of supporting obligation, as dened in Section 9-102. Under Sections 9-203 and 9-308, a security interest in a letter-of-credit right automatically attaches and is automatically perfected if the security interest in the supported obligation is a perfected security interest. However, unless the secured party has control of the letter-of-credit right or itself becomes a transferee beneciary, it cannot obtain any rights against the issuer or a nominated person under Article 5. Consequently, as a practical matter, the secured party's rights would be limited to its ability to locate and identify proceeds distributed by the issuer or nominated person under the letter of credit.

9-108. Suciency of Description. (a) [Suciency of description.] Except as otherwise provided in subsections (c), (d), and (e), a description of personal or real property is sucient, whether or not it is specic, if it reasonably identies what is described. (b) [Examples of reasonable identication.] Except as otherwise provided in subsection (d), a description of collateral reasonably identies the collateral if it identies the collateral by: (1) specic listing; (2) category; (3) except as otherwise provided in subsection (e), a type of collateral dened in [the Uniform Commercial Code]; (4) quantity; (5) computational or allocational formula or procedure; or (6) except as otherwise provided in subsection (c), any other method, if the identity of the collateral is objectively determinable.
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(c) [Supergeneric description not sucient.] A description of collateral as all the debtor's assets or all the debtor's personal property or using words of similar import does not reasonably identify the collateral. (d) [Investment property.] Except as otherwise provided in subsection (e), a description of a security entitlement, securities account, or commodity account is sucient if it describes: (1) the collateral by those terms or as investment property; or (2) the underlying nancial asset or commodity contract. (e) [When description by type insucient.] A description only by type of collateral dened in [the Uniform Commercial Code] is an insufcient description of: (1) a commercial tort claim; or (2) in a consumer transaction, consumer goods, a security entitlement, a securities account, or a commodity account. Ocial Comment
1. Source. Former Sections 9-110, 9-115(3). 2. General Rules. Subsection (a) retains substantially the same formulation as former Section 9-110. Subsection (b) expands upon subsection (a) by indicating a variety of ways in which a description might reasonably identify collateral. Whereas a provision similar to subsection (b) was applicable only to investment property under former Section 9-115(3), subsection (b) applies to all types of collateral, subject to the limitation in subsection (d). Subsection (b) is subject to subsection (c), which follows prevailing case law and adopts the view that an all assets or all personal property description for purposes of a security agreement is not sucient. Note, however, that under Section 9-504, a nancing statement suciently indicates the collateral if it covers all assets or all personal property. The purpose of requiring a description of collateral in a security agreement under Section 9-203 is evidentiary. The test of suciency of a description under this section, as under former Section 9-110, is that the description do the job assigned to it: make possible the identication of the collateral described. This section rejects any requirement that a description is insucient unless it is exact and detailed (the so-called serial number test). 3. After-Acquired Collateral. Much litigation has arisen over whether a description in a security agreement is sucient to include after-acquired collateral if the agreement does not explicitly so provide. This question is one of contract interpretation and is not susceptible to a statutory rule (other than a rule to the eect that it is a question of contract interpretation). Accordingly, this section contains no reference to descriptions of after-acquired collateral. 4. Investment Property. Under subsection (d), the use of the wrong Article 8 terminology does not render a description invalid (e.g., a security agreement intended to cover a debtor's security entitlements is sucient if it refers to the debtor's securities). Note also that given the broad denition of securities account in Section 8-501, a security interest in a securities account also includes all other rights of the debtor against the securities intermediary arising out of the securities account. For example, a security interest in a securities account would include credit balances due to the debtor from the securities intermediary, whether or not they are proceeds of a security entitlement. Moreover, describing collateral as a securities account is a simple way of describing all of the security entitlements carried in the account. 5. Consumer Investment Property; Commercial Tort Claims. Subsection (e) requires greater specicity of description in order to prevent debtors from inadvertently encumbering certain property. Subsection (e) requires that a description by dened type of collateral alone of a commercial tort claim or, in a consumer transaction, of a security entitlement, securities account, or commodity account, is not sucient. For example, all existing and after-acquired investment property or all existing and after-acquired security entitlements, without more, would be insucient in a consumer transaction to describe a security entitlement, securities account, or commodity account. The reference to only by type in subsection (e) means that a description is sucient if it satises subsec870

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tion (a) and contains a descriptive component beyond the type alone. Moreover, if the collateral consists of a securities account or commodity account, a description of the account is sucient to cover all existing and future security entitlements or commodity contracts carried in the account. See Section 9-203(h), (i). Under Section 9-204, an after-acquired collateral clause in a security agreement will not reach future commercial tort claims. It follows that when an eective security agreement covering a commercial tort claim is entered into the claim already will exist. Subsection (e) does not require a description to be specic. For example, a description such as all tort claims arising out of the explosion of debtor's factory would suce, even if the exact amount of the claim, the theory on which it may be based, and the identity of the tortfeasor(s) are not described. (Indeed, those facts may not be known at the time.)

[SUBPART 2. APPLICABILITY OF ARTICLE] 9-109. Scope. (a) [General scope of article.] Except as otherwise provided in subsections (c) and (d), this article applies to: (1) a transaction, regardless of its form, that creates a security interest in personal property or xtures by contract; (2) an agricultural lien; (3) a sale of accounts, chattel paper, payment intangibles, or promissory notes; (4) a consignment; (5) a security interest arising under Section 2-401, 2-505, 2-711(3), or 2A-508(5), as provided in Section 9-110; and (6) a security interest arising under Section 4-210 or 5-118. (b) [Security interest in secured obligation.] The application of this article to a security interest in a secured obligation is not aected by the fact that the obligation is itself secured by a transaction or interest to which this article does not apply. (c) [Extent to which article does not apply.] This article does not apply to the extent that: (1) a statute, regulation, or treaty of the United States preempts this article; (2) another statute of this State expressly governs the creation, perfection, priority, or enforcement of a security interest created by this State or a governmental unit of this State; (3) a statute of another State, a foreign country, or a governmental unit of another State or a foreign country, other than a statute generally applicable to security interests, expressly governs creation, perfection, priority, or enforcement of a security interest created by the State, country, or governmental unit; or (4) the rights of a transferee beneciary or nominated person under a letter of credit are independent and superior under Section 5-114. (d) [Inapplicability of article.] This article does not apply to: (1) a landlord's lien, other than an agricultural lien; (2) a lien, other than an agricultural lien, given by statute or other rule of law for services or materials, but Section 9-333 applies with respect to priority of the lien;
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(3) an assignment of a claim for wages, salary, or other compensation of an employee; (4) a sale of accounts, chattel paper, payment intangibles, or promissory notes as part of a sale of the business out of which they arose; (5) an assignment of accounts, chattel paper, payment intangibles, or promissory notes which is for the purpose of collection only; (6) an assignment of a right to payment under a contract to an assignee that is also obligated to perform under the contract; (7) an assignment of a single account, payment intangible, or promissory note to an assignee in full or partial satisfaction of a preexisting indebtedness; (8) a transfer of an interest in or an assignment of a claim under a policy of insurance, other than an assignment by or to a health-care provider of a health-care-insurance receivable and any subsequent assignment of the right to payment, but Sections 9-315 and 9-322 apply with respect to proceeds and priorities in proceeds; (9) an assignment of a right represented by a judgment, other than a judgment taken on a right to payment that was collateral; (10) a right of recoupment or set-o, but: (A) Section 9-340 applies with respect to the eectiveness of rights of recoupment or set-o against deposit accounts; and (B) Section 9-404 applies with respect to defenses or claims of an account debtor; (11) the creation or transfer of an interest in or lien on real property, including a lease or rents thereunder, except to the extent that provision is made for: (A) liens on real property in Sections 9-203 and 9-308; (B) xtures in Section 9-334; (C) xture lings in Sections 9-501, 9-502, 9-512, 9-516, and 9-519; and (D) security agreements covering personal and real property in Section 9-604; (12) an assignment of a claim arising in tort, other than a commercial tort claim, but Sections 9-315 and 9-322 apply with respect to proceeds and priorities in proceeds; or (13) an assignment of a deposit account in a consumer transaction, but Sections 9-315 and 9-322 apply with respect to proceeds and priorities in proceeds. Ocial Comment
1. Source. Former Sections 9-102, 9-104. 2. Basic Scope Provision. Subsection (a)(1) derives from former Section 9-102(1) and (2). These subsections have been combined and shortened. No change in meaning is intended. Under subsection (a)(1), all consensual security interests in personal property and xtures are covered by this Article, except for transactions excluded by subsections (c) and (d). As to which transactions give rise to a security interest, the denition of that term in Section 1-201 must be consulted. When a security interest is created, this Article applies regardless of the form of the transaction or the name that parties have given to it. 3. Agricultural Liens. Subsection (a)(2) is new. It expands the scope of this Article to 872

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cover agricultural liens, as dened in Section 9-102. 4. Sales of Accounts, Chattel Paper, Payment Intangibles, Promissory Notes, and Other Receivables. Under subsection (a)(3), as under former Section 9-102, this Article applies to sales of accounts and chattel paper. This approach generally has been successful in avoiding dicult problems of distinguishing between transactions in which a receivable secures an obligation and those in which the receivable has been sold outright. In many commercial nancing transactions the distinction is blurred. Subsection (a)(3) expands the scope of this Article by including the sale of a payment intangible (dened in Section 9-102 as a general intangible under which the account debtor's principal obligation is a monetary obligation) and a promissory note (also dened in Section 9-102). To a considerable extent, this Article aords these transactions treatment identical to that given sales of accounts and chattel paper. In some respects, however, sales of payment intangibles and promissory notes are treated dierently from sales of other receivables. See, e.g., Sections 9-309 (automatic perfection upon attachment), 9-408 (eect of restrictions on assignment). By virtue of the expanded denition of account (dened in Section 9-102), this Article now covers sales of (and other security interests in) health-care-insurance receivables (also dened in Section 9-102). Although this Article occasionally distinguishes between outright sales of receivables and sales that secure an obligation, neither this Article nor the denition of security interest (Section 1-201(37)) delineates how a particular transaction is to be classied. That issue is left to the courts. 5. Transfer of Ownership in Sales of Receivables. A sale of an account, chattel paper, a promissory note, or a payment intangible includes a sale of a right in the receivable, such as a sale of a participation interest. The term also includes the sale of an enforcement right. For example, a [p]erson entitled to enforce a negotiable promissory note (Section 3-301) may sell its ownership rights in the instrument. See Section 3-203, Comment 1 (Ownership rights in instruments may be determined by principles of the law of property, independent of Article 3, which do not depend upon whether the instrument was transferred under Section 3-203.). Also, the right under Section 3-309 to enforce a lost, destroyed, or stolen negotiable promissory note may be sold to a purchaser who could enforce that right by causing the seller to provide the proof required under that section. This Article rejects decisions reaching a contrary result, e.g., Dennis Joslin Co. v. Robinson Broadcasting, 977 F. Supp. 491 (D.D.C. 1997). Nothing in this section or any other provision of Article 9 prevents the transfer of full and complete ownership of an account, chattel paper, an instrument, or a payment intangible in a transaction of sale. However, as mentioned in Comment 4, neither this Article nor the denition of security interest in Section 1-201 provides rules for distinguishing sales transactions from those that create a security interest securing an obligation. This Article applies to both types of transactions. The principal eect of this coverage is to apply this Article's perfection and priority rules to these sales transactions. Use of terminology such as security interest, debtor, and collateral is merely a drafting convention adopted to reach this end, and its use has no relevance to distinguishing sales from other transactions. See PEB Commentary No. 14. Following a debtor's outright sale and transfer of ownership of a receivable, the debtorseller retains no legal or equitable rights in the receivable that has been sold. See Section 9-318(a). This is so whether or not the buyer's security interest is perfected. (A security interest arising from the sale of a promissory note or payment intangible is perfected upon attachment without further action. See Section 9-309.) However, if the buyer's interest in accounts or chattel paper is unperfected, a subsequent lien creditor, perfected secured party, or qualied buyer can reach the sold receivable and achieve priority over (or take free of) the buyer's unperfected security interest under Section 9-317. This is so not because the seller of a receivable retains rights in the property sold; it does not. Nor is this so because the seller of a receivable is a debtor and the buyer of a receivable is a secured party under this Article (they are). It is so for the simple reason that Sections 9-318(b), 9-317, and 9-322 make it so, as did former Sections 9-301 and 9-312. Because the buyer's security interest is unperfected, for purposes of determining the rights of creditors of and purchasers for value from the debtor-seller, under Section 9-318(b) the debtor-seller is deemed to have the rights and title it sold. Section 9-317 subjects the buyer's unperfected interest in accounts and chattel paper to that of the debtor-seller's lien creditor and other persons who qualify under that section. 873

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6. Consignments. Subsection (a)(4) is new. This Article applies to every consignment. The term, dened in Section 9-102, includes many but not all true consignments (i.e., bailments for the purpose of sale). If a transaction is a sale or return, as dened in revised Section 2-326, it is not a consignment. In a sale or return transaction, the buyer becomes the owner of the goods, and the seller may obtain an enforceable security interest in the goods only by satisfying the requirements of Section 9-203. Under common law, creditors of a bailee were unable to reach the interest of the bailor (in the case of a consignment, the consignor-owner). Like former Section 2-326 and former Article 9, this Article changes the common-law result; however, it does so in a dierent manner. For purposes of determining the rights and interests of third-party creditors of, and purchasers of the goods from, the consignee, but not for other purposes, such as remedies of the consignor, the consignee is deemed to acquire under this Article whatever rights and title the consignor had or had power to transfer. See Section 9-319. The interest of a consignor is dened to be a security interest under revised Section 1-201(37), more specically, a purchase-money security interest in the consignee's inventory. See Section 9-103(d). Thus, the rules pertaining to lien creditors, buyers, and attachment, perfection, and priority of competing security interests apply to consigned goods. The relationship between the consignor and consignee is left to other law. Consignors also have no duties under Part 6. See Section 9-601(g). Sometimes parties characterize transactions that secure an obligation (other than the bailee's obligation to returned bailed goods) as consignments. These transactions are not consignments as contemplated by Section 9-109(a)(4). See Section 9-102. This Article applies also to these transactions, by virtue of Section 9-109(a)(1). They create a security interest within the meaning of the rst sentence of Section 1-201(37). This Article does not apply to bailments for sale that fall outside the denition of consignment in Section 9-102 and that do not create a security interest that secures an obligation. 7. Security Interest in Obligation Secured by Non-Article 9 Transaction. Subsection (b) is unchanged in substance from former Section 9-102(3). The following example provides an illustration. Example 1: O borrows $10,000 from M and secures its repayment obligation, evidenced by a promissory note, by granting to M a mortgage on O's land. This Article does not apply to the creation of the real-property mortgage. However, if M sells the promissory note to X or gives a security interest in the note to secure M's own obligation to X, this Article applies to the security interest thereby created in favor of X. The security interest in the promissory note is covered by this Article even though the note is secured by a real-property mortgage. Also, X's security interest in the note gives X an attached security interest in the mortgage lien that secures the note and, if the security interest in the note is perfected, the security interest in the mortgage lien likewise is perfected. See Sections 9-203, 9-308. It also follows from subsection (b) that an attempt to obtain or perfect a security interest in a secured obligation by complying with non-Article 9 law, as by an assignment of record of a real-property mortgage, would be ineective. Finally, it is implicit from subsection (b) that one cannot obtain a security interest in a lien, such as a mortgage on real property, that is not also coupled with an equally eective security interest in the secured obligation. This Article rejects cases such as In re Maryville Savings & Loan Corp., 743 F.2d 413 (6th Cir. 1984), claried on reconsideration, 760 F.2d 119 (1985). 8. Federal Preemption. Former Section 9-104(a) excluded from Article 9 a security interest subject to any statute of the United States, to the extent that such statute governs the rights of parties to and third parties aected by transactions in particular types of property. Some (erroneously) read the former section to suggest that Article 9 sometimes deferred to federal law even when federal law did not preempt Article 9. Subsection (c)(1) recognizes explicitly that this Article defers to federal law only when and to the extent that it musti.e., when federal law preempts it. 9. Governmental Debtors. Former Section 9-104(e) excluded transfers by governmental debtors. It has been revised and replaced by the exclusions in new paragraphs (2) and (3) of subsection (c). These paragraphs reect the view that Article 9 should apply to security interests created by a State, foreign country, or a governmental unit (dened in Section 9-102) of either except to the extent that another statute governs the issue in question. Under paragraph (2), this Article defers to all statutes of the forum State. (A forum cannot 874

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determine whether it should consult the choice-of-law rules in the forum's UCC unless it rst determines that its UCC applies to the transaction before it.) Paragraph (3) defers to statutes of another State or a foreign country only to the extent that those statutes contain rules applicable specically to security interests created by the governmental unit in question. Example 2: A New Jersey state commission creates a security interest in favor of a New York bank. The validity of the security interest is litigated in New York. The relevant security agreement provides that it is governed by New York law. To the extent that a New Jersey statute contains rules peculiar to creation of security interests by governmental units generally, to creation of security interests by state commissions, or to creation of security interests by this particular state commission, then that law will govern. On the other hand, to the extent that New Jersey law provides that security interests created by governmental units, state commissions, or this state commission are governed by the law generally applicable to secured transactions (i.e., New Jersey's Article 9), then New York's Article 9 will govern. Example 3: An airline that is an instrumentality of a foreign country creates a security interest in favor of a New York bank. The analysis used in the previous example would apply here. That is, if the matter is litigated in New York, New York law would govern except to the extent that the foreign country enacted a statute applicable to security interests created by governmental units generally or by the airline specically. The fact that New York law applies does not necessarily mean that perfection is accomplished by ling in New York. Rather, it means that the court should apply New York's Article 9, including its choice-of-law provisions. Under New York's Section 9-301, perfection is governed by the law of the jurisdiction in which the debtor is located. Section 9-307 determines the debtor's location for choice-of-law purposes. If a transaction does not bear an appropriate relation to the forum State, then that State's Article 9 will not apply, regardless of whether the transaction would be excluded by paragraph (3). Example 4: A Belgian governmental unit grants a security interest in its equipment to a Swiss secured party. The equipment is located in Belgium. A dispute arises and, for some reason, an action is brought in a New Mexico state court. Inasmuch as the transaction bears no appropriate relation to New Mexico, New Mexico's UCC, including its Article 9, is inapplicable. See Section 1-105(1). New Mexico's Section 9-109(c) on excluded transactions should not come into play. Even if the parties agreed that New Mexico law would govern, the parties' agreement would not be eective because the transaction does not bear a reasonable relation to New Mexico. See Section 1-105(1). Conversely, Article 9 will come into play only if the litigation arises in a UCC jurisdiction or if a foreign choice-of-law rule leads a foreign court to apply the law of a UCC jurisdiction. For example, if issues concerning a security interest granted by a foreign airline to a New York bank are litigated overseas, the court may be bound to apply the law of the debtor's jurisdiction and not New York's Article 9. 10. Certain Statutory and Common-Law Liens; Interests in Real Property. With few exceptions (nonconsensual agricultural liens being one), this Article applies only to consensual security interests in personal property. Following former Section 9-104(b) and (j), paragraphs (1) and (11) of subsection (d) exclude landlord's liens and leases and most other interests in or liens on real property. These exclusions generally reiterate the limitations on coverage (i.e., by contract, in personal property and xtures) made explicit in subsection (a)(1). Similarly, most jurisdictions provide special liens to suppliers of many types of services and materials, either by statute or by common law. With the exception of agricultural liens, it is not necessary for this Article to provide general codication of this lien structure, which is determined in large part by local conditions and which is far removed from ordinary commercial nancing. As under former Section 9-104(c), subsection (d)(2) excludes these suppliers' liens (other than agricultural liens) from this Article. However, Section 9-333 provides a rule for determining priorities between certain possessory suppliers' liens and security interests covered by this Article. 11. Wage and Similar Claims. As under former Section 9-104(d), subsection (d)(3) excludes assignments of claims for wages and the like from this Article. These assignments present important social issues that other law addresses. The Federal Trade Commission has ruled that, with some exceptions, the taking of an assignment of wages or other earnings is an unfair act or practice under the Federal Trade Commission Act. See 16 C.F.R. 875

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Part 444. State statutes also may regulate such assignments. 12. Certain Sales and Assignments of Receivables; Judgments. In general this Article covers security interests in (including sales of) accounts, chattel paper, payment intangibles, and promissory notes. Paragraphs (4), (5), (6), and (7) of subsection (d) exclude from the Article certain sales and assignments of receivables that, by their nature, do not concern commercial nancing transactions. These paragraphs add to the exclusions in former Section 9-104(f) analogous sales and assignments of payment intangibles and promissory notes. For similar reasons, subsection (d)(9) retains the exclusion of assignments of judgments under former Section 9-104(h) (other than judgments taken on a right to payment that itself was collateral under this Article). 13. Insurance. Subsection (d)(8) narrows somewhat the broad exclusion of interests in insurance policies under former Section 9-104(g). This Article now covers assignments by or to a health-care provider of health-care-insurance receivables (dened in Section 9-102). 14. Set-O. Subsection (d)(10) adds two exceptions to the general exclusion of set-o rights from Article 9 under former Section 9-104(i). The rst takes account of new Section 9-340, which regulates the eectiveness of a set-o against a deposit account that stands as collateral. The second recognizes Section 9-404, which aords the obligor on an account, chattel paper, or general intangible the right to raise claims and defenses against an assignee (secured party). 15. Tort Claims. Subsection (d)(12) narrows somewhat the broad exclusion of transfers of tort claims under former Section 9-104(k). This Article now applies to assignments of commercial tort claims (dened in Section 9-102) as well as to security interests in tort claims that constitute proceeds of other collateral (e.g., a right to payment for negligent destruction of the debtor's inventory). Note that once a claim arising in tort has been settled and reduced to a contractual obligation to pay, the right to payment becomes a payment intangible and ceases to be a claim arising in tort. This Article contains two special rules governing creation of a security interest in tort claims. First, a description of collateral in a security agreement as all tort claims is insufcient to meet the requirement for attachment. See Section 9-108(e). Second, no security interest attaches under an after-acquired property clause to a tort claim. See Section 9-204(b). In addition, this Article does not determine whom the tortfeasor must pay to discharge its obligation. Inasmuch as a tortfeasor is not an account debtor, the rules governing waiver of defenses and discharge of an obligation by an obligor (Sections 9-403, 9-404, 9-405, and 9-406) are inapplicable to tort-claim collateral. 16. Deposit Accounts. Except in consumer transactions, deposit accounts may be taken as original collateral under this Article. Under former Section 9-104(l), deposit accounts were excluded as original collateral, leaving security interests in deposit accounts to be governed by the common law. The common law is nonuniform, often dicult to discover and comprehend, and frequently costly to implement. As a consequence, debtors who wished to use deposit accounts as collateral sometimes were precluded from doing so as a practical matter. By excluding deposit accounts from the Article's scope as original collateral in consumer transactions, subsection (d)(13) leaves those transactions to law other than this Article. However, in both consumer and non-consumer transactions, sections 9-315 and 9-322 apply to deposit accounts as proceeds and with respect to priorities in proceeds. This Article contains several safeguards to protect debtors against inadvertently encumbering deposit accounts and to reduce the likelihood that a secured party will realize a windfall from a debtor's deposit accounts. For example, because deposit account is a separate type of collateral, a security agreement covering general intangibles will not adequately describe deposit accounts. Rather, a security agreement must reasonably identify the deposit accounts that are the subject of a security interest, e.g., by using the term deposit accounts. See Section 9-108. To perfect a security interest in a deposit account as original collateral, a secured party (other than the bank with which the deposit account is maintained) must obtain control of the account either by obtaining the bank's authenticated agreement or by becoming the bank's customer with respect to the deposit account. See Sections 9-312(b)(1), 9-104. Either of these steps requires the debtor's consent. This Article also contains new rules that determine which State's law governs perfection and priority of a security interest in a deposit account (Section 9-304), priority of conicting security interests in and set-o rights against a deposit account (Sections 9-327, 9-340), the 876

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rights of transferees of funds from an encumbered deposit account (Section 9-332), the obligations of the bank (Section 9-341), enforcement of security interests in a deposit account (Section 9-607(c)), and the duty of a secured party to terminate control of a deposit account (Section 9-208(b)).

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

9-110. Security Interests Arising Under Article 2 or 2A. A security interest arising under Section 2-401, 2-505, 2-711(3), or 2A-508(5) is subject to this article. However, until the debtor obtains possession of the goods: (1) the security interest is enforceable, even if Section 9-203(b)(3) has not been satised; (2) ling is not required to perfect the security interest; (3) the rights of the secured party after default by the debtor are governed by Article 2 or 2A; and (4) the security interest has priority over a conicting security interest created by the debtor. Ocial Comments
1. Source. Former Section 9-113. 2. Background. Former Section 9-113, from which this section derives, referred generally to security interests arising solely under the Article on Sales (Article 2) or the Article on Leases (Article 2A). Views diered as to the precise scope of that section. In contrast, Section 9-110 species the security interests to which it applies. 3. Security Interests Under Articles 2 and 2A. Section 2-505 explains how a seller of goods may reserve a security interest in them. Section 2-401 indicates that a reservation of title by the seller of goods, despite delivery to the buyer, is limited to reservation of a security interest. As did former Article 9, this Article governs a security interest arising solely under one of those sections; however, until the buyer obtains possession of the goods, the security interest is enforceable even in the absence of a security agreement, ling is not necessary to perfect the security interest, and the seller-secured party's rights on the buyer's default are governed by Article 2. Sections 2-711(3) and 2A-508(5) create a security interest in favor of a buyer or lessee in possession of goods that were rightfully rejected or as to which acceptance was justiably revoked. As did former Article 9, this Article governs a security interest arising solely under one of those sections; however, until the seller or lessor obtains possession of the goods, the security interest is enforceable even in the absence of a security agreement, ling is not necessary to perfect the security interest, and the secured party's (buyer's or lessee's) rights on the debtor's (seller's or lessor's) default are governed by Article 2 or 2A, as the case may be. 4. Priority. This section adds to former Section 9-113 a priority rule. Until the debtor obtains possession of the goods, a security interest arising under one of the specied sections of Article 2 or 2A has priority over conicting security interests created by the debtor. Thus, a security interest arising under Section 2-401 or 2-505 has priority over a conicting security interest in the buyer's after-acquired goods, even if the goods in question are inventory. Arguably, the same result would obtain under Section 9-322, but even if it would not, a purchase-money-like priority is appropriate. Similarly, a security interest under Section 2-711(3) or 2A-508(5) has priority over security interests claimed by the seller's or lessor's secured lender. This result is appropriate, inasmuch as the payments giving rise to the debt secured by the Article 2 or 2A security interest are likely to be included among the lender's proceeds. Example: Seller owns equipment subject to a security interest created by Seller in favor of Lender. Buyer pays for the equipment, accepts the goods, and then justiably revokes acceptance. As long as Seller does not recover possession of the equipment, 877

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Buyer's security interest under Section 2-711(3) is senior to that of Lender. In the event that a security interest referred to in this section conicts with a security interest that is created by a person other than the debtor, Section 9-325 applies. Thus, if Lender's security interest in the example was created not by Seller but by the person from whom Seller acquired the goods, Section 9-325 would govern. 5. Relationship to Other Rights and Remedies Under Articles 2 and 2A. This Article does not specically address the conict between (i) a security interest created by a buyer or lessee and (ii) the seller's or lessor's right to withhold delivery under Section 2-702(1), 2-703(a), or 2A-525, the seller's or lessor's right to stop delivery under Section 2-705 or 2A-526, or the seller's right to reclaim under Section 2-507(2) or 2-702(2). These conicts are governed by the rst sentence of Section 2-403(1), under which the buyer's secured party obtains no greater rights in the goods than the buyer had or had power to convey, or Section 2A-307(1), under which creditors of the lessee take subject to the lease contract.

PART 2. EFFECTIVENESS OF SECURITY AGREEMENT; ATTACHMENT OF SECURITY INTEREST; RIGHTS OF PARTIES TO SECURITY AGREEMENT
[SUBPART 1. EFFECTIVENESS AND ATTACHMENT] 9-201. General Eectiveness of Security Agreement. (a) [General eectiveness.] Except as otherwise provided in [the Uniform Commercial Code], a security agreement is eective according to its terms between the parties, against purchasers of the collateral, and against creditors. (b) [Applicable consumer laws and other law.] A transaction subject to this article is subject to any applicable rule of law which establishes a dierent rule for consumers and [insert reference to (i) any other statute or regulation that regulates the rates, charges, agreements, and practices for loans, credit sales, or other extensions of credit and (ii) any consumerprotection statute or regulation]. (c) [Other applicable law controls.] In case of conict between this article and a rule of law, statute, or regulation described in subsection (b), the rule of law, statute, or regulation controls. Failure to comply with a statute or regulation described in subsection (b) has only the eect the statute or regulation species. (d) [Further deference to other applicable law.] This article does not: (1) validate any rate, charge, agreement, or practice that violates a rule of law, statute, or regulation described in subsection (b); or (2) extend the application of the rule of law, statute, or regulation to a transaction not otherwise subject to it. Ocial Comment
1. Source. Former Sections 9-201, 9-203(4). 2. Eectiveness of Security Agreement. Subsection (a) provides that a security agreement is generally eective. With certain exceptions, a security agreement is eective between the debtor and secured party and is likewise eective against third parties. Note that security agreement is used here (and elsewhere in this Article) as it is dened in Section 9-102: an agreement that creates or provides for a security interest. It follows 878

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that subsection (a) does not provide that every term or provision contained in a record that contains a security agreement or that is so labeled is eective. Properly read, former Section 9-201 was to the same eect. Exceptions to the general rule of subsection (a) arise where there is an overriding provision in this Article or any other Article of the UCC. For example, Section 9-317 subordinates unperfected security interests to lien creditors and certain buyers, and several provisions in Part 3 subordinate some security interests to other security interests and interests of purchasers. 3. Law, Statutes, and Regulations Applicable to Certain Transactions. Subsection (b) makes clear that certain transactions, although subject to this Article, also are subject to other applicable laws relating to consumers or specied in that subsection. Subsection (c) provides that the other law is controlling in the event of a conict, and that a violation of other law does not ipso facto constitute a violation of this Article. Subsection (d) provides that this Article does not validate violations under or extend the application of the other applicable laws.

9-202. Title to Collateral Immaterial. Except as otherwise provided with respect to consignments or sales of accounts, chattel paper, payment intangibles, or promissory notes, the provisions of this article with regard to rights and obligations apply whether title to collateral is in the secured party or the debtor. Ocial Comment
1. Source. Former Section 9-202. 2. Title Immaterial. The rights and duties of parties to a secured transaction and affected third parties are provided in this Article without reference to the location of title to the collateral. For example, the characteristics of a security interest that secures the purchase price of goods are the same whether the secured party appears to have retained title or the debtor appears to have obtained title and then conveyed title or a lien to the secured party. 3. When Title Matters. a. Under This Article. This section explicitly acknowledges two circumstances in which the eect of certain Article 9 provisions turns on ownership (title). First, in some respects sales of accounts, chattel paper, payment intangibles, and promissory notes receive special treatment. See, e.g., Sections 9-207(a), 9-210(b), 9-615(e). Buyers of receivables under former Article 9 were treated specially, as well. See, e.g., former Section 9-502(2). Second, the remedies of a consignor under a true consignment and, for the most part, the remedies of a buyer of accounts, chattel paper, payment intangibles, or promissory notes are determined by other law and not by Part 6. See Section 9-601(g). b. Under Other Law. This Article does not determine which line of interpretation (e.g., title theory or lien theory, retained title or conveyed title) should be followed in cases in which the applicability of another rule of law depends upon who has title. If, for example, a revenue law imposes a tax on the legal owner of goods or if a corporation law makes a vote of the stockholders prerequisite to a corporation giving a security interest but not if it acquires property subject to a security interest, this Article does not attempt to dene whether the secured party is a legal owner or whether the transaction gives a security interest for the purpose of such laws. Other rules of law or the agreement of the parties determines the location and source of title for those purposes.

9-203. Attachment and Enforceability of Security Interest; Proceeds; Supporting Obligations; Formal Requisites. (a) [Attachment.] A security interest attaches to collateral when it becomes enforceable against the debtor with respect to the collateral, unless an agreement expressly postpones the time of attachment. (b) [Enforceability.] Except as otherwise provided in subsections (c) through (i), a security interest is enforceable against the debtor and third parties with respect to the collateral only if : (1) value has been given;
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(2) the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party; and (3) one of the following conditions is met: (A) the debtor has authenticated a security agreement that provides a description of the collateral and, if the security interest covers timber to be cut, a description of the land concerned; (B) the collateral is not a certicated security and is in the possession of the secured party under Section 9-313 pursuant to the debtor's security agreement; (C) the collateral is a certicated security in registered form and the security certicate has been delivered to the secured party under Section 8-301 pursuant to the debtor's security agreement; or (D) the collateral is deposit accounts, electronic chattel paper, investment property, letter-of-credit rights, or electronic documents, and the secured party has control under Section 7-106, 9-104, 9-105, 9-106, or 9-107 pursuant to the debtor's security agreement. (c) [Other UCC provisions.] Subsection (b) is subject to Section 4-210 on the security interest of a collecting bank, Section 5-118 on the security interest of a letter-of-credit issuer or nominated person, Section 9-110 on a security interest arising under Article 2 or 2A, and Section 9-206 on security interests in investment property. (d) [When person becomes bound by another person's security agreement.] A person becomes bound as debtor by a security agreement entered into by another person if, by operation of law other than this article or by contract: (1) the security agreement becomes eective to create a security interest in the person's property; or (2) the person becomes generally obligated for the obligations of the other person, including the obligation secured under the security agreement, and acquires or succeeds to all or substantially all of the assets of the other person. (e) [Eect of new debtor becoming bound.] If a new debtor becomes bound as debtor by a security agreement entered into by another person: (1) the agreement satises subsection (b)(3) with respect to existing or after-acquired property of the new debtor to the extent the property is described in the agreement; and (2) another agreement is not necessary to make a security interest in the property enforceable. (f) [Proceeds and supporting obligations.] The attachment of a security interest in collateral gives the secured party the rights to proceeds provided by Section 9-315 and is also attachment of a security interest in a supporting obligation for the collateral. (g) [Lien securing right to payment.] The attachment of a security interest in a right to payment or performance secured by a security interest or other lien on personal or real property is also attachment of a security interest in the security interest, mortgage, or other lien. (h) [Security entitlement carried in securities account.] The attachment of a security interest in a securities account is also attachment
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of a security interest in the security entitlements carried in the securities account. (i) [Commodity contracts carried in commodity account.] The attachment of a security interest in a commodity account is also attachment of a security interest in the commodity contracts carried in the commodity account. As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Source. Former Sections 9-203, 9-115(2), (6). 2. Creation, Attachment, and Enforceability. Subsection (a) states the general rule that a security interest attaches to collateral only when it becomes enforceable against the debtor. Subsection (b) species the circumstances under which a security interest becomes enforceable. Subsection (b) states three basic prerequisites to the existence of a security interest: value (paragraph (1)), rights or power to transfer rights in collateral (paragraph (2)), and agreement plus satisfaction of an evidentiary requirement (paragraph (3)). When all of these elements exist, a security interest becomes enforceable between the parties and attaches under subsection (a). Subsection (c) identies certain exceptions to the general rule of subsection (b). 3. Security Agreement; Authentication. Under subsection (b)(3), enforceability requires the debtor's security agreement and compliance with an evidentiary requirement in the nature of a Statute of Frauds. Paragraph (3)(A) represents the most basic of the evidentiary alternatives, under which the debtor must authenticate a security agreement that provides a description of the collateral. Under Section 9-102, a security agreement is an agreement that creates or provides for a security interest. Neither that denition nor the requirement of paragraph (3)(A) rejects the deeply rooted doctrine that a bill of sale, although absolute in form, may be shown in fact to have been given as security. Under this Article, as under prior law, a debtor may show by parol evidence that a transfer purporting to be absolute was in fact for security. Similarly, a self-styled lease may serve as a security agreement if the agreement creates a security interest. See Section 1-201(37) (distinguishing security interest from lease). 4. Possession, Delivery, or Control Pursuant to Security Agreement. The other alternatives in subsection (b)(3) dispense with the requirement of an authenticated security agreement and provide alternative evidentiary tests. Under paragraph (3)(B), the secured party's possession substitutes for the debtor's authentication under paragraph (3)(A) if the secured party's possession is pursuant to the debtor's security agreement. That phrase refers to the debtor's agreement to the secured party's possession for the purpose of creating a security interest. The phrase should not be confused with the phrase debtor has authenticated a security agreement, used in paragraph (3)(A), which contemplates the debtor's authentication of a record. In the unlikely event that possession is obtained without the debtor's agreement, possession would not suce as a substitute for an authenticated security agreement. However, once the security interest has become enforceable and has attached, it is not impaired by the fact that the secured party's possession is maintained without the agreement of a subsequent debtor (e.g., a transferee). Possession as contemplated by Section 9-313 is possession for purposes of subsection (b)(3)(B), even though it may not constitute possession pursuant to the debtor's agreement and consequently might not serve as a substitute for an authenticated security agreement under subsection (b)(3)(A). Subsection (b)(3)(C) provides that delivery of a certicated security to the secured party under Section 8-301 pursuant to the debtor's security agreement is sucient as a substitute for an authenticated security agreement. Similarly, under subsection (b)(3)(D), control of investment property, a deposit account, electronic chattel paper, a letter-of-credit right, or electronic documents satises the evidentiary test if control is pursuant to the debtor's security agreement. 5. Collateral Covered by Other Statute or Treaty. One evidentiary purpose of the formal requisites stated in subsection (b) is to minimize the possibility of future disputes as to the terms of a security agreement (e.g., as to the property that stands as collateral for 881

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the obligation secured). One should distinguish the evidentiary functions of the formal requisites of attachment and enforceability (such as the requirement that a security agreement contain a description of the collateral) from the more limited goals of notice ling for nancing statements under Part 5, explained in Section 9-502, Comment 2. When perfection is achieved by compliance with the requirements of a statute or treaty described in Section 9-311(a), such as a federal recording act or a certicate-of-title statute, the manner of describing the collateral in a registry imposed by the statute or treaty may or may not be adequate for purposes of this section and Section 9-108. However, the description contained in the security agreement, not the description in a public registry or on a certicate of title, controls for purposes of this section. 6. Debtor's Rights; Debtor's Power to Transfer Rights. Subsection (b)(2) conditions attachment on the debtor's having rights in the collateral or the power to transfer rights in the collateral to a secured party. A debtor's limited rights in collateral, short of full ownership, are sucient for a security interest to attach. However, in accordance with basic personal property conveyancing principles, the baseline rule is that a security interest attaches only to whatever rights a debtor may have, broad or limited as those rights may be. Certain exceptions to the baseline rule enable a debtor to transfer, and a security interest to attach to, greater rights than the debtor has. See Part 3, Subpart 3 (priority rules). The phrase, or the power to transfer rights in the collateral to a secured party, accommodates those exceptions. In some cases, a debtor may have power to transfer another person's rights only to a class of transferees that excludes secured parties. See, e.g., Section 2-403(2) (giving certain merchants power to transfer an entruster's rights to a buyer in ordinary course of business). Under those circumstances, the debtor would not have the power to create a security interest in the other person's rights, and the condition in subsection (b)(2) would not be satised. 7. New Debtors. Subsection (e) makes clear that the enforceability requirements of subsection (b)(3) are met when a new debtor becomes bound under an original debtor's security agreement. If a new debtor becomes bound as debtor by a security agreement entered into by another person, the security agreement satises the requirement of subsection (b)(3) as to the existing and after-acquired property of the new debtor to the extent the property is described in the agreement. Subsection (d) explains when a new debtor becomes bound. Persons who become bound under paragraph (2) are limited to those who both become primarily liable for the original debtor's obligations and succeed to (or acquire) its assets. Thus, the paragraph excludes sureties and other secondary obligors as well as persons who become obligated through veil piercing and other non-successorship doctrines. In many cases, paragraph (2) will exclude successors to the assets and liabilities of a division of a debtor. See also Section 9-508, Comment 3. 8. Supporting Obligations. Under subsection (f), a security interest in a supporting obligation (dened in Section 9-102) automatically follows from a security interest in the underlying, supported collateral. This result was implicit under former Article 9. Implicit in subsection (f) is the principle that the secured party's interest in a supporting obligation extends to the supporting obligation only to the extent that it supports the collateral in which the secured party has a security interest. Complex issues may arise, however, if a supporting obligation supports many separate obligations of a particular account debtor and if the supported obligations are separately assigned as security to several secured parties. The problems may be exacerbated if a supporting obligation is limited to an aggregate amount that is less than the aggregate amount of the obligations it supports. This Article does not contain provisions dealing with competing claims to a limited supporting obligation. As under former Article 9, the law of suretyship and the agreements of the parties will control. 9. Collateral Follows Right to Payment or Performance. Subsection (g) codies the common-law rule that a transfer of an obligation secured by a security interest or other lien on personal or real property also transfers the security interest or lien. See Restatement (3d), Property (Mortgages) 5.4(a) (1997). See also Section 9-308(e) (analogous rule for perfection). 10. Investment Property. Subsections (h) and (i) make clear that attachment of a security interest in a securities account or commodity account is also attachment in security 882

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entitlements or commodity contracts carried in the accounts.

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Text in 2003.

9-204. After-Acquired Property; Future Advances. (a) [After-acquired collateral.] Except as otherwise provided in subsection (b), a security agreement may create or provide for a security interest in after-acquired collateral. (b) [When after-acquired property clause not eective.] A security interest does not attach under a term constituting an after-acquired property clause to: (1) consumer goods, other than an accession when given as additional security, unless the debtor acquires rights in them within 10 days after the secured party gives value; or (2) a commercial tort claim. (c) [Future advances and other value.] A security agreement may provide that collateral secures, or that accounts, chattel paper, payment intangibles, or promissory notes are sold in connection with, future advances or other value, whether or not the advances or value are given pursuant to commitment. Ocial Comment
1. Source. Former Section 9-204. 2. After-Acquired Property; Continuing General Lien. Subsection (a) makes clear that a security interest arising by virtue of an after-acquired property clause is no less valid than a security interest in collateral in which the debtor has rights at the time value is given. A security interest in after-acquired property is not merely an equitable interest; no further action by the secured partysuch as a supplemental agreement covering the new collateralis required. This section adopts the principle of a continuing general lien or oating lien. It validates a security interest in the debtor's existing and (upon acquisition) future assets, even though the debtor has liberty to use or dispose of collateral without being required to account for proceeds or substitute new collateral. See Section 9-205. Subsection (a), together with subsection (c), also validates cross-collateral clauses under which collateral acquired at any time secures advances whenever made. 3. After-Acquired Consumer Goods. Subsection (b)(1) makes ineective an afteracquired property clause covering consumer goods (dened in Section 9-109), except as accessions (see Section 9-335), acquired more than 10 days after the secured party gives value. Subsection (b)(1) is unchanged in substance from the corresponding provision in former Section 9-204(2). 4. Commercial Tort Claims. Subsection (b)(2) provides that an after-acquired property clause in a security agreement does not reach future commercial tort claims. In order for a security interest in a tort claim to attach, the claim must be in existence when the security agreement is authenticated. In addition, the security agreement must describe the tort claim with greater specicity than simply all tort claims. See Section 9-108(e). 5. Future Advances; Obligations Secured. Under subsection (c) collateral may secure future as well as past or present advances if the security agreement so provides. This is in line with the policy of this Article toward security interests in after-acquired property under subsection (a). Indeed, the parties are free to agree that a security interest secures any obligation whatsoever. Determining the obligations secured by collateral is solely a matter of construing the parties' agreement under applicable law. This Article rejects the holdings of cases decided under former Article 9 that applied other tests, such as whether a future advance or other subsequently incurred obligation was of the same or a similar type or class as earlier advances and obligations secured by the collateral. 6. Sales of Receivables. Subsections (a) and (c) expressly validate after-acquired prop883

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erty and future advance clauses not only when the transaction is for security purposes but also when the transaction is the sale of accounts, chattel paper, payment intangibles, or promissory notes.. This result was implicit under former Article 9. 7. Financing Statements. The eect of after-acquired property and future advance clauses as components of a security agreement should not be confused with the requirements applicable to nancing statements under this Article's system of perfection by notice ling. The references to after-acquired property clauses and future advance clauses in this section are limited to security agreements. There is no need to refer to after-acquired property or future advances or other obligations secured in a nancing statement. See Section 9-502, Comment 2.

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

9-205. Use or Disposition of Collateral Permissible. (a) [When security interest not invalid or fraudulent.] A security interest is not invalid or fraudulent against creditors solely because: (1) the debtor has the right or ability to: (A) use, commingle, or dispose of all or part of the collateral, including returned or repossessed goods; (B) collect, compromise, enforce, or otherwise deal with collateral; (C) accept the return of collateral or make repossessions; or (D) use, commingle, or dispose of proceeds; or (2) the secured party fails to require the debtor to account for proceeds or replace collateral. (b) [Requirements of possession not relaxed.] This section does not relax the requirements of possession if attachment, perfection, or enforcement of a security interest depends upon possession of the collateral by the secured party. Ocial Comment
1. Source. Former Section 9-205. 2. Validity of Unrestricted Floating Lien. This Article expressly validates the oating lien on shifting collateral. See Sections 9-201, 9-204 and Comment 2. This section provides that a security interest is not invalid or fraudulent by reason of the debtor's liberty to dispose of the collateral without being required to account to the secured party for proceeds or substitute new collateral. As did former Section 9-205, this section repeals the rule of Benedict v. Ratner, 268 U.S. 353 (1925), and other cases which held such arrangements void as a matter of law because the debtor was given unfettered dominion or control over collateral. The Benedict rule did not eectively discourage or eliminate security transactions in inventory and receivables. Instead, it forced nancing arrangements to be self-liquidating. Although this section repeals Benedict, the ling and other perfection requirements (see Part 3, Subpart 2, and Part 5) provide for public notice that overcomes any potential misleading eects of a debtor's use and control of collateral. Moreover, nothing in this section prevents the debtor and secured party from agreeing to procedures by which the secured party polices or monitors collateral or to restrictions on the debtor's dominion. However, this Article leaves these matters to agreement based on business considerations, not on legal requirements. 3. Possessory Security Interests. Subsection (b) makes clear that this section does not relax the requirements for perfection by possession under Section 9-313. If a secured party allows the debtor access to and control over collateral its security interest may be or become unperfected. 4. Permissible Freedom for Debtor to Enforce Collateral. Former Section 9-205 referred to a debtor's liberty..to collect or compromise accounts or chattel paper. This sec884

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tion recognizes the broader rights of a debtor to enforce, as well as to collect and compromise collateral. This section's reference to collecting, compromising, and enforcing collateral instead of accounts or chattel paper contemplates the many other types of collateral that a debtor may wish to collect, compromise, or enforce: e.g., deposit accounts, documents, general intangibles, instruments, investment property, and letter-of-credit rights.

9-206. Security Interest Arising in Purchase or Delivery of Financial Asset. (a) [Security interest when person buys through securities intermediary.] A security interest in favor of a securities intermediary attaches to a person's security entitlement if: (1) the person buys a nancial asset through the securities intermediary in a transaction in which the person is obligated to pay the purchase price to the securities intermediary at the time of the purchase; and (2) the securities intermediary credits the nancial asset to the buyer's securities account before the buyer pays the securities intermediary. (b) [Security interest secures obligation to pay for nancial asset.] The security interest described in subsection (a) secures the person's obligation to pay for the nancial asset. (c) [Security interest in payment against delivery transaction.] A security interest in favor of a person that delivers a certicated security or other nancial asset represented by a writing attaches to the security or other nancial asset if: (1) the security or other nancial asset: (A) in the ordinary course of business is transferred by delivery with any necessary indorsement or assignment; and (B) is delivered under an agreement between persons in the business of dealing with such securities or nancial assets; and (2) the agreement calls for delivery against payment. (d) [Security interest secures obligation to pay for delivery.] The security interest described in subsection (c) secures the obligation to make payment for the delivery. Ocial Comment
1. Source. Former 9-116. 2. Codication of Broker's Lien. Depending upon a securities intermediary's arrangements with its entitlement holders, the securities intermediary may treat the entitlement holder as entitled to nancial assets before the entitlement holder has actually made payment for them. For example, many brokers permit retail customers to pay for nancial assets by check. The broker may not receive nal payment of the check until several days after the broker has credited the customer's securities account for the nancial assets. Thus, the customer will have acquired a security entitlement prior to payment. Subsection (a) provides that, in such circumstances, the securities intermediary has a security interest in the entitlement holder's security entitlement. Under subsection (b) the security interest secures the customer's obligation to pay for the nancial asset in question. Subsections (a) and (b) codify and adapt to the indirect holding system the so-called broker's lien, which has long been recognized. See Restatement, Security 12. 3. Financial Assets Delivered Against Payment. Subsection (c) creates a security interest in favor of persons who deliver certicated securities or other nancial assets in physical form, such as money market instruments, if the agreed payment is not received. In some arrangements for settlement of transactions in physical nancial assets, the seller's securities custodian will deliver physical certicates to the buyer's securities 885

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custodian and receive a time-stamped delivery receipt. The buyer's securities custodian will examine the certicate to ensure that it is in good order, and that the delivery matches a trade in which the buyer has instructed the seller to deliver to that custodian. If all is in order, the receiving custodian will settle with the delivering custodian through whatever funds settlement system has been agreed upon or is used by custom and usage in that market. The understanding of the trade, however, is that the delivery is conditioned upon payment, so that if payment is not made for any reason, the security will be returned to the deliverer. Subsection (c) claries the rights of persons making deliveries in such circumstances. It provides the person making delivery with a security interest in the securities or other nancial assets; under subsection (d), the security interest secures the seller's right to receive payment for the delivery. Section 8-301 species when delivery of a certicated security occurs; that section should be applied as well to other nancial assets as well for purposes of this section. 4. Automatic Attachment and Perfection. Subsections (a) and (c) refer to attachment of a security interest. Attachment under this section has the same incidents (enforceability, right to proceeds, etc.) as attachment under Section 9-203. This section overrides the general attachment rules in Section 9-203. See Section 9-203(c). A securities intermediary's security interest under subsection (a) is perfected by control without further action. See Section 8-106 (control); 9-314 (perfection). Security interests arising under subsection (c) are automatically perfected. See Section 9-309(9).

[SUBPART 2. RIGHTS AND DUTIES] 9-207. Rights and Duties of Secured Party Having Possession or Control of Collateral. (a) [Duty of care when secured party in possession.] Except as otherwise provided in subsection (d), a secured party shall use reasonable care in the custody and preservation of collateral in the secured party's possession. In the case of chattel paper or an instrument, reasonable care includes taking necessary steps to preserve rights against prior parties unless otherwise agreed. (b) [Expenses, risks, duties, and rights when secured party in possession.] Except as otherwise provided in subsection (d), if a secured party has possession of collateral: (1) reasonable expenses, including the cost of insurance and payment of taxes or other charges, incurred in the custody, preservation, use, or operation of the collateral are chargeable to the debtor and are secured by the collateral; (2) the risk of accidental loss or damage is on the debtor to the extent of a deciency in any eective insurance coverage; (3) the secured party shall keep the collateral identiable, but fungible collateral may be commingled; and (4) the secured party may use or operate the collateral: (A) for the purpose of preserving the collateral or its value; (B) as permitted by an order of a court having competent jurisdiction; or (C) except in the case of consumer goods, in the manner and to the extent agreed by the debtor. (c) [Duties and rights when secured party in possession or control.] Except as otherwise provided in subsection (d), a secured party having possession of collateral or control of collateral under Section 7-106, 9-104, 9-105, 9-106, or 9-107:
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(1) may hold as additional security any proceeds, except money or funds, received from the collateral; (2) shall apply money or funds received from the collateral to reduce the secured obligation, unless remitted to the debtor; and (3) may create a security interest in the collateral. (d) [Buyer of certain rights to payment.] If the secured party is a buyer of accounts, chattel paper, payment intangibles, or promissory notes or a consignor: (1) subsection (a) does not apply unless the secured party is entitled under an agreement: (A) to charge back uncollected collateral; or (B) otherwise to full or limited recourse against the debtor or a secondary obligor based on the nonpayment or other default of an account debtor or other obligor on the collateral; and (2) subsections (b) and (c) do not apply. As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Source. Former Section 9-207. 2. Duty of Care for Collateral in Secured Party's Possession. Like former section 9-207, subsection (a) imposes a duty of care, similar to that imposed on a pledgee at common law, on a secured party in possession of collateral. See Restatement, Security 17, 18. In many cases a secured party in possession of collateral may satisfy this duty by notifying the debtor of action that should be taken and allowing the debtor to take the action itself. If the secured party itself takes action, its reasonable expenses may be added to the secured obligation. The revised denitions of collateral, debtor, and secured party in Section 9-102 make this section applicable to collateral subject to an agricultural lien if the collateral is in the lienholder's possession. Under Section 1-102 the duty to exercise reasonable care may not be disclaimed by agreement, although under that section the parties remain free to determine by agreement standards that are not manifestly unreasonable as to what constitutes reasonable care. Unless otherwise agreed, for a secured party in possession of chattel paper or an instrument, reasonable care includes the preservation of rights against prior parties. The secured party's right to have instruments or documents indorsed or transferred to it or its order is dealt with in the relevant sections of Articles 3, 7, and 8. See Sections 3-201, 7-506, 8-304(d). 3. Specic Rules When Secured Party in Possession or Control of Collateral. Subsections (b) and (c) provide rules following common-law precedents which apply unless the parties otherwise agree. The rules in subsection (b) apply to typical issues that may arise while a secured party is in possession of collateral, including expenses, insurance, and taxes, risk of loss or damage, identiable and fungible collateral, and use or operation of collateral. Subsection (c) contains rules that apply in certain circumstances that may arise when a secured party is in either possession or control of collateral. These circumstances include the secured party's receiving proceeds from the collateral and the secured party's creation of a security interest in the collateral. 4. Applicability Following Default. This section applies when the secured party has possession of collateral either before or after default. See Sections 9-601(b), 9-609. Subsection (b)(4)(C) limits agreements concerning the use or operation of collateral to collateral other than consumer goods. Under Section 9-602(1), a debtor cannot waive or vary that limitation. 5. Repledges and Right of Redemption. Subsection (c)(3) eliminates the qualication in former Section 9-207 to the eect that the terms of a repledge may not impair a debtor's right to redeem collateral. The change is primarily for clarication. There is no basis on which to draw from subsection (c)(3) any inference concerning the debtor's right to 887

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redeem the collateral. The debtor enjoys that right under Section 9-623; this section need not address it. For example, if the collateral is a negotiable note that the secured party (SP-1) repledges to SP-2, nothing in this section suggests that the debtor (D) does not retain the right to redeem the note upon payment to SP-1 of all obligations secured by the note. But, as explained below, the debtor's unimpaired right to redeem as against the debtor's original secured party nevertheless may not be enforceable as against the new secured party. In resolving questions that arise from the creation of a security interest by SP-1, one must take care to distinguish D's rights against SP-1 from D's rights against SP-2. Once D discharges the secured obligation, D becomes entitled to the note; SP-1 has no legal basis upon which to withhold it. If, as a practical matter, SP-1 is unable to return the note because SP-2 holds it as collateral for SP-1's unpaid debt, then SP-1 is liable to D under the law of conversion. Whether SP-2 would be liable to D depends on the relative priority of SP-2's security interest and D's interest. By permitting SP-1 to create a security interest in the collateral (repledge), subsection (c)(3) provides a statutory power for SP-1 to give SP-2 a security interest (subject, of course, to any agreement by SP-1 not to give a security interest). In the vast majority of cases where repledge rights are signicant, the security interest of the second secured party, SP-2 in the example, will be senior to the debtor's interest. By virtue of the debtor's consent or applicable legal rules, SP-2 typically would cut o D's rights in investment property or be immune from D's claims. See Sections 9-331, 3-306 (holder in due course), 8-303 (protected purchaser), 8-502 (acquisition of a security entitlement), 8-503(e) (action by entitlement holder). Moreover, the expectations and business practices in some markets, such as the securities markets, are such that D's consent to SP-2's taking free of D's rights inheres in D's creation of SP-1's security interest which gives rise to SP1's power under this section. In these situations, D would have no right to recover the collateral or recover damages from SP-2. Nevertheless, D would have a damage claim against SP-1 if SP-1 had given a security interest to SP-2 in breach of its agreement with D. Moreover, if SP-2's security interest secures an amount that is less than the amount secured by SP-1's security interest (granted by D), then D's exercise of its right to redeem would provide value sucient to discharge SP-1's obligations to SP-2. For the most part this section does not change the law under former Section 9-207, although eliminating the reference to the debtor's right of redemption may alter the secured party's right to repledge in one respect. Former Section 9-207 could have been read to limit the secured party's statutory right to repledge collateral to repledge transactions in which the collateral did not secure a greater obligation than that of the original debtor. Inasmuch as this is a matter normally dealt with by agreement between the debtor and secured party, any change would appear to have little practical eect. 6. Repledges of Investment Property. The following example will aid the discussion of repledges of investment property. Example. Debtor grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Alpha does not have an account with Able. Alpha uses Beta Bank as its securities custodian. Debtor instructs Able to transfer the shares to Beta, for the account of Alpha, and Able does so. Beta then credits Alpha's account. Alpha has control of the security entitlement for the 1000 shares under Section 8-106(d). (These are the facts of Example 2, Section 8-106, Comment 4.) Although, as between Debtor and Alpha, Debtor may have become the benecial owner of the new securities entitlement with Beta, Beta has agreed to act on Alpha's entitlement orders because, as between Beta and Alpha, Alpha has become the entitlement holder. Next, Alpha grants Gamma Bank a security interest in the security entitlement with Beta that includes the 1000 shares of XYZ Co. stock. In order to aord Gamma control of the entitlement, Alpha instructs Beta to transfer the stock to Gamma's custodian, Delta Bank, which credits Gamma's account for 1000 shares. At this point Gamma holds its securities entitlement for its benet as well as that of its debtor, Alpha. Alpha's derivative rights also are for the benet of Debtor. In many, probably most, situations and at any particular point in time, it will be impossible for Debtor or Alpha to trace Alpha's repledge to any particular securities entitlement or nancial asset of Gamma or anyone else. Debtor would retain, of course, a right to redeem the collateral from Alpha upon satisfaction of the secured obligation. However, in 888

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the absence of a traceable interest, Debtor would retain only a personal claim against Alpha in the event Alpha failed to restore the security entitlement to Debtor. Moreover, even in the unlikely event that Debtor could trace a property interest, in the context of the nancial markets, normally the operation of this section, Debtor's explicit agreement to permit Alpha to create a senior security interest, or legal rules permitting Gamma to cut o Debtor's rights or become immune from Debtor's claims would eectively subordinate Debtor's interest to the holder of a security interest created by Alpha. And, under the shelter principle, all subsequent transferees would obtain interests to which Debtor's interest also would be subordinate. 7. Buyers of Chattel Paper and Other Receivables; Consignors. This section has been revised to reect the fact that a seller of accounts, chattel paper, payment intangibles, or promissory notes retains no interest in the collateral and so is not disadvantaged by the secured party's noncompliance with the requirements of this section. Accordingly, subsection (d) provides that subsection (a) applies only to security interests that secure an obligation and to sales of receivables in which the buyer has recourse against the debtor. (Of course, a buyer of accounts or payment intangibles could not have possession of original collateral, but might have possession of proceeds, such as promissory notes or checks.) The meaning of recourse in this respect is limited to recourse arising out of the account debtor's failure to pay or other default. Subsection (d) makes subsections (b) and (c) inapplicable to buyers of accounts, chattel paper, payment intangibles, or promissory notes and consignors. Of course, there is no reason to believe that a buyer of receivables or a consignor could not, for example, create a security interest or otherwise transfer an interest in the collateral, regardless of who has possession of the collateral. However, this section leaves the rights of those owners to law other than Article 9.

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

9-208. Additional Duties of Secured Party Having Control of Collateral. (a) [Applicability of section.] This section applies to cases in which there is no outstanding secured obligation and the secured party is not committed to make advances, incur obligations, or otherwise give value. (b) [Duties of secured party after receiving demand from debtor.] Within 10 days after receiving an authenticated demand by the debtor: (1) a secured party having control of a deposit account under Section 9-104(a)(2) shall send to the bank with which the deposit account is maintained an authenticated statement that releases the bank from any further obligation to comply with instructions originated by the secured party; (2) a secured party having control of a deposit account under Section 9-104(a)(3) shall: (A) pay the debtor the balance on deposit in the deposit account; or (B) transfer the balance on deposit into a deposit account in the debtor's name; (3) a secured party, other than a buyer, having control of electronic chattel paper under Section 9-105 shall: (A) communicate the authoritative copy of the electronic chattel paper to the debtor or its designated custodian; (B) if the debtor designates a custodian that is the designated custodian with which the authoritative copy of the electronic chattel paper is maintained for the secured party, communicate to the
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custodian an authenticated record releasing the designated custodian from any further obligation to comply with instructions originated by the secured party and instructing the custodian to comply with instructions originated by the debtor; and (C) take appropriate action to enable the debtor or its designated custodian to make copies of or revisions to the authoritative copy which add or change an identied assignee of the authoritative copy without the consent of the secured party; (4) a secured party having control of investment property under Section 8-106(d)(2) or 9-106(b) shall send to the securities intermediary or commodity intermediary with which the security entitlement or commodity contract is maintained an authenticated record that releases the securities intermediary or commodity intermediary from any further obligation to comply with entitlement orders or directions originated by the secured party; (5) a secured party having control of a letter-of-credit right under Section 9-107 shall send to each person having an unfullled obligation to pay or deliver proceeds of the letter of credit to the secured party an authenticated release from any further obligation to pay or deliver proceeds of the letter of credit to the secured party; and (6) a secured party having control of an electronic document shall: (A) give control of the electronic document to the debtor or its designated custodian; (B) if the debtor designates a custodian that is the designated custodian with which the authoritative copy of the electronic document is maintained for the secured party, communicate to the custodian an authenticated record releasing the designated custodian from any further obligation to comply with instructions originated by the secured party and instructing the custodian to comply with instructions originated by the debtor; and (C) take appropriate action to enable the debtor or its designated custodian to make copies of or revisions to the authoritative copy which add or change an identied assignee of the authoritative copy without the consent of the secured party. As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Source. New. 2. Scope and Purpose. This section imposes duties on a secured party who has control of a deposit account, electronic chattel paper, investment property, a letter-of-credit right, or electronic documents of title. The duty to terminate the secured party's control is analogous to the duty to le a termination statement, imposed by Section 9-513. Under subsection (a), it applies only when there is no outstanding secured obligation and the secured party is not committed to give value. The requirements of this section can be varied by agreement under Section 1-102(3). For example, a debtor could by contract agree that the secured party may comply with subsection (b) by releasing control more than 10 days after demand. Also, duties under this section should not be read to conict with the terms of the collateral itself. For example, if the collateral is a time deposit account, subsection (b)(2) should not require a secured party with control to make an early withdrawal of the funds 890

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(assuming that were possible) in order to pay them over to the debtor or put them in an account in the debtor's name. 3. Remedy for Failure to Relinquish Control. If a secured party fails to comply with the requirements of subsection (b), the debtor has the remedy set forth in Section 9-625(e). This remedy is identical to that applicable to failure to provide or le a termination statement under Section 9-513. 4. Duty to Relinquish Possession. Although Section 9-207 addresses directly the duties of a secured party in possession of collateral, that section does not require the secured party to relinquish possession when the secured party ceases to hold a security interest. Under common law, absent agreement to the contrary, the failure to relinquish possession of collateral upon satisfaction of the secured obligation would constitute a conversion. Inasmuch as problems apparently have not surfaced in the absence of statutory duties under former Article 9 and the common-law duty appears to have been sucient, this Article does not impose a statutory duty to relinquish possession.

As amended in 2000 and 2003.

See Appendix P for material relating to changes made in Ocial Comment in 2000. See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

9-209. Duties of Secured Party if Account Debtor Has Been Notied of Assignment. (a) [Applicability of section.] Except as otherwise provided in subsection (c), this section applies if: (1) there is no outstanding secured obligation; and (2) the secured party is not committed to make advances, incur obligations, or otherwise give value. (b) [Duties of secured party after receiving demand from debtor.] Within 10 days after receiving an authenticated demand by the debtor, a secured party shall send to an account debtor that has received notication of an assignment to the secured party as assignee under Section 9-406(a) an authenticated record that releases the account debtor from any further obligation to the secured party. (c) [Inapplicability to sales.] This section does not apply to an assignment constituting the sale of an account, chattel paper, or payment intangible. Ocial Comment
1. Source. New. 2. Scope and Purpose. Like Sections 9-208 and 9-513, which require a secured party to relinquish control of collateral and to le or provide a termination statement for a nancing statement, this section requires a secured party to free up collateral when there no longer is any outstanding secured obligation or any commitment to give value in the future. This section addresses the case in which account debtors have been notied to pay a secured party to whom the receivables have been assigned. It requires the secured party (assignee) to inform the account debtors that they no longer are obligated to make payment to the secured party. See subsection (b). It does not apply to account debtors whose obligations on an account, chattel paper, or payment intangible have been sold. See subsection (c).

9-210. Request for Accounting; Request Regarding List of Collateral or Statement of Account. (a) [Denitions.] In this section: (1) Request means a record of a type described in paragraph (2), (3), or (4).
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(2) Request for an accounting means a record authenticated by a debtor requesting that the recipient provide an accounting of the unpaid obligations secured by collateral and reasonably identifying the transaction or relationship that is the subject of the request. (3) Request regarding a list of collateral means a record authenticated by a debtor requesting that the recipient approve or correct a list of what the debtor believes to be the collateral securing an obligation and reasonably identifying the transaction or relationship that is the subject of the request. (4) Request regarding a statement of account means a record authenticated by a debtor requesting that the recipient approve or correct a statement indicating what the debtor believes to be the aggregate amount of unpaid obligations secured by collateral as of a specied date and reasonably identifying the transaction or relationship that is the subject of the request. (b) [Duty to respond to requests.] Subject to subsections (c), (d), (e), and (f), a secured party, other than a buyer of accounts, chattel paper, payment intangibles, or promissory notes or a consignor, shall comply with a request within 14 days after receipt: (1) in the case of a request for an accounting, by authenticating and sending to the debtor an accounting; and (2) in the case of a request regarding a list of collateral or a request regarding a statement of account, by authenticating and sending to the debtor an approval or correction. (c) [Request regarding list of collateral; statement concerning type of collateral.] A secured party that claims a security interest in all of a particular type of collateral owned by the debtor may comply with a request regarding a list of collateral by sending to the debtor an authenticated record including a statement to that eect within 14 days after receipt. (d) [Request regarding list of collateral; no interest claimed.] A person that receives a request regarding a list of collateral, claims no interest in the collateral when it receives the request, and claimed an interest in the collateral at an earlier time shall comply with the request within 14 days after receipt by sending to the debtor an authenticated record: (1) disclaiming any interest in the collateral; and (2) if known to the recipient, providing the name and mailing address of any assignee of or successor to the recipient's interest in the collateral. (e) [Request for accounting or regarding statement of account; no interest in obligation claimed.] A person that receives a request for an accounting or a request regarding a statement of account, claims no interest in the obligations when it receives the request, and claimed an interest in the obligations at an earlier time shall comply with the request within 14 days after receipt by sending to the debtor an authenticated record: (1) disclaiming any interest in the obligations; and (2) if known to the recipient, providing the name and mailing address
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of any assignee of or successor to the recipient's interest in the obligations. (f) [Charges for responses.] A debtor is entitled without charge to one response to a request under this section during any six-month period. The secured party may require payment of a charge not exceeding $25 for each additional response. As amended in 1999.
See Appendix P for material relating to changes made in text in 1999.

Ocial Comment
1. Source. Former Section 9-208. 2. Scope and Purpose. This section provides a procedure whereby a debtor may obtain from a secured party information about the secured obligation and the collateral in which the secured party may claim a security interest. It claries and resolves some of the issues that arose under former Section 9-208 and makes information concerning the secured indebtedness readily available to debtors, both before and after default. It applies to agricultural lien transactions (see the denitions of debtor, secured party, and collateral in Section 9-102), but generally not to sales of receivables. See subsection (b). 3. Requests by Debtors Only. A nancing statement led under Part 5 may disclose only that a secured party may have a security interest in specied types of collateral. In most cases the nancing statement will contain no indication of the obligation (if any) secured, whether any security interest actually exists, or the particular property subject to a security interest. Because creditors of and prospective purchasers from a debtor may have legitimate needs for more detailed information, it is necessary to provide a procedure under which the secured party will be required to provide information. On the other hand, the secured party should not be under a duty to disclose any details of the debtor's nancial aairs to any casual inquirer or competitor who may inquire. For this reason, this section gives the right to request information to the debtor only. The debtor may submit a request in connection with negotiations with subsequent creditors and purchasers, as well as for the purpose of determining the status of its credit relationship or demonstrating which of its assets are free of a security interest. 4. Permitted Types of Requests for Information. Subsection (a) contemplates that a debtor may request three types of information by submitting three types of requests to the secured party. First, the debtor may request the secured party to prepare and send an accounting (dened in Section 9-102). Second, the debtor may submit to the secured party a list of collateral for the secured party's approval or correction. Third, the debtor may submit to the secured party for its approval or correction a statement of the aggregate amount of unpaid secured obligations. Inasmuch as a secured party may have numerous transactions and relationships with a debtor, each request must identify the relevant transactions or relationships. Subsections (b) and (c) require the secured party to respond to a request within 14 days following receipt of the request. 5. Recipients Claiming No Interest in the Transaction. A debtor may be unaware that a creditor with whom it has dealt has assigned its security interest or the secured obligation. Subsections (d) and (e) impose upon recipients of requests under this section the duty to inform the debtor that they claim no interest in the collateral or secured obligation, respectively, and to inform the debtor of the name and mailing address of any known assignee or successor. As under subsections (b) and (c), a response to a request under subsection (d) or (e) is due 14 days following receipt. 6. Waiver; Remedy for Failure to Comply. The debtor's rights under this section may not be waived or varied. See Section 9-602(2). Section 9-625 sets forth the remedies for noncompliance with the requirements of this section. 7. Limitation on Free Responses to Requests. Under subsection (f), during a sixmonth period a debtor is entitled to receive from the secured party one free response to a request. The debtor is not entitled to a free response to each type of request (i.e., three free responses) during a six-month period.

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.
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PART 3. PERFECTION AND PRIORITY

[SUBPART 1. LAW GOVERNING PERFECTION AND PRIORITY] 9-301. Law Governing Perfection and Priority of Security Interests. Except as otherwise provided in Sections 9-303 through 9-306, the following rules determine the law governing perfection, the eect of perfection or nonperfection, and the priority of a security interest in collateral: (1) Except as otherwise provided in this section, while a debtor is located in a jurisdiction, the local law of that jurisdiction governs perfection, the eect of perfection or nonperfection, and the priority of a security interest in collateral. (2) While collateral is located in a jurisdiction, the local law of that jurisdiction governs perfection, the eect of perfection or nonperfection, and the priority of a possessory security interest in that collateral. (3) Except as otherwise provided in paragraph (4), while tangible negotiable documents, goods, instruments, money, or tangible chattel paper is located in a jurisdiction, the local law of that jurisdiction governs: (A) perfection of a security interest in the goods by ling a xture ling; (B) perfection of a security interest in timber to be cut; and (C) the eect of perfection or nonperfection and the priority of a nonpossessory security interest in the collateral. (4) The local law of the jurisdiction in which the wellhead or minehead is located governs perfection, the eect of perfection or nonperfection, and the priority of a security interest in as-extracted collateral. As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Source. Former Sections 9-103(1)(a), (b), 9-103(3)(a), (b), 9-103(5), substantially modied. 2. Scope of This Subpart. Part 3, Subpart 1 (Sections 9-301 through 9-307) contains choice-of-law rules similar to those of former Section 9-103. Former Section 9-103 generally addresses which State's law governs perfection and the eect of perfection or non-perfection of security interests. See, e.g., former Section 9-103(1)(b). This Article follows the broader and more precise formulation in former Section 9-103(6)(b), which was revised in connection with the promulgation of Revised Article 8 in 1994: perfection, the eect of perfection or non-perfection, and the priority of security interests. Priority, in this context, subsumes all of the rules in Part 3, including cut o or take free rules such as Sections 9-317(b), (c), and (d), 9-320(a), (b), and (d), and 9-332. This subpart does not address choice of law for other purposes. For example, the law applicable to issues such as attachment, validity, characterization (e.g., true lease or security interest), and enforcement is governed by the rules in Section 1-105; that governing law typically is specied in the same agreement that contains the security agreement. And, another jurisdiction's law may govern other thirdparty matters addressed in this Article. See Section 9-401, Comment 3. 3. Scope of Referral. In designating the jurisdiction whose law governs, this Article directs the court to apply only the substantive (local) law of a particular jurisdiction and not its choice-of-law rules. Example 1: Litigation over the priority of a security interest in accounts arises in 894

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State X. State X has adopted the ocial text of this Article, which provides that priority is determined by the local law of the jurisdiction in which the debtor is located. See Section 9-301(1). The debtor is located in State Y. Even if State Y has retained former Article 9 or enacted a nonuniform choice-of-law rule (e.g., one that provides that perfection is governed by the law of State Z), a State X court should look only to the substantive law of State Y and disregard State Y's choice-of-law rule. State Y's substantive law (e.g., its Section 9-501) provides that nancing statements should be led in a ling oce in State Y. Note, however, that if the identical perfection issue were to be litigated in State Y, the court would look to State Y's former Section 9-103 or nonuniform 9-301 and conclude that a ling in State Y is ineective. Example 2: In the preceding Example, assume that State X has adopted the ocial text of this Article, and State Y has adopted a nonuniform Section 9-301(1) under which perfection is governed by the whole law of State X, including its choice-of-law rules. If litigation occurs in State X, the court should look to the substantive law of State Y, which provides that nancing statements are to be led in a ling oce in State Y. If litigation occurs in State Y, the court should look to the law of State X, whose choice-of-law rule requires that the court apply the substantive law of State Y. Thus, regardless of the jurisdiction in which the litigation arises, the nancing statement should be led in State Y. 4. Law Governing Perfection: General Rule. Paragraph (1) contains the general rule: the law governing perfection of security interests in both tangible and intangible collateral, whether perfected by ling or automatically, is the law of the jurisdiction of the debtor's location, as determined under Section 9-307. Paragraph (1) substantially simplies the choice-of-law rules. Former Section 9-103 contained dierent choice-of-law rules for dierent types of collateral. Under Section 9-301(1), the law of a single jurisdiction governs perfection with respect to most types of collateral, both tangible and intangible. Paragraph (1) eliminates the need for former Section 9-103(1)(c), which concerned purchase-money security interests in tangible collateral that is intended to move from one jurisdiction to the other. It is likely to reduce the frequency of cases in which the governing law changes after a nancing statement is properly led. (Presumably, debtors change their own location less frequently than they change the location of their collateral.) The approach taken in paragraph (1) also eliminates some dicult priority issues and the need to distinguish between mobile and ordinary goods, and it reduces the number of ling oces in which secured parties must le or search when collateral is located in several jurisdictions. 5. Law Governing Perfection: Exceptions. The general rule is subject to several exceptions. It does not apply to goods covered by a certicate of title (see Section 9-303), deposit accounts (see Section 9-304), investment property (see Section 9-305), or letter-ofcredit rights (see Section 9-306). Nor does it apply to possessory security interests, i.e., security interests that the secured party has perfected by taking possession of the collateral (see paragraph (2)), security interests perfected by ling a xture ling (see subparagraph (3)(A)), security interests in timber to be cut (subparagraph (3)(B)), or security interests in as-extracted collateral (see paragraph (4)). a. Possessory Security Interests. Paragraph (2) applies to possessory security interests and provides that perfection is governed by the local law of the jurisdiction in which the collateral is located. This is the rule of former Section 9-103(1)(b), except paragraph (2) eliminates the troublesome last event test of former law. The distinction between nonpossessory and possessory security interests creates the potential for the same jurisdiction to apply two dierent choice-of-law rules to determine perfection in the same collateral. For example, were a secured party in possession of an instrument or a tangible document to relinquish possession in reliance on temporary perfection, the applicable law immediately would change from that of the location of the collateral to that of the location of the debtor. The applicability of two dierent choice-oflaw rules for perfection is unlikely to lead to any material practical problems. The perfection rules of one Article 9 jurisdiction are likely to be identical to those of another. Moreover, under paragraph (3), the relative priority of competing security interests in tangible collateral is resolved by reference to the law of the jurisdiction in which the collateral is located, regardless of how the security interests are perfected. b. Fixtures. Application of the general rule in paragraph (1) to perfection of a security interest in xtures would yield strange results. For example, perfection of a security inter895

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est in xtures located in Arizona and owned by a Delaware corporation would be governed by the law of Delaware. Although Delaware law would send one to a ling oce in Arizona for the place to le a nancing statement as a xture ling, see Section 9-501, Delaware law would not take account of local, nonuniform, real-property ling and recording requirements that Arizona law might impose. For this reason, paragraph (3)(A) contains a special rule for security interests perfected by a xture ling; the law of the jurisdiction in which the xtures are located governs perfection, including the formal requisites of a xture ling. Under paragraph (3)(C), the same law governs priority. Fixtures are goods as dened in Section 9-102. c. Timber to Be Cut. Application of the general rule in paragraph (1) to perfection of a security interest in timber to be cut would yield undesirable results analogous to those described with respect to xtures. Paragraph (3)(B) adopts a similar solution: perfection is governed by the law of the jurisdiction in which the timber is located. As with xtures, under paragraph (3)(C), the same law governs priority. Timber to be cut also is goods as dened in Section 9-102. Paragraph (3)(B) applies only to timber to be cut, not to timber that has been cut. Consequently, once the timber is cut, the general choice-of-law rule in paragraph (1) becomes applicable. To ensure continued perfection, a secured party should le in both the jurisdiction in which the timber to be cut is located and in the state where the debtor is located. The former ling would be with the oce in which a real property mortgage would be led, and the latter would be a central ling. See Section 9-501. d. As-Extracted Collateral. Paragraph (4) adopts the rule of former Section 9-103(5) with respect to certain security interests in minerals and related accounts. Like security interests in xtures perfected by ling a xture ling, security interests in minerals that are as-extracted collateral are perfected by ling in the oce designated for the ling or recording of a mortgage on the real property. For the same reasons, the law governing perfection and priority is the law of the jurisdiction in which the wellhead or minehead is located. 6. Change in Law Governing Perfection. When the debtor changes its location to another jurisdiction, the jurisdiction whose law governs perfection under paragraph (1) changes, as well. Similarly, the law governing perfection of a possessory security interest in collateral under paragraph (2) changes when the collateral is removed to another jurisdiction. Nevertheless, these changes will not result in an immediate loss of perfection. See Section 9-316(a), (b). 7. Law Governing Eect of Perfection and Priority: Goods, Documents, Instruments, Money, Negotiable Documents, and Tangible Chattel Paper. Under former Section 9-103, the law of a single jurisdiction governed both questions of perfection and those of priority. This Article generally adopts that approach. See paragraph (1). But the approach may create problems if the debtor and collateral are located in dierent jurisdictions. For example, assume a security interest in equipment located in Pennsylvania is perfected by ling in Illinois, where the debtor is located. If the law of the jurisdiction in which the debtor is located were to govern priority, then the priority of an execution lien on goods located in Pennsylvania would be governed by rules enacted by the Illinois legislature. To address this problem, paragraph (3)(C) divorces questions of perfection from questions of the eect of perfection or nonperfection and the priority of a security interest. Under paragraph (3)(C), the rights of competing claimants to tangible collateral are resolved by reference to the law of the jurisdiction in which the collateral is located. A similar bifurcation applied to security interests in investment property under former Section 9-103(6). See Section 9-305. Paragraph (3)(C) applies the law of the situs to determine priority only with respect to goods (including xtures), instruments, money, tangible negotiable documents, and tangible chattel paper. Compare former Section 9-103(1), which applied the law of the location of the collateral to documents, instruments, and ordinary (as opposed to mobile) goods. This Article does not distinguish among types of goods. The ordinary/mobile goods distinction appears to address concerns about where to le and search, rather than concerns about priority. There is no reason to preserve this distinction under the bifurcated approach. Particularly serious confusion may arise when the choice-of-law rules of a given jurisdiction result in each of two competing security interests in the same collateral being governed by a dierent priority rule. The potential for this confusion existed under former Section 9-103(4) with respect to chattel paper: Perfection by possession was governed by the law of 896

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the location of the paper, whereas perfection by ling was governed by the law of the location of the debtor. Consider the mess that would have been created if the language or interpretation of former Section 9-308 were to dier in the two relevant States, or if one of the relevant jurisdictions (e.g., a foreign country) had not adopted Article 9. The potential for confusion could have been exacerbated when a secured party perfected both by taking possession in the State where the collateral is located (State A) and by ling in the State where the debtor is located (State B)a common practice for some chattel paper nancers. By providing that the law of the jurisdiction in which the collateral is located governs priority, paragraph (3) substantially diminishes this problem. 8. Non-U.S. Debtors. This Article applies the same choice-of-law rules to all debtors, foreign and domestic. For example, it adopts the bifurcated approach for determining the law applicable to security interests in goods and other tangible collateral. See Comment 5.a., above. The Article contains a new rule specifying the location of non-U.S. debtors for purposes of this Part. The rule appears in Section 9-307 and is explained in the Comments to that section. Former Section 9-103(3)(c), which contained a special choice-of-law rule governing security interests created by debtors located in a non-U.S. jurisdiction, proved unsatisfactory and was deleted.

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

9-302. Law Governing Perfection and Priority of Agricultural Liens. While farm products are located in a jurisdiction, the local law of that jurisdiction governs perfection, the eect of perfection or nonperfection, and the priority of an agricultural lien on the farm products. Ocial Comment
1. Source. New. 2. Agricultural Liens. This section provides choice-of-law rules for agricultural liens on farm products. Perfection, the eect of perfection or nonperfection, and priority all are governed by the law of the jurisdiction in which the farm products are located. Other choice-of-law rules, including Section 1-105, determine which jurisdiction's law governs other matters, such as the secured party's rights on default. See Section 9-301, Comment 2. Inasmuch as no agricultural lien on proceeds arises under this Article, this section does not expressly apply to proceeds of agricultural liens. However, if another statute creates an agricultural lien on proceeds, it may be appropriate for courts to apply the choice-of-law rule in this section to determine priority in the proceeds.

9-303. Law Governing Perfection and Priority of Security Interests in Goods Covered by a Certicate of Title. (a) [Applicability of section.] This section applies to goods covered by a certicate of title, even if there is no other relationship between the jurisdiction under whose certicate of title the goods are covered and the goods or the debtor. (b) [When goods covered by certicate of title.] Goods become covered by a certicate of title when a valid application for the certicate of title and the applicable fee are delivered to the appropriate authority. Goods cease to be covered by a certicate of title at the earlier of the time the certicate of title ceases to be eective under the law of the issuing jurisdiction or the time the goods become covered subsequently by a certicate of title issued by another jurisdiction. (c) [Applicable law.] The local law of the jurisdiction under whose certicate of title the goods are covered governs perfection, the eect of perfec897

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tion or nonperfection, and the priority of a security interest in goods covered by a certicate of title from the time the goods become covered by the certicate of title until the goods cease to be covered by the certicate of title. Ocial Comment
1. Source. Former Section 9-103(2)(a), (b), substantially revised. 2. Scope of This Section. This section applies to goods covered by a certicate of title. The new denition of certicate of title in Section 9-102 makes clear that this section applies not only to certicate-of-title statutes under which perfection occurs upon notation of the security interest on the certicate but also to those that contemplate notation but provide that perfection is achieved by another method, e.g., delivery of designated documents to an ocial. Subsection (a), which is new, makes clear that this section applies to certicates of a jurisdiction having no other contacts with the goods or the debtor. This result comports with most of the reported cases on the subject and with contemporary business practices in the trucking industry. 3. Law Governing Perfection and Priority. Subsection (c) is the basic choice-of-law rule for goods covered by a certicate of title. Perfection and priority of a security interest are governed by the law of the jurisdiction under whose certicate of title the goods are covered from the time the goods become covered by the certicate of title until the goods cease to be covered by the certicate of title. Normally, under the law of the relevant jurisdiction, the perfection step would consist of compliance with that jurisdiction's certicate-of-title statute and a resulting notation of the security interest on the certicate of title. See Section 9-311(b). In the typical case of an automobile or over-the-road truck, a person who wishes to take a security interest in the vehicle can ascertain whether it is subject to any security interests by looking at the certificate of title. But certicates of title cover certain types of goods in some States but not in others. A secured party who does not realize this may extend credit and attempt to perfect by ling in the jurisdiction in which the debtor is located. If the goods had been titled in another jurisdiction, the lender would be unperfected. Subsection (b) explains when goods become covered by a certicate of title and when they cease to be covered. Goods may become covered by a certicate of title, even though no certicate of title has issued. Former Section 9-103(2)(b) provided that the law of the jurisdiction issuing the certicate ceases to apply upon surrender of the certicate. This Article eliminates the concept of surrender. However, if the certicate is surrendered in conjunction with an appropriate application for a certicate to be issued by another jurisdiction, the law of the original jurisdiction ceases to apply because the goods became covered subsequently by a certicate of title from another jurisdiction. Alternatively, the law of the original jurisdiction ceases to apply when the certicate ceases to be eective under the law of that jurisdiction. Given the diversity in certicate-of-title statutes, the term eective is not dened. 4. Continued Perfection. The fact that the law of one State ceases to apply under subsection (b) does not mean that a security interest perfected under that law becomes unperfected automatically. In most cases, the security interest will remain perfected. See Section 9-316(d), (e). Moreover, a perfected security interest may be subject to defeat by certain buyers and secured parties. See Section 9-337. 5. Inventory. Compliance with a certicate-of-title statute generally is not the method of perfecting security interests in inventory. Section 9-311(d) provides that a security interest created in inventory held by a person in the business of selling goods of that kind is subject to the normal ling rules; compliance with a certicate-of-title statute is not necessary or eective to perfect the security interest. Most certicate-of-title statutes are in accord. The following example explains the subtle relationship between this rule and the choiceof-law rules in Section 9-303 and former Section 9-103(2): Example: Goods are located in State A and covered by a certicate of title issued under the law of State A. The State A certicate of title is clean; it does not reect a security interest. Owner takes the goods to State B and sells (trades in) the goods to Dealer, who is in the business of selling goods of that kind and is located (within the meaning of Section 9-307) in State B. As is customary, Dealer retains the duly assigned State A certicate of title pending resale of the goods. Dealer's inventory nancer, SP, 898

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obtains a security interest in the goods under its after-acquired property clause. Under Section 9-311(d) of both State A and State B, Dealer's inventory nancer, SP, must perfect by ling instead of complying with a certicate-of-title statute. If Section 9-303 were read to provide that the law applicable to perfection of SP's security interest is that of State A, because the goods are covered by a State A certicate, then SP would be required to le in State A under State A's Section 9-501. That result would be anomalous, to say the least, since the principle underlying Section 9-311(d) is that the inventory should be treated as ordinary goods. Section 9-303 (and former Section 9-103(2)) should be read as providing that the law of State B, not State A, applies. A court looking to the forum's Section 9-303(a) would nd that Section 9-303 applies only if two conditions are met: (i) the goods are covered by the certicate as explained in Section 9-303(b), i.e., application had been made for a State (here, State A) to issue a certicate of title covering the goods and (ii) the certicate is a certicate of title as dened in Section 9-102, i.e., a statute provides for the security interest in question to be indicated on the certicate as a condition or result of the security interest's obtaining priority over the rights of a lien creditor. Stated otherwise, Section 9-303 applies only when compliance with a certicate-of-title statute, and not ling, is the appropriate method of perfection. Under the law of State A, for purposes of perfecting SP's security interest in the dealer's inventory, the proper method of perfection is lingnot compliance with State A's certicate-of-title statute. For that reason, the goods are not covered by a certicate of title, and the second condition is not met. Thus, Section 9-303 does not apply to the goods. Instead, Section 9-301 applies, and the applicable law is that of State B, where the debtor (dealer) is located. 6. External Constraints on This Section. The need to coordinate Article 9 with a variety of nonuniform certicate-of-title statutes, the need to provide rules to take account of situations in which multiple certicates of title are outstanding with respect to particular goods, and the need to govern the transition from perfection by ling in one jurisdiction to perfection by notation in another all create pressure for a detailed and complex set of rules. In an eort to minimize complexity, this Article does not attempt to coordinate Article 9 with the entire array of certicate-of-title statutes. In particular, Sections 9-303, 9-311, and 9-316(d) and (e) assume that the certicate-of-title statutes to which they apply do not have relation-back provisions (i.e., provisions under which perfection is deemed to occur at a time earlier than when the perfection steps actually are taken). A Legislative Note to Section 9-311 recommends the elimination of relation-back provisions in certicate-of-title statutes aecting perfection of security interests. Ideally, at any given time, only one certicate of title is outstanding with respect to particular goods. In fact, however, sometimes more than one jurisdiction issues more than one certicate of title with respect to the same goods. This situation results from defects in certicate-of-title laws and the interstate coordination of those laws, not from deciencies in this Article. As long as the possibility of multiple certicates of title remains, the potential for innocent parties to suer losses will continue. At best, this Article can identify clearly which innocent parties will bear the losses in familiar fact patterns.

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

9-304. Law Governing Perfection and Priority of Security Interests in Deposit Accounts. (a) [Law of bank's jurisdiction governs.] The local law of a bank's jurisdiction governs perfection, the eect of perfection or nonperfection, and the priority of a security interest in a deposit account maintained with that bank. (b) [Bank's jurisdiction.] The following rules determine a bank's jurisdiction for purposes of this part: (1) If an agreement between the bank and its customer governing the deposit account expressly provides that a particular jurisdiction is the
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bank's jurisdiction for purposes of this part, this article, or [the Uniform Commercial Code], that jurisdiction is the bank's jurisdiction. (2) If paragraph (1) does not apply and an agreement between the bank and its customer governing the deposit account expressly provides that the agreement is governed by the law of a particular jurisdiction, that jurisdiction is the bank's jurisdiction. (3) If neither paragraph (1) nor paragraph (2) applies and an agreement between the bank and its customer governing the deposit account expressly provides that the deposit account is maintained at an oce in a particular jurisdiction, that jurisdiction is the bank's jurisdiction. (4) If none of the preceding paragraphs applies, the bank's jurisdiction is the jurisdiction in which the oce identied in an account statement as the oce serving the customer's account is located. (5) If none of the preceding paragraphs applies, the bank's jurisdiction is the jurisdiction in which the chief executive oce of the bank is located. Ocial Comment
1. Source. New; derived from Section 8-110(e) and former Section 9-103(6). 2. Deposit Accounts. Under this section, the law of the bank's jurisdiction governs perfection and priority of a security interest in deposit accounts. Subsection (b) contains rules for determining the bank's jurisdiction. The substance of these rules is substantially similar to that of the rules determining the security intermediary's jurisdiction under former Section 8-110(e), except that subsection (b)(1) provides more exibility than the analogous provision in former Section 8-110(e)(1). Subsection (b)(1) permits the parties to choose the law of one jurisdiction to govern perfection and priority of security interests and a different governing law for other purposes. The parties' choice is eective, even if the jurisdiction whose law is chosen bears no relationship to the parties or the transaction. Section 8-110(e)(1) has been conformed to subsection (b)(1) of this section, and Section 9-305(b)(1), concerning a commodity intermediary's jurisdiction, makes a similar departure from former Section 9-103(6)(e)(i). 3. Change in Law Governing Perfection. When the bank's jurisdiction changes, the jurisdiction whose law governs perfection under subsection (a) changes, as well. Nevertheless, the change will not result in an immediate loss of perfection. See Section 9-316(f), (g).

9-305. Law Governing Perfection and Priority of Security Interests in Investment Property. (a) [Governing law: general rules.] Except as otherwise provided in subsection (c), the following rules apply: (1) While a security certicate is located in a jurisdiction, the local law of that jurisdiction governs perfection, the eect of perfection or nonperfection, and the priority of a security interest in the certicated security represented thereby. (2) The local law of the issuer's jurisdiction as specied in Section 8-110(d) governs perfection, the eect of perfection or nonperfection, and the priority of a security interest in an uncerticated security. (3) The local law of the securities intermediary's jurisdiction as specied in Section 8-110(e) governs perfection, the eect of perfection or nonperfection, and the priority of a security interest in a security entitlement or securities account. (4) The local law of the commodity intermediary's jurisdiction governs perfection, the eect of perfection or nonperfection, and the priority of a security interest in a commodity contract or commodity account.
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(b) [Commodity intermediary's jurisdiction.] The following rules determine a commodity intermediary's jurisdiction for purposes of this part: (1) If an agreement between the commodity intermediary and commodity customer governing the commodity account expressly provides that a particular jurisdiction is the commodity intermediary's jurisdiction for purposes of this part, this article, or [the Uniform Commercial Code], that jurisdiction is the commodity intermediary's jurisdiction. (2) If paragraph (1) does not apply and an agreement between the commodity intermediary and commodity customer governing the commodity account expressly provides that the agreement is governed by the law of a particular jurisdiction, that jurisdiction is the commodity intermediary's jurisdiction. (3) If neither paragraph (1) nor paragraph (2) applies and an agreement between the commodity intermediary and commodity customer governing the commodity account expressly provides that the commodity account is maintained at an oce in a particular jurisdiction, that jurisdiction is the commodity intermediary's jurisdiction. (4) If none of the preceding paragraphs applies, the commodity intermediary's jurisdiction is the jurisdiction in which the oce identied in an account statement as the oce serving the commodity customer's account is located. (5) If none of the preceding paragraphs applies, the commodity intermediary's jurisdiction is the jurisdiction in which the chief executive oce of the commodity intermediary is located. (c) [When perfection governed by law of jurisdiction where debtor located.] The local law of the jurisdiction in which the debtor is located governs: (1) perfection of a security interest in investment property by ling; (2) automatic perfection of a security interest in investment property created by a broker or securities intermediary; and (3) automatic perfection of a security interest in a commodity contract or commodity account created by a commodity intermediary. Ocial Comment
1. Source. Former Section 9-103(6). 2. Investment Property: General Rules. This section species choice-of-law rules for perfection and priority of security interests in investment property. Subsection (a)(1) covers security interests in certicated securities. Subsection (a)(2) covers security interests in uncerticated securities. Subsection (a)(3) covers security interests in security entitlements and securities accounts. Subsection (a)(4) covers security interests in commodity contracts and commodity accounts. The approach of each of these paragraphs is essentially the same. They identify the jurisdiction's law that governs questions of perfection and priority by using the same principles that Article 8 uses to determine other questions concerning that form of investment property. Thus, for certicated securities, the law of the jurisdiction in which the certicate is located governs. Cf. Section 8-110(c). For uncerticated securities, the law of the issuer's jurisdiction governs. Cf. Section 8-110(a). For security entitlements and securities accounts, the law of the securities intermediary's jurisdiction governs. Cf. Section 8-110(b). For commodity contracts and commodity accounts, the law of the commodity intermediary's jurisdiction governs. Because commodity contracts and commodity accounts are not governed by Article 8, subsection (b) contains rules that specify the commodity intermediary's jurisdiction. These are analogous to the rules in Section 8-110(e) 901

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specifying a securities intermediary's jurisdiction. Subsection (b)(1) aords the parties greater exibility than did former Section 9-103(6)(3). See also Section 9-304(b) (bank's jurisdiction); Revised Section 8-110(e)(1) (securities intermediary's jurisdiction). 3. Investment Property: Exceptions. Subsection (c) establishes an exception to the general rules set out in subsection (a). It provides that perfection of a security interest by ling, automatic perfection of a security interest in investment property created by a debtor who is a broker or securities intermediary (see Section 9-309(10)), and automatic perfection of a security interest in a commodity contract or commodity account of a debtor who is a commodity intermediary (see Section 9-309(11)) are governed by the law of the jurisdiction in which the debtor is located, as determined under Section 9-307. 4. Examples: The following examples illustrate the rules in this section: Example 1: A customer residing in New Jersey maintains a securities account with Able & Co. The agreement between the customer and Able species that it is governed by Pennsylvania law but expressly provides that the law of California is Able's jurisdiction for purposes of the Uniform Commercial Code. Through the account the customer holds securities of a Massachusetts corporation, which Able holds through a clearing corporation located in New York. The customer obtains a margin loan from Able. Subsection (a)(3) provides that California lawthe law of the securities intermediary's jurisdictiongoverns perfection and priority of the security interest, even if California has no other relationship to the parties or the transaction. Example 2: A customer residing in New Jersey maintains a securities account with Able & Co. The agreement between the customer and Able species that it is governed by Pennsylvania law. Through the account the customer holds securities of a Massachusetts corporation, which Able holds through a clearing corporation located in New York. The customer obtains a loan from a lender located in Illinois. The lender takes a security interest and perfects by obtaining an agreement among the debtor, itself, and Able, which satises the requirement of Section 8-106(d)(2) to give the lender control. Subsection (a)(3) provides that Pennsylvania lawthe law of the securities intermediary's jurisdictiongoverns perfection and priority of the security interest, even if Pennsylvania has no other relationship to the parties or the transaction. Example 3: A customer residing in New Jersey maintains a securities account with Able & Co. The agreement between the customer and Able species that it is governed by Pennsylvania law. Through the account, the customer holds securities of a Massachusetts corporation, which Able holds through a clearing corporation located in New York. The customer borrows from SP-1, and SP-1 les a nancing statement in New Jersey. Later, the customer obtains a loan from SP-2. SP-2 takes a security interest and perfects by obtaining an agreement among the debtor, itself, and Able, which satises the requirement of Section 8-106(d)(2) to give the SP-2 control. Subsection (c) provides that perfection of SP-1's security interest by ling is governed by the location of the debtor, so the ling in New Jersey was appropriate. Subsection (a)(3), however, provides that Pennsylvania lawthe law of the securities intermediary's jurisdictiongoverns all other questions of perfection and priority. Thus, Pennsylvania law governs perfection of SP-2's security interest, and Pennsylvania law also governs the priority of the security interests of SP-1 and SP-2. 5. Change in Law Governing Perfection. When the issuer's jurisdiction, the securities intermediary's jurisdiction, or commodity intermediary's jurisdiction changes, the jurisdiction whose law governs perfection under subsection (a) changes, as well. Similarly, the law governing perfection of a possessory security interest in a certicated security changes when the collateral is removed to another jurisdiction, see subsection (a)(1), and the law governing perfection by ling changes when the debtor changes its location. See subsection (c). Nevertheless, these changes will not result in an immediate loss of perfection. See Section 9-316.

9-306. Law Governing Perfection and Priority of Security Interests in Letter-of-Credit Rights. (a) [Governing law: issuer's or nominated person's jurisdiction.] Subject to subsection (c), the local law of the issuer's jurisdiction or a nominated person's jurisdiction governs perfection, the eect of perfection or nonperfection, and the priority of a security interest in a letter-of-credit
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right if the issuer's jurisdiction or nominated person's jurisdiction is a State. (b) [Issuer's or nominated person's jurisdiction.] For purposes of this part, an issuer's jurisdiction or nominated person's jurisdiction is the jurisdiction whose law governs the liability of the issuer or nominated person with respect to the letter-of-credit right as provided in Section 5-116. (c) [When section not applicable.] This section does not apply to a security interest that is perfected only under Section 9-308(d). Ocial Comment
1. Source. New; derived in part from Section 8-110(e) and former Section 9-103(6). 2. Sui Generis Treatment. This section governs the applicable law for perfection and priority of security interests in letter-of-credit rights, other than a security interest perfected only under Section 9-308(d) (i.e., as a supporting obligation). The treatment differs substantially from that provided in Section 9-304 for deposit accounts. The basic rule is that the law of the issuer's or nominated person's (e.g., conrmer's) jurisdiction, derived from the terms of the letter of credit itself, controls perfection and priority, but only if the issuer's or nominated person's jurisdiction is a State, as dened in Section 9-102. If the issuer's or nominated person's jurisdiction is not a State, the baseline rule of Section 9-301 appliesperfection and priority are governed by the law of the debtor's location, determined under Section 9-307. Export transactions typically involve a foreign issuer and a domestic nominated person, such as a conrmer, located in a State. The principal goal of this section is to reduce the likelihood that perfection and priority would be governed by the law of a foreign jurisdiction in a transaction that is essentially domestic from the standpoint of the debtor-beneciary, its creditors, and a domestic nominated person. 3. Issuer's or Nominated Person's Jurisdiction. Subsection (b) defers to the rules established under Section 5-116 for determination of an issuer's or nominated person's jurisdiction. Example: An Italian bank issues a letter of credit that is conrmed by a New York bank. The beneciary is a Connecticut corporation. The letter of credit provides that the issuer's liability is governed by Italian law, and the conrmation provides that the conrmer's liability is governed by the law of New York. Under Sections 9-306(b) and 5-116(a), Italy is the issuer's jurisdiction and New York is the conrmer's (nominated person's) jurisdiction. Because the conrmer's jurisdiction is a State, the law of New York governs perfection and priority of a security interest in the beneciary's letter-ofcredit right against the conrmer. See Section 9-306(a). However, because the issuer's jurisdiction is not a State, the law of that jurisdiction does not govern. See Section 9-306(a). Rather, the choice-of-law rule in Section 9-301(1) applies to perfection and priority of a security interest in the beneciary's letter-of-credit right against the issuer. Under that section, perfection and priority are governed by the law of the jurisdiction in which the debtor (beneciary) is located. That jurisdiction is Connecticut. See Section 9-307. 4. Scope of this Section. This section species only the law governing perfection, the effect of perfection or nonperfection, and priority of security interests. Section 5-116 species the law governing the liability of, and Article 5 (or other applicable law) deals with the rights and duties of, an issuer or nominated person. Perfection, nonperfection, and priority have no eect on those rights and duties. 5. Change in Law Governing Perfection. When the issuer's jurisdiction, or nominated person's jurisdiction changes, the jurisdiction whose law governs perfection under subsection (a) changes, as well. Nevertheless, this change will not result in an immediate loss of perfection. See Section 9-316(f), (g).

9-307. Location of Debtor. (a) [Place of business.] In this section, place of business means a place where a debtor conducts its aairs. (b) [Debtor's location: general rules.] Except as otherwise provided in this section, the following rules determine a debtor's location:
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(1) A debtor who is an individual is located at the individual's principal residence. (2) A debtor that is an organization and has only one place of business is located at its place of business. (3) A debtor that is an organization and has more than one place of business is located at its chief executive oce. (c) [Limitation of applicability of subsection (b).] Subsection (b) applies only if a debtor's residence, place of business, or chief executive oce, as applicable, is located in a jurisdiction whose law generally requires information concerning the existence of a nonpossessory security interest to be made generally available in a ling, recording, or registration system as a condition or result of the security interest's obtaining priority over the rights of a lien creditor with respect to the collateral. If subsection (b) does not apply, the debtor is located in the District of Columbia. (d) [Continuation of location: cessation of existence, etc.] A person that ceases to exist, have a residence, or have a place of business continues to be located in the jurisdiction specied by subsections (b) and (c). (e) [Location of registered organization organized under State law.] A registered organization that is organized under the law of a State is located in that State. (f) [Location of registered organization organized under federal law; bank branches and agencies.] Except as otherwise provided in subsection (i), a registered organization that is organized under the law of the United States and a branch or agency of a bank that is not organized under the law of the United States or a State are located: (1) in the State that the law of the United States designates, if the law designates a State of location; (2) in the State that the registered organization, branch, or agency designates, if the law of the United States authorizes the registered organization, branch, or agency to designate its State of location; or (3) in the District of Columbia, if neither paragraph (1) nor paragraph (2) applies. (g) [Continuation of location: change in status of registered organization.] A registered organization continues to be located in the jurisdiction specied by subsection (e) or (f) notwithstanding: (1) the suspension, revocation, forfeiture, or lapse of the registered organization's status as such in its jurisdiction of organization; or (2) the dissolution, winding up, or cancellation of the existence of the registered organization. (h) [Location of United States.] The United States is located in the District of Columbia. (i) [Location of foreign bank branch or agency if licensed in only one state.] A branch or agency of a bank that is not organized under the law of the United States or a State is located in the State in which the branch or agency is licensed, if all branches and agencies of the bank are licensed in only one State. (j) [Location of foreign air carrier.] A foreign air carrier under the Federal Aviation Act of 1958, as amended, is located at the designated of904

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ce of the agent upon which service of process may be made on behalf of the carrier. (k) [Section applies only to this part.] This section applies only for purposes of this part. Ocial Comment
1. Source. Former Section 9-103(3)(d), substantially revised. 2. General Rules. As a general matter, the location of the debtor determines the jurisdiction whose law governs perfection of a security interest. See Sections 9-301(1), 9-305(c). It also governs priority of a security interest in certain types of intangible collateral, such as accounts, electronic chattel paper, and general intangibles. This section determines the location of the debtor for choice-of-law purposes, but not for other purposes. See subsection (k). Subsection (b) states the general rules: An individual debtor is deemed to be located at the individual's principal residence with respect to both personal and business assets. Any other debtor is deemed to be located at its place of business if it has only one, or at its chief executive oce if it has more than one place of business. As used in this section, a place of business means a place where the debtor conducts its aairs. See subsection (a). Thus, every organization, even eleemosynary institutions and other organizations that do not conduct for prot business activities, has a place of business. Under subsection (d), a person who ceases to exist, have a residence, or have a place of business continues to be located in the jurisdiction determined by subsection (b). The term chief executive oce is not dened in this Section or elsewhere in the Uniform Commercial Code. Chief executive oce means the place from which the debtor manages the main part of its business operations or other aairs. This is the place where persons dealing with the debtor would normally look for credit information, and is the appropriate place for ling. With respect to most multi-state debtors, it will be simple to determine which of the debtor's oces is the chief executive oce. Even when a doubt arises, it would be rare that there could be more than two possibilities. A secured party in such a case may protect itself by perfecting under the law of each possible jurisdiction. Similarly, the term principal residence is not dened. If the security interest in question is a purchase-money security interest in consumer goods which is perfected upon attachment, see Section 9-309(1), the choice of law may make no dierence. In other cases, when a doubt arises, prudence may dictate perfecting under the law of each jurisdiction that might be the debtor's principal residence. The general rule is subject to several exceptions, each of which is discussed below. 3. Non-U.S. Debtors. Under the general rules of this section, a non-U.S. debtor normally would be located in a foreign jurisdiction and, as a consequence, foreign law would govern perfection. When foreign law aords no public notice of security interests, the general rule yields unacceptable results. Accordingly, subsection (c) provides that the normal rules for determining the location of a debtor (i.e., the rules in subsection (b)) apply only if they yield a location that is a jurisdiction whose law generally requires information concerning the existence of a nonpossessory security interest to be made generally available in a ling, recording, or registration system as a condition or result of the security interest's obtaining priority over the rights of a lien creditor with respect to the collateral. The phrase generally requires is meant to include legal regimes that generally require notice in a ling or recording system as a condition of perfecting nonpossessory security interests, but which permit perfection by another method (e.g., control, automatic perfection, temporary perfection) in limited circumstances. A jurisdiction that has adopted this Article or an earlier version of this Article is such a jurisdiction. If the rules in subsection (b) yield a jurisdiction whose law does not generally require notice in a ling or registration system, the debtor is located in the District of Columbia. Example 1: Debtor is an English corporation with 7 oces in the United States and its chief executive oce in London, England. Debtor creates a security interest in its accounts. Under subsection (b)(3), Debtor would be located in England. However, subsection (c) provides that subsection (b) applies only if English law generally conditions perfection on giving public notice in a ling, recording, or registration system. Otherwise, Debtor is located in the District of Columbia. Under Section 9-301(1), perfection, the ef905

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fect of perfection, and priority are governed by the law of the jurisdiction of the debtor's locationhere, England or the District of Columbia (depending on the content of English law). Example 2: Debtor is an English corporation with 7 oces in the United States and its chief executive oce in London, England. Debtor creates a security interest in equipment located in London. Under subsection (b)(3) Debtor would be located in England. However, subsection (c) provides that subsection (b) applies only if English law generally conditions perfection on giving public notice in a ling, recording, or registration system. Otherwise, Debtor is located in the District of Columbia. Under Section 9-301(1), perfection is governed by the law of the jurisdiction of the debtor's location, whereas, under Section 9-301(3), the law of the jurisdiction in which the collateral is locatedhere, Englandgoverns priority. The foregoing discussion assumes that each transaction bears an appropriate relation to the forum State. In the absence of an appropriate relation, the forum State's entire UCC, including the choice-of-law provisions in Article 9 (Sections 9-301 through 9-307), will not apply. See Section 9-109, Comment 9. 4. Registered Organizations Organized Under Law of a State. Under subsection (e), a registered organization (e.g., a corporation or limited partnership) organized under the law of a State (dened in Section 9-102) is located in its State of organization. Subsection (g) makes clear that events aecting the status of a registered organization, such as the dissolution of a corporation or revocation of its charter, do not aect its location for purposes of subsection (e). However, certain of these events may result in, or be accompanied by, a transfer of collateral from the registered organization to another debtor. This section does not determine whether a transfer occurs, nor does it determine the legal consequences of any transfer. Determining the registered organization-debtor's location by reference to the jurisdiction of organization could provide some important side benets for the ling systems. A jurisdiction could structure its ling system so that it would be impossible to make a mistake in a registered organization-debtor's name on a nancing statement. For example, a ler would be informed if a led record designated an incorrect corporate name for the debtor. Linking ling to the jurisdiction of organization also could reduce pressure on the system imposed by transactions in which registered organizations cease to existas a consequence of merger or consolidation, for example. The jurisdiction of organization might prohibit such transactions unless steps were taken to ensure that existing lings were reled against a successor or terminated by the secured party. 5. Registered Organizations Organized Under Law of United States; Branches and Agencies of Banks Not Organized Under Law of United States. Subsection (f) species the location of a debtor that is a registered organization organized under the law of the United States. It defers to the law of the United States, to the extent that that law determines, or authorizes the debtor to determine, the debtor's location. Thus, if the law of the United States designates a particular State as the debtor's location, that State is the debtor's location for purposes of this Article's choice-of-law rules. Similarly, if the law of the United States authorizes the registered organization to designate its State of location, the State that the registered organization designates is the State in which it is located for purposes of this Article's choice-of-law rules. In other cases, the debtor is located in the District of Columbia. In some cases, the law of the United States authorizes the registered organization to designate a main oce, home oce, or other comparable oce. See, e.g., 12 U.S.C. 22 and 1464(a); 12 C.F.R. 552.3. Designation of such an oce constitutes the designation of the State of location for purposes of Section 9-307(f)(2). In cases not governed by subsection (f) or (i), the location of a foreign bank is determined by subsections (b) and (c). 6. United States. To the extent that Article 9 governs (see Sections 1-105, 9-109(c)), the United States is located in the District of Columbia for purposes of this Article's choice-oflaw rules. See subsection (h). 7. Foreign Air Carriers. Subsection (j) follows former Section 9-103(3)(d). To the extent that it is applicable, the Convention on the International Recognition of Rights in Aircraft (Geneva Convention) supersedes state legislation on this subject, as set forth in Section 9-311(b), but some nations are not parties to that Convention. 906

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[SUBPART 2. PERFECTION] 9-308. When Security Interest or Agricultural Lien Is Perfected; Continuity of Perfection. (a) [Perfection of security interest.] Except as otherwise provided in this section and Section 9-309, a security interest is perfected if it has attached and all of the applicable requirements for perfection in Sections 9-310 through 9-316 have been satised. A security interest is perfected when it attaches if the applicable requirements are satised before the security interest attaches. (b) [Perfection of agricultural lien.] An agricultural lien is perfected if it has become eective and all of the applicable requirements for perfection in Section 9-310 have been satised. An agricultural lien is perfected when it becomes eective if the applicable requirements are satised before the agricultural lien becomes eective. (c) [Continuous perfection; perfection by dierent methods.] A security interest or agricultural lien is perfected continuously if it is originally perfected by one method under this article and is later perfected by another method under this article, without an intermediate period when it was unperfected. (d) [Supporting obligation.] Perfection of a security interest in collateral also perfects a security interest in a supporting obligation for the collateral. (e) [Lien securing right to payment.] Perfection of a security interest in a right to payment or performance also perfects a security interest in a security interest, mortgage, or other lien on personal or real property securing the right. (f) [Security entitlement carried in securities account.] Perfection of a security interest in a securities account also perfects a security interest in the security entitlements carried in the securities account. (g) [Commodity contract carried in commodity account.] Perfection of a security interest in a commodity account also perfects a security interest in the commodity contracts carried in the commodity account.
Legislative Note: Any statute conicting with subsection (e) must be made expressly subject to that subsection.

Ocial Comment
1. Source. Former Sections 9-303, 9-115(2). 2. General Rule. This Article uses the term attach to describe the point at which property becomes subject to a security interest. The requisites for attachment are stated in Section 9-203. When it attaches, a security interest may be either perfected or unperfected. Perfected means that the security interest has attached and the secured party has taken all the steps required by this Article as specied in Sections 9-310 through 9-316. A perfected security interest may still be or become subordinate to other interests. See, e.g., Sections 9-320, 9-322. However, in general, after perfection the secured party is protected against creditors and transferees of the debtor and, in particular, against any representative of creditors in insolvency proceedings instituted by or against the debtor. See, e.g., Section 9-317. Subsection (a) explains that the time of perfection is when the security interest has attached and any necessary steps for perfection, such as taking possession or ling, have been taken. The except clause refers to the perfection-upon-attachment rules appearing in Section 9-309. It also reects that other subsections of this section, e.g., subsection (d), 907

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contain automatic-perfection rules. If the steps for perfection have been taken in advance, as when the secured party les a nancing statement before giving value or before the debtor acquires rights in the collateral, then the security interest is perfected when it attaches. 3. Agricultural Liens. Subsection (b) is new. It describes the elements of perfection of an agricultural lien. 4. Continuous Perfection. The following example illustrates the operation of subsection (c): Example 1: Debtor, an importer, creates a security interest in goods that it imports and the documents of title that cover the goods. The secured party, Bank, takes possession of a tangible negotiable bill of lading covering certain imported goods and thereby perfects its security interest in the bill of lading and the goods. See Sections 9-313(a), 9-312(c)(1). Bank releases the bill of lading to the debtor for the purpose of procuring the goods from the carrier and selling them. Under Section 9-312(f), Bank continues to have a perfected security interest in the document and goods for 20 days. Bank les a nancing statement covering the collateral before the expiration of the 20-day period. Its security interest now continues perfected for as long as the ling is good. If the successive stages of Bank's security interest succeed each other without an intervening gap, the security interest is perfected continuously, and the date of perfection is when the security interest rst became perfected (i.e., when Bank received possession of the tangible bill of lading). If, however, there is a gap between stagesfor example, if Bank does not le until after the expiration of the 20-day period specied in Section 9-312(f) and leaves the collateral in the debtor's possessionthen, the chain being broken, the perfection is no longer continuous. The date of perfection would now be the date of ling (after expiration of the 20-day period). Bank's security interest would be vulnerable to any interests arising during the gap period which under Section 9-317 take priority over an unperfected security interest. 5. Supporting Obligations. Subsection (d) is new. It provides for automatic perfection of a security interest in a supporting obligation for collateral if the security interest in the collateral is perfected. This is unlikely to eect any change in the law prior to adoption of this Article. Example 2: Buyer is obligated to pay Debtor for goods sold. Buyer's president guarantees the obligation. Debtor creates a security interest in the right to payment (account) in favor of Lender. Under Section 9-203(f), the security interest attaches to Debtor's rights under the guarantee (supporting obligation). Under subsection (d), perfection of the security interest in the account constitutes perfection of the security interest in Debtor's rights under the guarantee. 6. Rights to Payment Secured by Lien. Subsection (e) is new. It deals with the situation in which a security interest is created in a right to payment that is secured by a security interest, mortgage, or other lien. Example 3: Owner gives to Mortgagee a mortgage on Blackacre to secure a loan. Owner's obligation to pay is evidenced by a promissory note. In need of working capital, Mortgagee borrows from Financer and creates a security interest in the note in favor of Financer. Section 9-203(g) adopts the traditional view that the mortgage follows the note; i.e., the transferee of the note acquires the mortgage, as well. This subsection adopts a similar principle: perfection of a security interest in the right to payment constitutes perfection of a security interest in the mortgage securing it. An important consequence of the rules in Section 9-203(g) and subsection (e) is that, by acquiring a perfected security interest in a mortgage (or other secured) note, the secured party acquires a security interest in the mortgage (or other lien) that is senior to the rights of a person who becomes a lien creditor of the mortgagee (Article 9 debtor). See Section 9-317(a)(2). This result helps prevent the separation of the mortgage (or other lien) from the note. Under this Article, attachment and perfection of a security interest in a secured right to payment do not of themselves aect the obligation to pay. For example, if the obligation is evidenced by a negotiable note, then Article 3 dictates the person whom the maker must pay to discharge the note and any lien securing it. See Section 3-602. If the right to payment is a payment intangible, then Section 9-406 determines whom the account debtor must pay. 908

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Similarly, this Article does not determine who has the power to release a mortgage of record. That issue is determined by real-property law. 7. Investment Property. Subsections (f) and (g) follow former Section 9-115(2).

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

9-309. Security Interest Perfected Upon Attachment. The following security interests are perfected when they attach: (1) a purchase-money security interest in consumer goods, except as otherwise provided in Section 9-311(b) with respect to consumer goods that are subject to a statute or treaty described in Section 9-311(a); (2) an assignment of accounts or payment intangibles which does not by itself or in conjunction with other assignments to the same assignee transfer a signicant part of the assignor's outstanding accounts or payment intangibles; (3) a sale of a payment intangible; (4) a sale of a promissory note; (5) a security interest created by the assignment of a health-careinsurance receivable to the provider of the health-care goods or services; (6) a security interest arising under Section 2-401, 2-505, 2-711(3), or 2A-508(5), until the debtor obtains possession of the collateral; (7) a security interest of a collecting bank arising under Section 4-210; (8) a security interest of an issuer or nominated person arising under Section 5-118; (9) a security interest arising in the delivery of a nancial asset under Section 9-206(c); (10) a security interest in investment property created by a broker or securities intermediary; (11) a security interest in a commodity contract or a commodity account created by a commodity intermediary; (12) an assignment for the benet of all creditors of the transferor and subsequent transfers by the assignee thereunder; (13) a security interest created by an assignment of a benecial interest in a decedent's estate; and (14) a sale by an individual of an account that is a right to payment of winnings in a lottery or other game of chance. Ocial Comment
1. Source. Derived from former Sections 9-302(1), 9-115(4)(c), (d), 9-116. 2. Automatic Perfection. This section contains the perfection-upon-attachment rules previously located in former Sections 9-302(1), 9-115(4)(c), (d), and 9-116. Rather than continue to state the rule by indirection, this section explicitly provides for perfection upon attachment. 3. Purchase-Money Security Interest in Consumer Goods. Former Section 9-302(1)(d) has been revised and appears here as paragraph (1). No ling or other step is required to perfect a purchase-money security interest in consumer goods, other than goods, such as automobiles, that are subject to a statute or treaty described in Section 9-311(a). However, ling is required to perfect a non-purchase-money security interest in consumer goods and is necessary to prevent a buyer of consumer goods from taking free of 909

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a security interest under Section 9-320(b). A xture ling is required for priority over conicting interests in xtures to the extent provided in Section 9-334. 4. Rights to Payment. Paragraph (2) expands upon former Section 9-302(1)(e) by affording automatic perfection to certain assignments of payment intangibles as well as accounts. The purpose of paragraph (2) is to save from ex post facto invalidation casual or isolated assignmentsassignments which no one would think of ling. Any person who regularly takes assignments of any debtor's accounts or payment intangibles should le. In this connection Section 9-109(d)(4) through (7), which excludes certain transfers of accounts, chattel paper, payment intangibles, and promissory notes from this Article, should be consulted. Paragraphs (3) and (4), which are new, aord automatic perfection to sales of payment intangibles and promissory notes, respectively. They reect the practice under former Article 9. Under that Article, ling a nancing statement did not aect the rights of a buyer of payment intangibles or promissory notes, inasmuch as the former Article did not cover those sales. To the extent that the exception in paragraph (2) covers outright sales of payment intangibles, which automatically are perfected under paragraph (3), the exception is redundant. Paragraph (14), which is new, aords automatic perfection to sales by individuals of an account (as dened in Section 9-102) consisting of the right to winnings in a lottery or other game of chance. Payments on these accounts typically extend for periods of twenty years or more. It would be unduly burdensome for the secured party, who would have no other reason to maintain contact with the seller, to monitor the the seller's whereabouts for such a length of time. This paragraph was added in 2001. It applies to a sale of an account described in it, even if the sale was entered into before the eective date of the paragraph. However, if the relative priorities of conicting claims to the account were established before the paragraph took eect, Article 9 as in eect immediately prior to the date the paragraph took eect determines priority. 5. Health-Care-Insurance Receivables. Paragraph (5) extends automatic perfection to assignments of health-care-insurance receivables if the assignment is made to the healthcare provider that provided the health-care goods or services. The primary eect is that, when an individual assigns a right to payment under an insurance policy to the person who provided health-care goods or services, the provider has no need to le a nancing statement against the individual. The normal ling requirements apply to other assignments of health-care-insurance receivables covered by this Article, e.g., assignments from the healthcare provider to a nancer. 6. Investment Property. Paragraph (9) replaces the last clause of former Section 9-116(2), concerning security interests that arise in the delivery of a nancial asset. Paragraphs (10) and (11) replace former Section 9-115(4)(c) and (d), concerning secured nancing of securities and commodity rms and clearing corporations. The former sections indicated that, with respect to certain security interests created by a securities intermediary or commodity intermediary, [t]he ling of a nancing statement . . . has no eect for purposes of perfection or priority with respect to that security interest. No change in meaning is intended by the deletion of the quoted phrase. Secured nancing arrangements for securities rms are currently implemented in various ways. In some circumstances, lenders may require that the transactions be structured as hard pledges, where the securities are transferred on the books of a clearing corporation from the debtor's account to the lender's account or to a special pledge account for the lender where they cannot be disposed of without the specic consent of the lender. In other circumstances, lenders are content with so-called agreement to pledge or agreement to deliver arrangements, where the debtor retains the positions in its own account, but reects on its books that the positions have been hypothecated and promises that the securities will be transferred to the secured party's account on demand. The perfection and priority rules of this Article are designed to facilitate current secured nancing arrangements for securities rms as well as to provide sucient exibility to accommodate new arrangements that develop in the future. Hard pledge arrangements are covered by the concept of control. See Sections 9-314, 9-106, 8-106. Non-control secured nancing arrangements for securities rms are covered by the automatic perfection rule of paragraph (10). Before the 1994 revision of Articles 8 and 9, agreement to pledge arrangements could be implemented under a provision that a security interest in securities given 910

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for new value under a written security agreement was perfected without ling or possession for a period of 21 days. Although the security interests were temporary in legal theory, the nancing arrangements could, in practice, be continued indenitely by rolling over the loans at least every 21 days. Accordingly, a knowledgeable creditor of a securities rm realizes that the rm's securities may be subject to security interests that are not discoverable from any public records. The automatic-perfection rule of paragraph (10) makes it unnecessary to engage in the purely formal practice of rolling over these arrangements every 21 days. In some circumstances, a clearing corporation may be the debtor in a secured nancing arrangement. For example, a clearing corporation that settles delivery-versus-payment transactions among its participants on a net, same-day basis relies on timely payments from all participants with net obligations due to the system. If a participant that is a net debtor were to default on its payment obligation, the clearing corporation would not receive some of the funds needed to settle with participants that are net creditors to the system. To complete end-of-day settlement after a payment default by a participant, a clearing corporation that settles on a net, same-day basis may need to draw on credit lines and pledge securities of the defaulting participant or other securities pledged by participants in the clearing corporation to secure such drawings. The clearing corporation may be the top-tier securities intermediary for the securities pledged, so that it would not be practical for the lender to obtain control. Even where the clearing corporation holds some types of securities through other intermediaries, however, the clearing corporation is unlikely to be able to complete the arrangements necessary to convey control over the securities to be pledged in time to complete settlement in a timely manner. However, the term securities intermediary is dened in Section 8-102(a)(14) to include clearing corporations. Thus, the perfection rule of paragraph (10) applies to security interests in investment property granted by clearing corporations. 7. Benecial Interests in Trusts. Under former Section 9-302(1)(c), ling was not required to perfect a security interest created by an assignment of a benecial interest in a trust. Because benecial interests in trusts are now used as collateral with greater frequency in commercial transactions, under this Article ling is required to perfect a security interest in a benecial interest. 8. Assignments for Benet of Creditors. No ling or other action is required to perfect an assignment for the benet of creditors. These assignments are not nancing transactions, and the debtor ordinarily will not be engaging in further credit transactions.

9-310. When Filing Required to Perfect Security Interest or Agricultural Lien; Security Interests and Agricultural Liens to Which Filing Provisions Do Not Apply. (a) [General rule: perfection by ling.] Except as otherwise provided in subsection (b) and Section 9-312(b), a nancing statement must be led to perfect all security interests and agricultural liens. (b) [Exceptions: ling not necessary.] The ling of a nancing statement is not necessary to perfect a security interest: (1) that is perfected under Section 9-308(d), (e), (f), or (g); (2) that is perfected under Section 9-309 when it attaches; (3) in property subject to a statute, regulation, or treaty described in Section 9-311(a); (4) in goods in possession of a bailee which is perfected under Section 9-312(d)(1) or (2); (5) in certicated securities, documents, goods, or instruments which is perfected without ling, control, or possession under Section 9-312(e), (f), or (g); (6) in collateral in the secured party's possession under Section 9-313; (7) in a certicated security which is perfected by delivery of the security certicate to the secured party under Section 9-313;
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(8) in deposit accounts, electronic chattel paper, electronic documents, investment property, or letter-of-credit rights which is perfected by control under Section 9-314; (9) in proceeds which is perfected under Section 9-315; or (10) that is perfected under Section 9-316. (c) [Assignment of perfected security interest.] If a secured party assigns a perfected security interest or agricultural lien, a ling under this article is not required to continue the perfected status of the security interest against creditors of and transferees from the original debtor. As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Source. Former Section 9-302(1), (2). 2. General Rule. Subsection (a) establishes a central Article 9 principle: Filing a nancing statement is necessary for perfection of security interests and agricultural liens. However, ling is not necessary to perfect a security interest that is perfected by another permissible method, see subsection (b), nor does ling ordinarily perfect a security interest in a deposit account, letter-of-credit right, or money. See Section 9-312(b). Part 5 of the Article deals with the oce in which to le, mechanics of ling, and operations of the ling oce. 3. Exemptions from Filing. Subsection (b) lists the security interests for which ling is not required as a condition of perfection, because they are perfected automatically upon attachment (subsections (b)(2) and (b)(9)) or upon the occurrence of another event (subsections (b)(1), (b)(5), and (b)(9)), because they are perfected under the law of another jurisdiction (subsection (b)(10)), or because they are perfected by another method, such as by the secured party's taking possession or control (subsections (b)(3), (b)(4), (b)(5), (b)(6), (b)(7), and (b)(8)). 4. Assignments of Perfected Security Interests. Subsection (c) concerns assignment of a perfected security interest or agricultural lien. It provides that no ling is necessary in connection with an assignment by a secured party to an assignee in order to maintain perfection as against creditors of and transferees from the original debtor. Example 1: Buyer buys goods from Seller, who retains a security interest in them. After Seller perfects the security interest by ling, Seller assigns the perfected security interest to X. The security interest, in X's hands and without further steps on X's part, continues perfected against Buyer's transferees and creditors. Example 2: Dealer creates a security interest in specic equipment in favor of Lender. After Lender perfects the security interest in the equipment by ling, Lender assigns the chattel paper (which includes the perfected security interest in Dealer's equipment) to X. The security interest in the equipment, in X's hands and without further steps on X's part, continues perfected against Dealer's transferees and creditors. However, regardless of whether Lender made the assignment to secure Lender's obligation to X or whether the assignment was an outright sale of the chattel paper, the assignment creates a security interest in the chattel paper in favor of X. Accordingly, X must take whatever steps may be required for perfection in order to be protected against Lender's transferees and creditors with respect to the chattel paper. Subsection (c) applies not only to an assignment of a security interest perfected by ling but also to an assignment of a security interest perfected by a method other than by ling, such as by control or by possession. Although subsection (c) addresses explicitly only the absence of an additional ling requirement, the same result normally will follow in the case of an assignment of a security interest perfected by a method other than by ling. For example, as long as possession of collateral is maintained by an assignee or by the assignor or another person on behalf of the assignee, no further perfection steps need be taken on account of the assignment to continue perfection as against creditors and transferees of the original debtor. Of course, additional action may be required for perfection of the assignee's interest as against creditors and transferees of the assignor. 912

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Similarly, subsection (c) applies to the assignment of a security interest perfected by compliance with a statute, regulation, or treaty under Section 9-311(b), such as a certicateof-title statute. Unless the statute expressly provides to the contrary, the security interest will remain perfected against creditors of and transferees from the original debtor, even if the assignee takes no action to cause the certicate of title to reect the assignment or to cause its name to appear on the certicate of title. See PEB Commentary No. 12, which discusses this issue under former Section 9-302(3). Compliance with the statute is equivalent to ling under Section 9-311(b).

9-311. Perfection of Security Interests in Property Subject to Certain Statutes, Regulations, and Treaties. (a) [Security interest subject to other law.] Except as otherwise provided in subsection (d), the ling of a nancing statement is not necessary or eective to perfect a security interest in property subject to: (1) a statute, regulation, or treaty of the United States whose requirements for a security interest's obtaining priority over the rights of a lien creditor with respect to the property preempt Section 9-310(a); (2) [list any certicate-of-title statute covering automobiles, trailers, mobile homes, boats, farm tractors, or the like, which provides for a security interest to be indicated on the certicate as a condition or result of perfection, and any non-Uniform Commercial Code central ling statute]; or (3) a certicate-of-title statute of another jurisdiction which provides for a security interest to be indicated on the certicate as a condition or result of the security interest's obtaining priority over the rights of a lien creditor with respect to the property. (b) [Compliance with other law.] Compliance with the requirements of a statute, regulation, or treaty described in subsection (a) for obtaining priority over the rights of a lien creditor is equivalent to the ling of a nancing statement under this article. Except as otherwise provided in subsection (d) and Sections 9-313 and 9-316(d) and (e) for goods covered by a certicate of title, a security interest in property subject to a statute, regulation, or treaty described in subsection (a) may be perfected only by compliance with those requirements, and a security interest so perfected remains perfected notwithstanding a change in the use or transfer of possession of the collateral. (c) [Duration and renewal of perfection.] Except as otherwise provided in subsection (d) and Section 9-316(d) and (e), duration and renewal of perfection of a security interest perfected by compliance with the requirements prescribed by a statute, regulation, or treaty described in subsection (a) are governed by the statute, regulation, or treaty. In other respects, the security interest is subject to this article. (d) [Inapplicability to certain inventory.] During any period in which collateral subject to a statute specied in subsection (a)(2) is inventory held for sale or lease by a person or leased by that person as lessor and that person is in the business of selling goods of that kind, this section does not apply to a security interest in that collateral created by that person.
Legislative Note: This Article contemplates that perfection of a security interest in goods covered by a certicate of title occurs upon receipt by appropriate State ocials of a properly tendered application for a certicate of title on which the security interest is to be indicated, 913

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without a relation back to an earlier time. States whose certicate-of-title statutes provide for perfection at a dierent time or contain a relation-back provision should amend the statutes accordingly.

As amended in 2000.
See Appendix P for material relating to changes made in text in 2000.

Ocial Comment
1. Source. Former Section 9-302(3), (4). 2. Federal Statutes, Regulations, and Treaties. Subsection (a)(1) exempts from the ling provisions of this Article transactions as to which a system of lingstate or federal has been established under federal law. Subsection (b) makes clear that when such a system exists, perfection of a relevant security interest can be achieved only through compliance with that system (i.e., ling under this Article is not a permissible alternative). An example of the type of federal statute referred to in subsection (a)(1) is 49 U.S.C. 4410711, for civil aircraft of the United States. The Assignment of Claims Act of 1940, as amended, provides for notice to contracting and disbursing ocers and to sureties on bonds but does not establish a national ling system and therefore is not within the scope of subsection (a)(1). An assignee of a claim against the United States may benet from compliance with the Assignment of Claims Act. But regardless of whether the assignee complies with that Act, the assignee must le under this Article in order to perfect its security interest against creditors and transferees of its assignor. Subsection (a)(1) provides explicitly that the ling requirement of this Article defers only to federal statutes, regulations, or treaties whose requirements for a security interest's obtaining priority over the rights of a lien creditor preempt Section 9-310(a). The provision eschews reference to the term perfection, inasmuch as Section 9-308 species the meaning of that term and a preemptive rule may use other terminology. 3. State Statutes. Subsections (a)(2) and (3) exempt from the ling requirements of this Article transactions covered by State certicate-of-title statutes covering motor vehicles and the like. The description of certicate-of-title statutes in subsections (a)(2) and (a)(3) tracks the language of the denition of certicate of title in Section 9-102. For a discussion of the operation of state certicate-of-title statutes in interstate contexts, see the Comments to Section 9-303. Some states have enacted central ling statutes with respect to secured transactions in kinds of property that are of special importance in the local economy. Subsection (a)(2) defers to these statutes with respect to ling for that property. 4. Inventory Covered by Certicate of Title. Under subsection (d), perfection of a security interest in the inventory of a person in the business of selling goods of that kind is governed by the normal perfection rules, even if the inventory is subject to a certicate-oftitle statute. Compliance with a certicate-of-title statute is both unnecessary and ineective to perfect a security interest in inventory to which this subsection applies. Thus, a secured party who nances an automobile dealer that is in the business of selling and leasing its inventory of automobiles can perfect a security interest in all the automobiles by ling a nancing statement but not by compliance with a certicate-of-title statute. Subsection (d), and thus the ling and other perfection provisions of this Article, does not apply to inventory that is subject to a certicate-of-title statute and is of a kind that the debtor is not in the business of selling. For example, if goods are subject to a certicate-oftitle statute and the debtor is in the business of leasing but not of selling, goods of that kind, the other subsections of this section govern perfection of a security interest in the goods. The fact that the debtor eventually sells the goods does not, of itself, mean that the debtor is in the business of selling goods of that kind. The ling and other perfection provisions of this Article apply to goods subject to a certicate-of-title statute only during any period in which collateral is inventory held for sale or lease or leased. If the debtor takes goods of this kind out of inventory and uses them, say, as equipment, a led nancing statement would not remain eective to perfect a security interest. 5. Compliance with Perfection Requirements of Other Statute. Subsection (b) makes clear that compliance with the perfection requirements (i.e., the requirements for obtaining priority over a lien creditor), but not other requirements, of a statute, regulation, or treaty described in subsection (a) is sucient for perfection under this Article. Perfection 914

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of a security interest under such a statute, regulation, or treaty has all the consequences of perfection under this Article. The interplay of this section with certain certicate-of-title statutes may create confusion and uncertainty. For example, statutes under which perfection does not occur until a certificate of title is issued will create a gap between the time that the goods are covered by the certicate under Section 9-303 and the time of perfection. If the gap is long enough, it may result in turning some unobjectionable transactions into avoidable preferences under Bankruptcy Code Section 547. (The preference risk arises if more than 10 days (or 20 days, in the case of a purchase-money security interest) passes between the time a security interest attaches (or the debtor receives possession of the collateral, in the case of a purchasemoney security interest) and the time it is perfected.) Accordingly, the Legislative Note to this section instructs the legislature to amend the applicable certicate-of-title statute to provide that perfection occurs upon receipt by the appropriate State ocial of a properly tendered application for a certicate of title on which the security interest is to be indicated. Under some certicate-of-title statutes, including the Uniform Motor Vehicle Certicate of Title and Anti-Theft Act, perfection generally occurs upon delivery of specied documents to a state ocial but may, under certain circumstances, relate back to the time of attachment. This relation-back feature can create great diculties for the application of the rules in Sections 9-303 and 9-311(b). Accordingly, the Legislative Note also recommends to legislatures that they remove any relation-back provisions from certicate-of-title statutes aecting security interests. 6. Compliance with Perfection Requirements of Other Statute as Equivalent to Filing. Under Subsection (b), compliance with the perfection requirements (i.e., the requirements for obtaining priority over a lien creditor) of a statute, regulation, or treaty described in subsection (a) is equivalent to the ling of a nancing statement. The quoted phrase appeared in former Section 9-302(3). Its meaning was unclear, and many questions arose concerning the extent to which and manner in which Article 9 rules referring to ling were applicable to perfection by compliance with a certicate-of-title statute. This Article takes a variety of approaches for applying Article 9's ling rules to compliance with other statutes and treaties. First, as discussed above in Comment 5, it leaves the determination of some rules, such as the rule establishing time of perfection (Section 9-516(a)), to the other statutes themselves. Second, this Article explicitly applies some Article 9 ling rules to perfection under other statutes or treaties. See, e.g., Section 9-505. Third, this Article makes other Article 9 rules applicable to security interests perfected by compliance with another statute through the equivalent to . . . ling provision in the rst sentence of Section 9-311(b). The third approach is reected for the most part in occasional Comments explaining how particular rules apply when perfection is accomplished under Section 9-311(b). See, e.g., Section 9-310, Comment 4; Section 9-315, Comment 6; Section 9-317, Comment 8. The absence of a Comment indicating that a particular ling provision applies to perfection pursuant to Section 9-311(b) does not mean the provision is inapplicable. 7. Perfection by Possession of Goods Covered by Certicate-of-Title Statute. A secured party who holds a security interest perfected under the law of State A in goods that subsequently are covered by a State B certicate of title may face a predicament. Ordinarily, the secured party will have four months under State B's Section 9-316(c) and (d) in which to (re)perfect as against a purchaser of the goods by having its security interest noted on a State B certicate. This procedure is likely to require the cooperation of the debtor and any competing secured party whose security interest has been noted on the certicate. Comment 4(e) to former Section 9-103 observed that that cooperation is not likely to be forthcoming from an owner who wrongfully procured the issuance of a new certicate not showing the out-of-state security interest, or from a local secured party nding himself in a priority contest with the out-of-state secured party. According to that Comment, [t]he only solution for the out-of-state secured party under present certicate of title statutes seems to be to reperfect by possession, i.e., by repossessing the goods. But the solution may not have worked: Former Section 9-302(4) provided that a security interest in property subject to a certicate-of-title statute can be perfected only by compliance therewith. Sections 9-316(d) and (e), 9-311(c), and 9-313(b) of this Article resolve the conict by providing that a security interest that remains perfected solely by virtue of Section 9-316(e) can be (re)perfected by the secured party's taking possession of the collateral. These sections contemplate only that taking possession of goods covered by a certicate of title will 915

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work as a method of perfection. None of these sections creates a right to take possession. Section 9-609 and the agreement of the parties dene the secured party's right to take possession.

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

9-312. Perfection of Security Interests in Chattel Paper, Deposit Accounts, Documents, Goods Covered by Documents, Instruments, Investment Property, Letter-of-Credit Rights, and Money; Perfection by Permissive Filing; Temporary Perfection Without Filing or Transfer of Possession. (a) [Perfection by ling permitted.] A security interest in chattel paper, negotiable documents, instruments, or investment property may be perfected by ling. (b) [Control or possession of certain collateral.] Except as otherwise provided in Section 9-315(c) and (d) for proceeds: (1) a security interest in a deposit account may be perfected only by control under Section 9-314; (2) and except as otherwise provided in Section 9-308(d), a security interest in a letter-of-credit right may be perfected only by control under Section 9-314; and (3) a security interest in money may be perfected only by the secured party's taking possession under Section 9-313. (c) [Goods covered by negotiable document.] While goods are in the possession of a bailee that has issued a negotiable document covering the goods: (1) a security interest in the goods may be perfected by perfecting a security interest in the document; and (2) a security interest perfected in the document has priority over any security interest that becomes perfected in the goods by another method during that time. (d) [Goods covered by nonnegotiable document.] While goods are in the possession of a bailee that has issued a nonnegotiable document covering the goods, a security interest in the goods may be perfected by: (1) issuance of a document in the name of the secured party; (2) the bailee's receipt of notication of the secured party's interest; or (3) ling as to the goods. (e) [Temporary perfection: new value.] A security interest in certicated securities, negotiable documents, or instruments is perfected without ling or the taking of possession or control for a period of 20 days from the time it attaches to the extent that it arises for new value given under an authenticated security agreement. (f) [Temporary perfection: goods or documents made available to debtor.] A perfected security interest in a negotiable document or goods in possession of a bailee, other than one that has issued a negotiable document for the goods, remains perfected for 20 days without ling if the
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secured party makes available to the debtor the goods or documents representing the goods for the purpose of: (1) ultimate sale or exchange; or (2) loading, unloading, storing, shipping, transshipping, manufacturing, processing, or otherwise dealing with them in a manner preliminary to their sale or exchange. (g) [Temporary perfection: delivery of security certicate or instrument to debtor.] A perfected security interest in a certicated security or instrument remains perfected for 20 days without ling if the secured party delivers the security certicate or instrument to the debtor for the purpose of: (1) ultimate sale or exchange; or (2) presentation, collection, enforcement, renewal, or registration of transfer. (h) [Expiration of temporary perfection.] After the 20-day period specied in subsection (e), (f), or (g) expires, perfection depends upon compliance with this article. As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Source. Former Section 9-304, with additions and some changes. 2. Instruments. Under subsection (a), a security interest in instruments may be perfected by ling. This rule represents an important change from former Article 9, under which the secured party's taking possession of an instrument was the only method of achieving long-term perfection. The rule is likely to be particularly useful in transactions involving a large number of notes that a debtor uses as collateral but continues to collect from the makers. A security interest perfected by ling is subject to defeat by certain subsequent purchasers (including secured parties). Under Section 9-330(d), purchasers for value who take possession of an instrument without knowledge that the purchase violates the rights of the secured party generally would achieve priority over a security interest in the instrument perfected by ling. In addition, Section 9-331 provides that ling a nancing statement does not constitute notice that would preclude a subsequent purchaser from becoming a holder in due course and taking free of all claims under Section 3-306. 3. Chattel Paper; Negotiable Documents. Subsection (a) further provides that ling is available as a method of perfection for security interests in chattel paper and negotiable documents. Tangible chattel paper is sometimes delivered to the assignee, and sometimes left in the hands of the assignor for collection. Subsection (a) allows the assignee to perfect its security interest by ling in the latter case. Alternatively, the assignee may perfect by taking possession. See Section 9-313(a). An assignee of electronic chattel paper may perfect by taking control. See Sections 9-314(a), 9-105. The security interest of an assignee who takes possession or control may qualify for priority over a competing security interest perfected by ling. See Section 9-330. Negotiable documents may be, and usually are, delivered to the secured party. See Article 1, Section 1-201 (denition of delivery). The secured party's taking possession of a tangible document or control of an electronic document will suce as a perfection step. See Sections 9-313(a), 9-314 and 7-106. However, as is the case with chattel paper, a security interest in a negotiable document may be perfected by ling. 4. Investment Property. A security interest in investment property, including certicated securities, uncerticated securities, security entitlements, and securities accounts, may be perfected by ling. However, security interests created by brokers, securities intermediaries, or commodity intermediaries are automatically perfected; ling is of no eect. See Section 9-309(10), (11). A security interest in all kinds of investment property also may be perfected by control, see Sections 9-314, 9-106, and a security interest in a 917

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certicated security also may be perfected by the secured party's taking delivery under Section 8-301. See Section 9-313(a). A security interest perfected only by ling is subordinate to a conicting security interest perfected by control or delivery. See Section 9-328(1), (5). Thus, although ling is a permissible method of perfection, a secured party who perfects by ling takes the risk that the debtor has granted or will grant a security interest in the same collateral to another party who obtains control. Also, perfection by ling would not give the secured party protection against other types of adverse claims, since the Article 8 adverse claim cut-o rules require control. See Section 8-510. 5. Deposit Accounts. Under new subsection (b)(1), the only method of perfecting a security interest in a deposit account as original collateral is by control. Filing is ineective, except as provided in Section 9-315 with respect to proceeds. As explained in Section 9-104, control can arise as a result of an agreement among the secured party, debtor, and bank, whereby the bank agrees to comply with instructions of the secured party with respect to disposition of the funds on deposit, even though the debtor retains the right to direct disposition of the funds. Thus, subsection (b)(1) takes an intermediate position between certain non-UCC law, which conditions the eectiveness of a security interest on the secured party's enjoyment of such dominion and control over the deposit account that the debtor is unable to dispose of the funds, and the approach this Article takes to securities accounts, under which a secured party who is unable to reach the collateral without resort to judicial process may perfect by ling. By conditioning perfection on control, rather than requiring the secured party to enjoy absolute dominion to the exclusion of the debtor, subsection (b)(1) permits perfection in a wide variety of transactions, including those in which the secured party actually relies on the deposit account in extending credit and maintains some meaningful dominion over it, but does not wish to deprive the debtor of access to the funds altogether. 6. Letter-of-Credit Rights. Letter-of-credit rights commonly are supporting obligations, as dened in Section 9-102. Perfection as to the related account, chattel paper, document, general intangible, instrument, or investment property will perfect as to the letterof-credit rights. See Section 9-308(d). Subsection (b)(2) provides that, in other cases, a security interest in a letter-of-credit right may be perfected only by control. Control, for these purposes, is explained in Section 9-107. 7. Goods Covered by Document of Title. Subsection (c) applies to goods in the possession of a bailee who has issued a negotiable document covering the goods. Subsection (d) applies to goods in the possession of a bailee who has issued a nonnegotiable document of title, including a document of title that is non-negotiable under Section 7-104. Section 9-313 governs perfection of a security interest in goods in the possession of a bailee who has not issued a document of title. Subsection (c) claries the perfection and priority rules in former Section 9-304(2). Consistently with the provisions of Article 7, subsection (c) takes the position that, as long as a negotiable document covering goods is outstanding, title to the goods is, so to say, locked up in the document. Accordingly, a security interest in goods covered by a negotiable document may be perfected by perfecting a security interest in the document. The security interest also may be perfected by another method, e.g., by ling. The priority rule in subsection (c) governs only priority between (i) a security interest in goods which is perfected by perfecting in the document and (ii) a security interest in the goods which becomes perfected by another method while the goods are covered by the document. Example 1: While wheat is in a grain elevator and covered by a negotiable warehouse receipt, Debtor creates a security interest in the wheat in favor of SP-1 and SP-2. SP-1 perfects by ling a nancing statement covering wheat. Thereafter, SP-2 perfects by ling a nancing statement describing the warehouse receipt. Subsection (c)(1) provides that SP-2's security interest is perfected. Subsection (c)(2) provides that SP-2's security interest is senior to SP-1's. Example 2: The facts are as in Example 1, but SP-1's security interest attached and was perfected before the goods were delivered to the grain elevator. Subsection (c)(2) does not apply, because SP-1's security interest did not become perfected during the time that the wheat was in the possession of a bailee. Rather, the rst-to-le-or-perfect priority rule applies. See Sections 9-322 and 7-503. A secured party may become a holder to whom a negotiable document of title has been duly negotiated under Section 7-501. If so, the secured party acquires the rights specied by Article 7. Article 9 does not limit those rights, which may include the right to priority 918

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over an earlier-perfected security interest. See Section 9-331(a). Subsection (d) takes a dierent approach to the problem of goods covered by a nonnegotiable document. Here, title to the goods is not looked on as being locked up in the document, and the secured party may perfect its security interest directly in the goods by ling as to them. The subsection provides two other methods of perfection: issuance of the document in the secured party's name (as consignee of a straight bill of lading or the person to whom delivery would be made under a non-negotiable warehouse receipt) and receipt of notication of the secured party's interest by the bailee. Perfection under subsection (d) occurs when the bailee receives notication of the secured party's interest in the goods, regardless of who sends the notication. Receipt of notication is eective to perfect, regardless of whether the bailee responds. Unlike former Section 9-304(3), from which it derives, subsection (d) does not apply to goods in the possession of a bailee who has not issued a document of title. Section 9-313(c) covers that case and provides that perfection by possession as to goods not covered by a document requires the bailee's acknowledgment. 8. Temporary Perfection Without Having First Otherwise Perfected. Subsection (e) follows former Section 9-304(4) in giving perfected status to security interests in certicated securities, instruments, and negotiable documents for a short period (reduced from 21 to 20 days, which is the time period generally applicable in this Article), although there has been no ling and the collateral is in the debtor's possession or control. The 20day temporary perfection runs from the date of attachment. There is no limitation on the purpose for which the debtor is in possession, but the secured party must have given new value (dened in Section 9-102) under an authenticated security agreement. 9. Maintaining Perfection After Surrendering Possession. There are a variety of legitimate reasonsmany of them are described in subsections (f) and (g)why certain types of collateral must be released temporarily to a debtor. No useful purpose would be served by cluttering the les with records of such exceedingly short term transactions. Subsection (f) aords the possibility of 20-day perfection in negotiable documents and goods in the possession of a bailee but not covered by a negotiable document. Subsection (g) provides for 20-day perfection in certicated securities and instruments. These subsections derive from former Section 9-305(5). However, the period of temporary perfection has been reduced from 21 to 20 days, which is the time period generally applicable in this Article, and enforcement has been added in subsection (g) as one of the special and limited purposes for which a secured party can release an instrument or certicated security to the debtor and still remain perfected. The period of temporary perfection runs from the date a secured party who already has a perfected security interest turns over the collateral to the debtor. There is no new value requirement, but the turnover must be for one or more of the purposes stated in subsection (f) or (g). The 20-day period may be extended by perfecting as to the collateral by another method before the period expires. However, if the security interest is not perfected by another method until after the 20-day period expires, there will be a gap during which the security interest is unperfected. Temporary perfection extends only to the negotiable document or goods under subsection (f) and only to the certicated security or instrument under subsection (g). It does not extend to proceeds. If the collateral is sold, the security interest will continue in the proceeds for the period specied in Section 9-315. Subsections (f) and (g) deal only with perfection. Other sections of this Article govern the priority of a security interest in goods after surrender of possession or control of the document covering them. In the case of a purchase-money security interest in inventory, priority may be conditioned upon giving notication to a prior inventory nancer. See Section 9-324.

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

9-313. When Possession by or Delivery to Secured Party Perfects Security Interest Without Filing. (a) [Perfection by possession or delivery.] Except as otherwise provided in subsection (b), a secured party may perfect a security interest in tangible negotiable documents, goods, instruments, money, or tangible
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chattel paper by taking possession of the collateral. A secured party may perfect a security interest in certicated securities by taking delivery of the certicated securities under Section 8-301. (b) [Goods covered by certicate of title.] With respect to goods covered by a certicate of title issued by this State, a secured party may perfect a security interest in the goods by taking possession of the goods only in the circumstances described in Section 9-316(d). (c) [Collateral in possession of person other than debtor.] With respect to collateral other than certicated securities and goods covered by a document, a secured party takes possession of collateral in the possession of a person other than the debtor, the secured party, or a lessee of the collateral from the debtor in the ordinary course of the debtor's business, when: (1) the person in possession authenticates a record acknowledging that it holds possession of the collateral for the secured party's benet; or (2) the person takes possession of the collateral after having authenticated a record acknowledging that it will hold possession of collateral for the secured party's benet. (d) [Time of perfection by possession; continuation of perfection.] If perfection of a security interest depends upon possession of the collateral by a secured party, perfection occurs no earlier than the time the secured party takes possession and continues only while the secured party retains possession. (e) [Time of perfection by delivery; continuation of perfection.] A security interest in a certicated security in registered form is perfected by delivery when delivery of the certicated security occurs under Section 8-301 and remains perfected by delivery until the debtor obtains possession of the security certicate. (f) [Acknowledgment not required.] A person in possession of collateral is not required to acknowledge that it holds possession for a secured party's benet. (g) [Eectiveness of acknowledgment; no duties or conrmation.] If a person acknowledges that it holds possession for the secured party's benet: (1) the acknowledgment is eective under subsection (c) or Section 8-301(a), even if the acknowledgment violates the rights of a debtor; and (2) unless the person otherwise agrees or law other than this article otherwise provides, the person does not owe any duty to the secured party and is not required to conrm the acknowledgment to another person. (h) [Secured party's delivery to person other than debtor.] A secured party having possession of collateral does not relinquish possession by delivering the collateral to a person other than the debtor or a lessee of the collateral from the debtor in the ordinary course of the debtor's business if the person was instructed before the delivery or is instructed contemporaneously with the delivery: (1) to hold possession of the collateral for the secured party's benet; or
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(2) to redeliver the collateral to the secured party. (i) [Eect of delivery under subsection (h); no duties or conrmation.] A secured party does not relinquish possession, even if a delivery under subsection (h) violates the rights of a debtor. A person to which collateral is delivered under subsection (h) does not owe any duty to the secured party and is not required to conrm the delivery to another person unless the person otherwise agrees or law other than this article otherwise provides. As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Source. Former Sections 9-305, 9-115(6). 2. Perfection by Possession. As under the common law of pledge, no ling is required by this Article to perfect a security interest if the secured party takes possession of the collateral. See Section 9-310(b)(6). This section permits a security interest to be perfected by the taking of possession only when the collateral is goods, instruments, tangible negotiable documents, money, or tangible chattel paper. Accounts, commercial tort claims, deposit accounts, investment property, letter-of-credit rights, letters of credit, and oil, gas, or other minerals before extraction are excluded. (But see Comment 6, below, regarding certicated securities.) A security interest in accounts and payment intangiblesproperty not ordinarily represented by any writing whose delivery operates to transfer the right to paymentmay under this Article be perfected only by ling. This rule would not be aected by the fact that a security agreement or other record described the assignment of such collateral as a pledge. Section 9-309(2) exempts from ling certain assignments of accounts or payment intangibles which are out of the ordinary course of nancing. These exempted assignments are perfected when they attach. Similarly, under Section 9-309(3), sales of payment intangibles are automatically perfected. 3. Possession. This section does not dene possession. It adopts the general concept as it developed under former Article 9. As under former Article 9, in determining whether a particular person has possession, the principles of agency apply. For example, if the collateral is in possession of an agent of the secured party for the purposes of possessing on behalf of the secured party, and if the agent is not also an agent of the debtor, the secured party has taken actual possession, and subsection (c) does not apply. Sometimes a person holds collateral both as an agent of the secured party and as an agent of the debtor. The fact of dual agency is not of itself inconsistent with the secured party's having taken possession (and thereby having rendered subsection (c) inapplicable). The debtor cannot qualify as an agent for the secured party for purposes of the secured party's taking possession. And, under appropriate circumstances, a court may determine that a person in possession is so closely connected to or controlled by the debtor that the debtor has retained eective possession, even though the person may have agreed to take possession on behalf of the secured party. If so, the person's taking possession would not constitute the secured party's taking possession and would not be sucient for perfection. See also Section 9-205(b). In a typical escrow arrangement, where the escrowee has possession of collateral as agent for both the secured party and the debtor, the debtor's relationship to the escrowee is not such as to constitute retention of possession by the debtor. 4. Goods in Possession of Third Party: Perfection. Former Section 9-305 permitted perfection of a security interest by notication to a bailee in possession of collateral. This Article distinguishes between goods in the possession of a bailee who has issued a document of title covering the goods and goods in the possession of a third party who has not issued a document. Section 9-312(c) or (d) applies to the former, depending on whether the document is negotiable. Section 9-313(c) applies to the latter. It provides a method of perfection by possession when the collateral is possessed by a third person who is not the secured party's agent. Notication of a third person does not suce to perfect under Section 9-313(c). Rather, 921

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perfection does not occur unless the third person authenticates an acknowledgment that it holds possession of the collateral for the secured party's benet. Compare Section 9-312(d), under which receipt of notication of the security party's interest by a bailee holding goods covered by a nonnegotiable document is sucient to perfect, even if the bailee does not acknowledge receipt of the notication. A third person may acknowledge that it will hold for the secured party's benet goods to be received in the future. Under these circumstances, perfection by possession occurs when the third person obtains possession of the goods. Under subsection (c), acknowledgment of notication by a lessee . . . in . . . ordinary course of . . . business (dened in Section 2A-103) does not suce for possession. The section thus rejects the reasoning of In re Atlantic Systems, Inc., 135 B.R. 463 (Bankr. S.D.N.Y. 1992) (holding that notication to debtor-lessor's lessee suced to perfect security interest in leased goods). See Steven O. Weise, Perfection by Possession: The Need for an Objective Test, 29 Idaho Law Rev. 705 (199293) (arguing that lessee's possession in ordinary course of debtor-lessor's business does not provide adequate public notice of possible security interest in leased goods). Inclusion of a per se rule concerning lessees is not meant to preclude a court, under appropriate circumstances, from determining that a third person is so closely connected to or controlled by the debtor that the debtor has retained eective possession. If so, the third person's acknowledgment would not be sucient for perfection. In some cases, it may be uncertain whether a person who has possession of collateral is an agent of the secured party or a non-agent bailee. Under those circumstances, prudence might suggest that the secured party obtain the person's acknowledgment to avoid litigation and ensure perfection by possession regardless of how the relationship between the secured party and the person is characterized. 5. No Relation Back. Former Section 9-305 provided that a security interest is perfected by possession from the time possession is taken without a relation back. As the Comment to former Section 9-305 observed, the relation-back theory, under which the taking of possession was deemed to relate back to the date of the original security agreement, has had little vitality since the 1938 revision of the Federal Bankruptcy Act. The theory is inconsistent with former Article 9 and with this Article. See Section 9-313(d). Accordingly, this Article deletes the quoted phrase as unnecessary. Where a pledge transaction is contemplated, perfection dates only from the time possession is taken, although a security interest may attach, unperfected. The only exceptions to this rule are the short, 20-day periods of perfection provided in Section 9-312(e), (f), and (g), during which a debtor may have possession of specied collateral in which there is a perfected security interest. 6. Certicated Securities. The second sentence of subsection (a) reects the traditional rule for perfection of a security interest in certicated securities. Compare Section 9-115(6) (1994 Ocial Text); Sections 8-321, 8-313(1)(a) (1978 Ocial Text); Section 9-305 (1972 Ofcial Text). It has been modied to refer to delivery under Section 8-301. Corresponding changes appear in Section 9-203(b). Subsection (e), which is new, applies to a secured party in possession of security certicates or another person who has taken delivery of security certicates and holds them for the secured party's benet under Section 8-301. See Comment 8. Under subsection (e), a possessory security interest in a certicated security remains perfected until the debtor obtains possession of the security certicate. This rule is analogous to that of Section 9-314(c), which deals with perfection of security interests in investment property by control. See Section 9-314, Comment 3. 7. Goods Covered by Certicate of Title. Subsection (b) is necessary to eect changes to the choice-of-law rules governing goods covered by a certicate of title. These changes are described in the Comments to Section 9-311. Subsection (b), like subsection (a), does not create a right to take possession. Rather, it indicates the circumstances under which the secured party's taking possession of goods covered by a certicate of title is eective to perfect a security interest in the goods: the goods become covered by a certicate of title issued by this State at a time when the security interest is perfected by any method under the law of another jurisdiction. 8. Goods in Possession of Third Party: No Duty to Acknowledge; Consequences of Acknowledgment. Subsections (f) and (g) are new and address matters as to which former Article 9 was silent. They derive in part from Section 8-106(g). Subsection (f) provides that a person in possession of collateral is not required to acknowledge that it holds for a secured party. Subsection (g)(1) provides that an acknowledgment is eective even if 922

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wrongful as to the debtor. Subsection (g)(2) makes clear that an acknowledgment does not give rise to any duties or responsibilities under this Article. Arrangements involving the possession of goods are hardly standardized. They include bailments for services to be performed on the goods (such as repair or processing), for use (leases), as security (pledges), for carriage, and for storage. This Article leaves to the agreement of the parties and to any other applicable law the imposition of duties and responsibilities upon a person who acknowledges under subsection (c). For example, by acknowledging, a third party does not become obliged to act on the secured party's direction or to remain in possession of the collateral unless it agrees to do so or other law so provides. 9. Delivery to Third Party by Secured Party. New subsections (h) and (i) address the practice of mortgage warehouse lenders. These lenders typically send mortgage notes to prospective purchasers under cover of letters advising the prospective purchasers that the lenders hold security interests in the notes. These lenders relied on notication to maintain perfection under former 9-305. Requiring them to obtain authenticated acknowledgments from each prospective purchaser under subsection (c) could be unduly burdensome and disruptive of established practices. Under subsection (h), when a secured party in possession itself delivers the collateral to a third party, instructions to the third party would be sucient to maintain perfection by possession; an acknowledgment would not be necessary. Under subsection (i), the secured party does not relinquish possession by making a delivery under subsection (h), even if the delivery violates the rights of the debtor. That subsection also makes clear that a person to whom collateral is delivered under subsection (h) does not owe any duty to the secured party and is not required to conrm the delivery to another person unless the person otherwise agrees or law other than this Article provides otherwise.

As amended in 2000 and 2003.

See Appendix P for material relating to changes made in Ocial Comment in 2000. See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

9-314. Perfection by Control. (a) [Perfection by control.] A security interest in investment property, deposit accounts, letter-of-credit rights, electronic chattel paper, or electronic documents may be perfected by control of the collateral under Section 7-106, 9-104, 9-105, 9-106, or 9-107. (b) [Specied collateral: time of perfection by control; continuation of perfection.] A security interest in deposit accounts, electronic chattel paper, letter-of-credit rights, or electronic documents is perfected by control under Section 7-106, 9-104, 9-105, or 9-107 when the secured party obtains control and remains perfected by control only while the secured party retains control. (c) [Investment property: time of perfection by control; continuation of perfection.] A security interest in investment property is perfected by control under Section 9-106 from the time the secured party obtains control and remains perfected by control until: (1) the secured party does not have control; and (2) one of the following occurs: (A) if the collateral is a certicated security, the debtor has or acquires possession of the security certicate; (B) if the collateral is an uncerticated security, the issuer has registered or registers the debtor as the registered owner; or (C) if the collateral is a security entitlement, the debtor is or becomes the entitlement holder. As amended in 2003.
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See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Source. Substantially new; derived in part from former Section 9-115(4). 2. Control. This section provides for perfection by control with respect to investment property, deposit accounts, letter-of-credit rights, electronic chattel paper, and electronic documents. For explanations of how a secured party takes control of these types of collateral, see Sections 9-104 through 9-107 and Section 7-106. Subsection (b) explains when a security interest is perfected by control and how long a security interest remains perfected by control. Like Section 9-313(d) and for the same reasons, subsection (b) makes no reference to the doctrine of relation back. See Section 9-313, Comment 5. As to an electronic document that is reissued in a tangible medium, Section 7-105, a secured party that is perfected by control in the electronic document should le as to the document before relinquishing control in order to maintain continuous perfection in the document. See Section 9-308. 3. Investment Property. Subsection (c) provides a special rule for investment property. Once a secured party has control, its security interest remains perfected by control until the secured party ceases to have control and the debtor receives possession of collateral that is a certicated security, becomes the registered owner of collateral that is an uncerticated security, or becomes the entitlement holder of collateral that is a security entitlement. The result is particularly important in the repledge context. See Section 9-207, Comment 5. In a transaction in which a secured party who has control grants a security interest in investment property or sells outright the investment property, by virtue of the debtor's consent or applicable legal rules, a purchaser from the secured party typically will cut o the debtor's rights in the investment property or be immune from the debtor's claims. See Section 9-207, Comments 5 and 6. If the investment property is a security, the debtor normally would retain no interest in the security following the purchase from the secured party, and a claim of the debtor against the secured party for redemption (Section 9-623) or otherwise with respect to the security would be a purely personal claim. If the investment property transferred by the secured party is a nancial asset in which the debtor had a security entitlement credited to a securities account maintained with the secured party as a securities intermediary, the debtor's claim against the secured party could arise as a part of its securities account notwithstanding its personal nature. (This claim would be analogous to a credit balance in the securities account, which is a component of the securities account even though it is a personal claim against the intermediary.) In the case in which the debtor may retain an interest in investment property notwithstanding a repledge or sale by the secured party, subsection (c) makes clear that the security interest will remain perfected by control.

As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

9-315. Secured Party's Rights on Disposition of Collateral and in Proceeds. (a) [Disposition of collateral: continuation of security interest or agricultural lien; proceeds.] Except as otherwise provided in this article and in Section 2-403(2): (1) a security interest or agricultural lien continues in collateral notwithstanding sale, lease, license, exchange, or other disposition thereof unless the secured party authorized the disposition free of the security interest or agricultural lien; and (2) a security interest attaches to any identiable proceeds of collateral. (b) [When commingled proceeds identiable.] Proceeds that are commingled with other property are identiable proceeds:
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(1) if the proceeds are goods, to the extent provided by Section 9-336; and (2) if the proceeds are not goods, to the extent that the secured party identies the proceeds by a method of tracing, including application of equitable principles, that is permitted under law other than this article with respect to commingled property of the type involved. (c) [Perfection of security interest in proceeds.] A security interest in proceeds is a perfected security interest if the security interest in the original collateral was perfected. (d) [Continuation of perfection.] A perfected security interest in proceeds becomes unperfected on the 21st day after the security interest attaches to the proceeds unless: (1) the following conditions are satised: (A) a led nancing statement covers the original collateral; (B) the proceeds are collateral in which a security interest may be perfected by ling in the oce in which the nancing statement has been led; and (C) the proceeds are not acquired with cash proceeds; (2) the proceeds are identiable cash proceeds; or (3) the security interest in the proceeds is perfected other than under subsection (c) when the security interest attaches to the proceeds or within 20 days thereafter. (e) [When perfected security interest in proceeds becomes unperfected.] If a led nancing statement covers the original collateral, a security interest in proceeds which remains perfected under subsection (d)(1) becomes unperfected at the later of: (1) when the eectiveness of the led nancing statement lapses under Section 9-515 or is terminated under Section 9-513; or (2) the 21st day after the security interest attaches to the proceeds. Ocial Comment
1. Source. Former Section 9-306. 2. Continuation of Security Interest or Agricultural Lien Following Disposition of Collateral. Subsection (a)(1), which derives from former Section 9-306(2), contains the general rule that a security interest survives disposition of the collateral. In these cases, the secured party may repossess the collateral from the transferee or, in an appropriate case, maintain an action for conversion. The secured party may claim both any proceeds and the original collateral but, of course, may have only one satisfaction. In many cases, a purchaser or other transferee of collateral will take free of a security interest, and the secured party's only right will be to proceeds. For example, the general rule does not apply, and a security interest does not continue in collateral, if the secured party authorized the disposition, in the agreement that contains the security agreement or otherwise. Subsection (a)(1) adopts the view of PEB Commentary No. 3 and makes explicit that the authorized disposition to which it refers is an authorized disposition free of the security interest or agricultural lien. The secured party's right to proceeds under this section or under the express terms of an agreement does not in itself constitute an authorization of disposition. The change in language from former Section 9-306(2) is not intended to address the frequently litigated situation in which the eectiveness of the secured party's consent to a disposition is conditioned upon the secured party's receipt of the proceeds. In that situation, subsection (a) leaves the determination of authorization to the courts, as under former Article 9. This Article contains several provisions under which a transferee takes free of a security 925

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interest or agricultural lien. For example, Section 9-317 states when transferees take free of unperfected security interests; Sections 9-320 and 9-321 on goods, 9-321 on general intangibles, 9-330 on chattel paper and instruments, and 9-331 on negotiable instruments, negotiable documents, and securities state when purchasers of such collateral take free of a security interest, even though perfected and even though the disposition was not authorized. Section 9-332 enables most transferees (including non-purchasers) of funds from a deposit account and most transferees of money to take free of a perfected security interest in the deposit account or money. Likewise, the general rule that a security interest survives disposition does not apply if the secured party entrusts goods collateral to a merchant who deals in goods of that kind and the merchant sells the collateral to a buyer in ordinary course of business. Section 2-403(2) gives the merchant the power to transfer all the secured party's rights to the buyer, even if the sale is wrongful as against the secured party. Thus, under subsection (a)(1), an entrusting secured party runs the same risk as any other entruster. 3. Secured Party's Right to Identiable Proceeds. Under subsection (a)(2), which derives from former Section 9-306(2), a security interest attaches to any identiable proceeds, as dened in Section 9-102. See also Section 9-203(f). Subsection (b) is new. It indicates when proceeds commingled with other property are identiable proceeds and permits the use of whatever methods of tracing other law permits with respect to the type of property involved. Among the equitable principles whose use other law may permit is the lowest intermediate balance rule. See Restatement (2d), Trusts 202. 4. Automatic Perfection in Proceeds: General Rule. Under subsection (c), a security interest in proceeds is a perfected security interest if the security interest in the original collateral was perfected. This Article extends the period of automatic perfection in proceeds from 10 days to 20 days. Generally, a security interest in proceeds becomes unperfected on the 21st day after the security interest attaches to the proceeds. See subsection (d). The loss of perfected status under subsection (d) is prospective only. Compare, e.g., Section 9-515(c) (deeming security interest unperfected retroactively). 5. Automatic Perfection in Proceeds: Proceeds Acquired with Cash Proceeds. Subsection (d)(1) derives from former Section 9-306(3)(a). It carries forward the basic rule that a security interest in proceeds remains perfected beyond the period of automatic perfection if a led nancing statement covers the original collateral (e.g., inventory) and the proceeds are collateral in which a security interest may be perfected by ling in the ofce where the nancing statement has been led (e.g., equipment). A dierent rule applies if the proceeds are acquired with cash proceeds, as is the case if the original collateral (inventory) is sold for cash (cash proceeds) that is used to purchase equipment (proceeds). Under these circumstances, the security interest in the equipment proceeds remains perfected only if the description in the led nancing indicates the type of property constituting the proceeds (e.g., equipment). This section reaches the same result but takes a dierent approach. It recognizes that the treatment of proceeds acquired with cash proceeds under former Section 9-306(3)(a) essentially was superuous. In the example, had the ling covered equipment as well as inventory, the security interest in the proceeds would have been perfected under the usual rules governing after-acquired equipment (see former Sections 9-302, 9-303); paragraph (3)(a) added only an exception to the general rule. Subsection (d)(1)(C) of this section takes a more direct approach. It makes the general rule of continued perfection inapplicable to proceeds acquired with cash proceeds, leaving perfection of a security interest in those proceeds to the generally applicable perfection rules under subsection (d)(3). Example 1: Lender perfects a security interest in Debtor's inventory by ling a nancing statement covering inventory. Debtor sells the inventory and deposits the buyer's check into a deposit account. Debtor draws a check on the deposit account and uses it to pay for equipment. Under the lowest intermediate balance rule, which is a permitted method of tracing in the relevant jurisdiction, see Comment 3, the funds used to pay for the equipment were identiable proceeds of the inventory. Because the proceeds (equipment) were acquired with cash proceeds (deposit account), subsection (d)(1) does not extend perfection beyond the 20-day automatic period. Example 2: Lender perfects a security interest in Debtor's inventory by ling a nancing statement covering all debtor's property. As in Example 1, Debtor sells the inventory, deposits the buyer's check into a deposit account, draws a check on the deposit account, and uses the check to pay for equipment. Under the lowest intermediate bal926

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ance rule, which is a permitted method of tracing in the relevant jurisdiction, see Comment 3, the funds used to pay for the equipment were identiable proceeds of the inventory. Because the proceeds (equipment) were acquired with cash proceeds (deposit account), subsection (d)(1) does not extend perfection beyond the 20-day automatic period. However, because the nancing statement is sucient to perfect a security interest in debtor's equipment, under subsection (d)(3) the security interest in the equipment proceeds remains perfected beyond the 20-day period. 6. Automatic Perfection in Proceeds: Lapse or Termination of Financing Statement During 20-Day Period; Perfection Under Other Statute or Treaty. Subsection (e) provides that a security interest in proceeds perfected under subsection (d)(1) ceases to be perfected when the nancing statement covering the original collateral lapses or is terminated. If the lapse or termination occurs before the 21st day after the security interest attaches, however, the security interest in the proceeds remains perfected until the 21st day. Section 9-311(b) provides that compliance with the perfection requirements of a statute or treaty described in Section 9-311(a) is equivalent to the ling of a nancing statement. It follows that collateral subject to a security interest perfected by such compliance under Section 9-311(b) is covered by a led nancing statement within the meaning of Section 9-315(d) and (e). 7. Automatic Perfection in Proceeds: Continuation of Perfection in Cash Proceeds. Former Section 9-306(3)(b) provided that if a led nancing statement covered original collateral, a security interest in identiable cash proceeds of the collateral remained perfected beyond the ten-day period of automatic perfection. Former Section 9-306(3)(c) contained a similar rule with respect to identiable cash proceeds of investment property. Subsection (d)(2) extends the benets of former Sections 9-306(3)(b) and (3)(c) to identiable cash proceeds of all types of original collateral in which a security interest is perfected by any method. Under subsection (d)(2), if the security interest in the original collateral was perfected, a security interest in identiable cash proceeds will remain perfected indenitely, regardless of whether the security interest in the original collateral remains perfected. In many cases, however, a purchaser or other transferee of the cash proceeds will take free of the perfected security interest. See, e.g., Sections 9-330(d) (purchaser of check), 9-331 (holder in due course of check), 9-332 (transferee of money or funds from a deposit account). 8. Insolvency Proceedings; Returned and Repossessed Goods. This Article deletes former Section 9-306(4), which dealt with proceeds in insolvency proceedings. Except as otherwise provided by the Bankruptcy Code, the debtor's entering into bankruptcy does not aect a secured party's right to proceeds. This Article also deletes former Section 9-306(5), which dealt with returned and repossessed goods. Section 9-330, Comments 9 to 11 explain and clarify the application of priority rules to returned and repossessed goods as proceeds of chattel paper. 9. Proceeds of Collateral Subject to Agricultural Lien. This Article does not determine whether a lien extends to proceeds of farm products encumbered by an agricultural lien. If, however, the proceeds are themselves farm products on which an agricultural lien (dened in Section 9-102) arises under other law, then the agricultural-lien provisions of this Article apply to the agricultural lien on the proceeds in the same way in which they would apply had the farm products not been proceeds.

9-316. Continued Perfection of Security Interest Following Change in Governing Law. (a) [General rule: eect on perfection of change in governing law.] A security interest perfected pursuant to the law of the jurisdiction designated in Section 9-301(1) or 9-305(c) remains perfected until the earliest of: (1) the time perfection would have ceased under the law of that jurisdiction; (2) the expiration of four months after a change of the debtor's location to another jurisdiction; or (3) the expiration of one year after a transfer of collateral to a person that thereby becomes a debtor and is located in another jurisdiction.
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(b) [Security interest perfected or unperfected under law of new jurisdiction.] If a security interest described in subsection (a) becomes perfected under the law of the other jurisdiction before the earliest time or event described in that subsection, it remains perfected thereafter. If the security interest does not become perfected under the law of the other jurisdiction before the earliest time or event, it becomes unperfected and is deemed never to have been perfected as against a purchaser of the collateral for value. (c) [Possessory security interest in collateral moved to new jurisdiction.] A possessory security interest in collateral, other than goods covered by a certicate of title and as-extracted collateral consisting of goods, remains continuously perfected if: (1) the collateral is located in one jurisdiction and subject to a security interest perfected under the law of that jurisdiction; (2) thereafter the collateral is brought into another jurisdiction; and (3) upon entry into the other jurisdiction, the security interest is perfected under the law of the other jurisdiction. (d) [Goods covered by certicate of title from this state.] Except as otherwise provided in subsection (e), a security interest in goods covered by a certicate of title which is perfected by any method under the law of another jurisdiction when the goods become covered by a certicate of title from this State remains perfected until the security interest would have become unperfected under the law of the other jurisdiction had the goods not become so covered. (e) [When subsection (d) security interest becomes unperfected against purchasers.] A security interest described in subsection (d) becomes unperfected as against a purchaser of the goods for value and is deemed never to have been perfected as against a purchaser of the goods for value if the applicable requirements for perfection under Section 9-311(b) or 9-313 are not satised before the earlier of: (1) the time the security interest would have become unperfected under the law of the other jurisdiction had the goods not become covered by a certicate of title from this State; or (2) the expiration of four months after the goods had become so covered. (f) [Change in jurisdiction of bank, issuer, nominated person, securities intermediary, or commodity intermediary.] A security interest in deposit accounts, letter-of-credit rights, or investment property which is perfected under the law of the bank's jurisdiction, the issuer's jurisdiction, a nominated person's jurisdiction, the securities intermediary's jurisdiction, or the commodity intermediary's jurisdiction, as applicable, remains perfected until the earlier of: (1) the time the security interest would have become unperfected under the law of that jurisdiction; or (2) the expiration of four months after a change of the applicable jurisdiction to another jurisdiction. (g) [Subsection (f) security interest perfected or unperfected under law of new jurisdiction.] If a security interest described in
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subsection (f) becomes perfected under the law of the other jurisdiction before the earlier of the time or the end of the period described in that subsection, it remains perfected thereafter. If the security interest does not become perfected under the law of the other jurisdiction before the earlier of that time or the end of that period, it becomes unperfected and is deemed never to have been perfected as against a purchaser of the collateral for value. Ocial Comment
1. Source. Former Section 9-103(1)(d), (2)(b), (3)(e), as modied. 2. Continued Perfection. This section deals with continued perfection of security interests that have been perfected under the law of another jurisdiction. The fact that the law of a particular jurisdiction ceases to govern perfection under Sections 9-301 through 9-307 does not necessarily mean that a security interest perfected under that law automatically becomes unperfected. To the contrary: This section generally provides that a security interest perfected under the law of one jurisdiction remains perfected for a xed period of time (four months or one year, depending on the circumstances), even though the jurisdiction whose law governs perfection changes. However, cessation of perfection under the law of the original jurisdiction cuts short the xed period. The four-month and one-year periods are long enough for a secured party to discover in most cases that the law of a dierent jurisdiction governs perfection and to reperfect (typically by ling) under the law of that jurisdiction. If a secured party properly reperfects a security interest before it becomes unperfected under subsection (a), then the security interest remains perfected continuously thereafter. See subsection (b). Example 1: Debtor is a general partnership whose chief executive oce is in Pennsylvania. Lender perfects a security interest in Debtor's equipment by ling in Pennsylvania on May 15, 2002. On April 1, 2005, without Lender's knowledge, Debtor moves its chief executive oce to New Jersey. Lender's security interest remains perfected for four months after the move. See subsection (a)(2). Example 2: Debtor is a general partnership whose chief executive oce is in Pennsylvania. Lender perfects a security interest in Debtor's equipment by ling in Pennsylvania on May 15, 2002. On April 1, 2007, without Lender's knowledge, Debtor moves its chief executive oce to New Jersey. Lender's security interest remains perfected only through May 14, 2007, when the eectiveness of the led nancing statement lapses. See subsection (a)(1). Although, under these facts, Lender would have only a short period of time to discover that Debtor had relocated and to reperfect under New Jersey law, Lender could have protected itself by ling a continuation statement in Pennsylvania before Debtor relocated. By doing so, Lender would have prevented lapse and allowed itself the full four months to discover Debtor's new location and rele there or, if Debtor is in default, to perfect by taking possession of the equipment. Example 3: Under the facts of Example 2, Lender les a nancing statement in New Jersey before the eectiveness of the Pennsylvania nancing statement lapses. Under subsection (b), Lender's security interest is continuously perfected beyond May 14, 2007, for a period determined by New Jersey's Article 9. Subsection (a)(3) allows a one-year period in which to reperfect. The longer period is necessary, because, even with the exercise of due diligence, the secured party may be unable to discover that the collateral has been transferred to a person located in another jurisdiction. Example 4: Debtor is a Pennsylvania corporation. Lender perfects a security interest in Debtor's equipment by ling in Pennsylvania. Debtor's shareholders decide to reincorporate in Delaware. They form a Delaware corporation (Newcorp) into which they merge Debtor. The merger eectuates a transfer of the collateral from Debtor to Newcorp, which thereby becomes a debtor and is located in another jurisdiction. Under subsection (a)(3), the security interest remains perfected for one year after the merger. If a nancing statement is led in Delaware against Newcorp within the year following the merger, then the security interest remains perfected thereafter for a period determined by Delaware's Article 9. Note that although Newcorp is a new debtor as dened in Section 9-102, the application of subsection (a)(3) is not limited to transferees who are new debtors. Note also that, under Section 9-507, the nancing statement naming Debtor remains eective even though 929

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Newcorp has become the debtor. This section addresses security interests that are perfected (i.e., that have attached and as to which any required perfection step has been taken) before the debtor changes its location. As the following example explains, this section does not apply to security interests that have not attached before the location changes. Example 5: Debtor is a Pennsylvania corporation. Debtor grants to Lender a security interest in Debtor's existing and after-acquired inventory. Lender perfects by ling in Pennsylvania. Debtor's shareholders decide to reincorporate in Delaware. They form a Delaware corporation (Newcorp) into which they merge Debtor. By virtue of the merger, Newcorp becomes bound by Debtor's security agreement. See Section 9-203. After the merger, Newcorp acquires inventory to which Lender's security interest attaches. Because Newcorp is located in Delaware, Delaware law governs perfection of a security interest in Newcorp's inventory. See Sections 9-301, 9-307. Having failed to perfect under Delaware law, Lender holds an unperfected security interest in the inventory acquired by Newcorp after the merger. The same result follows regardless of the name of the Delaware corporation (i.e., even if the Delaware corporation and Debtor have the same name). A dierent result would occur if Debtor and Newcorp were incorporated in the same state. See Section 9-508, Comment 4. 3. Retroactive Unperfection. Subsection (b) sets forth the consequences of the failure to reperfect before perfection ceases under subsection (a): the security interest becomes unperfected prospectively and, as against purchasers for value, including buyers and secured parties, but not as against donees or lien creditors, retroactively. The rule applies to agricultural liens, as well. See also Section 9-515 (taking the same approach with respect to lapse). Although this approach creates the potential for circular priorities, the alternativeretroactive unperfection against lien creditorswould create substantial and unjustiable preference risks. Example 6: Under the facts of Example 4, six months after the merger, Buyer bought from Newcorp some equipment formerly owned by Debtor. At the time of the purchase, Buyer took subject to Lender's perfected security interest, of which Buyer was unaware. See Section 9-315(a)(1). However, subsection (b) provides that if Lender fails to reperfect in Delaware within a year after the merger, its security interest becomes unperfected and is deemed never to have been perfected against Buyer. Having given value and received delivery of the equipment without knowledge of the security interest and before it was perfected, Buyer would take free of the security interest. See Section 9-317(b). Example 7: Under the facts of Example 4, one month before the merger, Debtor created a security interest in certain equipment in favor of Financer, who perfected by ling in Pennsylvania. At that time, Financer's security interest is subordinate to Lender's. See Section 9-322(a)(1). Financer reperfects by ling in Delaware within a year after the merger, but Lender fails to do so. Under subsection (b), Lender's security interest is deemed never to have been perfected against Financer, a purchaser for value. Consequently, under Section 9-322(a)(2), Financer's security interest is now senior. Of course, the expiration of the time period specied in subsection (a) does not of itself prevent the secured party from later reperfecting under the law of the new jurisdiction. If the secured party does so, however, there will be a gap in perfection, and the secured party may lose priority as a result. Thus, in Example 7, if Lender perfects by ling in Delaware more than one year under the merger, it will have a new date of ling and perfection for purposes of Section 9-322(a)(1). Financer's security interest, whose perfection dates back to the ling in Pennsylvania under subsection (b), will remain senior. 4. Possessory Security Interests. Subsection (c) deals with continued perfection of possessory security interests. It applies not only to security interests perfected solely by the secured party's having taken possession of the collateral. It also applies to security interests perfected by a method that includes as an element of perfection the secured party's having taken possession, such as perfection by taking delivery of a certicated security in registered form, see Section 9-313(a), and perfection by obtaining control over a certicated security. See Section 9-314(a). 5. Goods Covered by Certicate of Title. Subsections (d) and (e) address continued perfection of a security interest in goods covered by a certicate of title. The following examples explain the operation of those subsections. Example 8: Debtor's automobile is covered by a certicate of title issued by Illinois. 930

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Lender perfects a security interest in the automobile by complying with Illinois' certicate-of-title statute. Thereafter, Debtor applies for a certicate of title in Indiana. Six months thereafter, Creditor acquires a judicial lien on the automobile. Under Section 9-303(b), Illinois law ceases to govern perfection; rather, once Debtor delivers the application and applicable fee to the appropriate Indiana authority, Indiana law governs. Nevertheless, under Indiana's Section 9-316(d), Lender's security interest remains perfected until it would become unperfected under Illinois law had no certicate of title been issued by Indiana. (For example, Illinois' certicate-of-title statute may provide that the surrender of an Illinois certicate of title in connection with the issuance of a certicate of title by another jurisdiction causes a security interest noted thereon to become unperfected.) If Lender's security interest remains perfected, it is senior to Creditor's judicial lien. Example 9: Under the facts in Example 8, ve months after Debtor applies for an Indiana certicate of title, Debtor sells the automobile to Buyer. Under subsection (e)(2), because Lender did not reperfect within the four months after the goods became covered by the Indiana certicate of title, Lender's security interest is deemed never to have been perfected against Buyer. Under Section 9-317(b), Buyer is likely to take free of the security interest. Lender could have protected itself by perfecting its security interest either under Indiana's certicate-of-title statute, see Section 9-311, or, if it had a right to do so under an agreement or Section 9-609, by taking possession of the automobile. See Section 9-313(b). The results in Examples 8 and 9 do not depend on the fact that the original perfection was achieved by notation on a certicate of title. Subsection (d) applies regardless of the method by which a security interest is perfected under the law of another jurisdiction when the goods became covered by a certicate of title from this State. Section 9-337 aords protection to a limited class of persons buying or acquiring a security interest in the goods while a security interest is perfected under the law of another jurisdiction but after this State has issued a clean certicate of title. 6. Deposit Accounts, Letter-of-Credit Rights, and Investment Property. Subsections (f) and (g) address changes in the jurisdiction of a bank, issuer of an uncerticated security, issuer of or nominated person under a letter of credit, securities intermediary, and commodity intermediary. The provisions are analogous to those of subsections (a) and (b). 7. Agricultural Liens. This section does not apply to agricultural liens. Example 10: Supplier holds an agricultural lien on corn. The lien arises under an Iowa statute. Supplier perfects by ling a nancing statement in Iowa, where the corn is located. See Section 9-302. Debtor stores the corn in Missouri. Assume the Iowa agricultural lien survives or an agricultural lien arises under Missouri law (matters that this Article does not govern). Once the corn is located in Missouri, Missouri becomes the jurisdiction whose law governs perfection. See Section 9-302. Thus, the agricultural lien will not be perfected unless Supplier les a nancing statement in Missouri.

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

[SUBPART 3. PRIORITY] 9-317. Interests That Take Priority Over or Take Free of Security Interest or Agricultural Lien. (a) [Conicting security interests and rights of lien creditors.] A security interest or agricultural lien is subordinate to the rights of: (1) a person entitled to priority under Section 9-322; and (2) except as otherwise provided in subsection (e), a person that becomes a lien creditor before the earlier of the time: (A) the security interest or agricultural lien is perfected; or (B) one of the conditions specied in Section 9-203(b)(3) is met and a nancing statement covering the collateral is led.
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(b) [Buyers that receive delivery.] Except as otherwise provided in subsection (e), a buyer, other than a secured party, of tangible chattel paper, tangible documents, goods, instruments, or a security certicate takes free of a security interest or agricultural lien if the buyer gives value and receives delivery of the collateral without knowledge of the security interest or agricultural lien and before it is perfected. (c) [Lessees that receive delivery.] Except as otherwise provided in subsection (e), a lessee of goods takes free of a security interest or agricultural lien if the lessee gives value and receives delivery of the collateral without knowledge of the security interest or agricultural lien and before it is perfected. (d) [Licensees and buyers of certain collateral.] A licensee of a general intangible or a buyer, other than a secured party, of accounts, electronic chattel paper, electronic documents, general intangibles, or investment property other than a certicated security takes free of a security interest if the licensee or buyer gives value without knowledge of the security interest and before it is perfected. (e) [Purchase-money security interest.] Except as otherwise provided in Sections 9-320 and 9-321, if a person les a nancing statement with respect to a purchase-money security interest before or within 20 days after the debtor receives delivery of the collateral, the security interest takes priority over the rights of a buyer, lessee, or lien creditor which arise between the time the security interest attaches and the time of ling. As amended in 2000 and 2003.
See Appendix P for material relating to changes made in text in 2000. See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Source. Former Sections 9-301, 2A-307(2). 2. Scope of This Section. As did former Section 9-301, this section lists the classes of persons who take priority over, or take free of, an unperfected security interest. Section 9-308 explains when a security interest or agricultural lien is perfected. A security interest that has attached (see Section 9-203) but as to which a required perfection step has not been taken is unperfected. Certain provisions have been moved from former Section 9-301. The denition of lien creditor now appears in Section 9-102, and the rules governing priority in future advances are found in Section 9-323. 3. Competing Security Interests. Section 9-322 states general rules for determining priority among conicting security interests and refers to other sections that state special rules of priority in a variety of situations. The security interests given priority under Section 9-322 and the other sections to which it refers take priority in general even over a perfected security interest. A fortiori they take priority over an unperfected security interest. Paragraph (a)(1) of this section so states.* 4. Filed but Unattached Security Interest vs. Lien Creditor. Under former Section 9-301(1)(b), a lien creditor's rights had priority over an unperfected security interest. Perfection required attachment (former Section 9-303), and attachment required the giving of value (former Section 9-203). It followed that, if a secured party had led a nancing statement, but the debtor had not entered into a security agreement and value had not yet been given, an intervening lien creditor whose lien arose after ling but before attachment [Section 9-317] *Amendments in italics approved by 932 the Permanent Editorial Board for Uniform Commercial Code October 20, 1999.

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of the security interest acquired rights that are senior to those of the secured party who later gives value. This result comported with the nemo dat concept: When the security interest attached, the collateral was already subject to the judicial lien. On the other hand, this approach treated the rst secured advance dierently from all other advances, even in circumstances in which a security agreement covering the collateral had been entered into before the judicial lien attached. The special rule for future advances in former Section 9-301(4) (substantially reproduced in Section 9-323(b)) aorded priority to a discretionary advance made by a secured party within 45 days after the lien creditor's rights arose as long as the secured party was perfected when the lien creditor's lien arose-i.e., as long as the advance was not the rst one and an earlier advance had been made. Subsection (a)(2) revises former Section 9-301(1)(b) and, in appropriate cases, treats the rst advance the same as subsequent advances. More specically, a judicial lien that arises after the security-agreement condition of Section 9-203(b)(3) is satised and a nancing statement is led, but before the security interest attaches and becomes perfected, is subordinate to all advances secured by the security interest, even the rst advance, except as otherwise provided in Section 9-323(b). However, if the security interest becomes unperfected (e.g., because the eectiveness of the led nancing statement lapses) before the judicial lien arises, the security interest is subordinate. If a nancing statement is led but a security interest does not attach, then no priority contest arises. The lien creditor has the only enforceable claim to the property. 5. Security Interest of Consignor or Receivables Buyer vs. Lien Creditor. Section 1-201(37) denes security interest to include the interest of most true consignors of goods and the interest of most buyers of certain receivables (accounts, chattel paper, payment intangibles, and promissory notes). A consignee of goods or a seller of accounts or chattel paper each is deemed to have rights in the collateral which a lien creditor may reach, as long as the competing security interest of the consignor or buyer is unperfected. This is so even though, as between the consignor and the debtor-consignee, the latter has only limited rights, and, as between the buyer and debtor-seller, the latter does not have any rights in the collateral. See Sections 9-318 (seller), 9-319 (consignee). Security interests arising from sales of payment intangibles and promissory notes are automatically perfected. See Section 9-309. Accordingly, a subsequent judicial lien always would be subordinate to the rights of a buyer of those types of receivables. 6. Purchasers Other Than Secured Parties. Subsections (b), (c), and (d) aord priority over an unperfected security interest to certain purchasers (other than secured parties) of collateral. They derive from former Sections 9-301(1)(c), 2A-307(2), and 9-301(d). Former Section 9-301(1)(c) and (1)(d) provided that unperfected security interests are subordinate to the rights of certain purchasers. But, as former Comment 9 suggested, the practical effect of subordination in this context is that the purchaser takes free of the security interest. To avoid any possible misinterpretation, subsections (b) and (d) of this section use the phrase takes free. Subsection (b) governs goods, as well as intangibles of the type whose transfer is eected by physical delivery of the representative piece of paper (tangible chattel paper, tangible documents, instruments, and security certicates). To obtain priority, a buyer must both give value and receive delivery of the collateral without knowledge of the existing security interest and before perfection. Even if the buyer gave value without knowledge and before perfection, the buyer would take subject to the security interest if perfection occurred before physical delivery of the collateral to the buyer. Subsection (c) contains a similar rule with respect to lessees of goods. Note that a lessee of goods in ordinary course of business takes free of all security interests created by the lessor, even if perfected. See Section 9-321. Normally, there will be no question when a buyer of tangible chattel paper, tangible documents, instruments, or security certicates receives delivery of the property. See Section 1-201 (dening delivery). However, sometimes a buyer or lessee of goods, such as complex machinery, takes delivery of the goods in stages and completes assembly at its own location. Under those circumstances, the buyer or lessee receives delivery within the meaning of subsections (b) and (c) when, after an inspection of the portion of the goods remaining with the seller or lessor, it would be apparent to a potential lender to the seller or lessor that another person might have an interest in the goods. The rule of subsection (b) obviously is not appropriate where the collateral consists of 933

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intangibles and there is no representative piece of paper whose physical delivery is the only or the customary method of transfer. Therefore, with respect to such intangibles (accounts, electronic chattel paper, electronic documents, general intangibles, and investment property other than certicated securities), subsection (d) gives priority to any buyer who gives value without knowledge, and before perfection, of the security interest. A licensee of a general intangible takes free of an unperfected security interest in the general intangible under the same circumstances. Note that a licensee of a general intangible in ordinary course of business takes rights under a nonexclusive license free of security interests created by the licensor, even if perfected. See Section 9-321. Unless Section 9-109 excludes the transaction from this Article, a buyer of accounts, chattel paper, payment intangibles, or promissory notes is a secured party (dened in Section 9-102), and subsections (b) and (d) do not determine priority of the security interest created by the sale. Rather, the priority rules generally applicable to competing security interests apply. See Section 9-322. 7. Agricultural Liens. Subsections (a), (b), and (c) subordinate unperfected agricultural liens in the same manner in which they subordinate unperfected security interests. 8. Purchase-Money Security Interests. Subsection (e) derives from former Section 9-301(2). It provides that, if a purchase-money security interest is perfected by ling no later than 20 days after the debtor receives delivery of the collateral, the security interest takes priority over the rights of buyers, lessees, or lien creditors which arise between the time the security interest attaches and the time of ling. Subsection (e) diers from former Section 9-301(2) in two signicant respects. First, subsection (e) protects a purchase-money security interest against all buyers and lessees, not just against transferees in bulk. Second, subsection (e) conditions this protection on ling within 20, as opposed to ten, days after delivery. Section 9-311(b) provides that compliance with the perfection requirements of a statute or treaty described in Section 9-311(a) is equivalent to the ling of a nancing statement. It follows that a person who perfects a security interest in goods covered by a certicate of title by complying with the perfection requirements of an applicable certicate-of-title statute les a nancing statement within the meaning of subsection(e).

As amended in 1999, 2000 and 2003.

See Appendix P for material relating to changes made in Ocial Comment in 1999 and 2000. See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

9-318. No Interest Retained in Right to Payment That Is Sold; Rights and Title of Seller of Account or Chattel Paper With Respect to Creditors and Purchasers. (a) [Seller retains no interest.] A debtor that has sold an account, chattel paper, payment intangible, or promissory note does not retain a legal or equitable interest in the collateral sold. (b) [Deemed rights of debtor if buyer's security interest unperfected.] For purposes of determining the rights of creditors of, and purchasers for value of an account or chattel paper from, a debtor that has sold an account or chattel paper, while the buyer's security interest is unperfected, the debtor is deemed to have rights and title to the account or chattel paper identical to those the debtor sold. Ocial Comment
1. Source. New. 2. Sellers of Accounts, Chattel Paper, Payment Intangibles, and Promissory Notes. Section 1-201(37) denes security interest to include the interest of a buyer of accounts, chattel paper, payment intangibles, or promissory notes. See also Section 9-109(a) and Comment 5. Subsection (a) makes explicit what was implicit, but perfectly obvious, under former Article 9: The fact that a sale of an account or chattel paper gives rise to a 934

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security interest does not imply that the seller retains an interest in the property that has been sold. To the contrary, a seller of an account or chattel paper retains no interest whatsoever in the property to the extent that it has been sold. Subsection (a) also applies to sales of payment intangibles and promissory notes, transactions that were not covered by former Article 9. Neither this Article nor the denition of security interest in Section 1-201 provides rules for distinguishing sales transactions from those that create a security interest securing an obligation. 3. Buyers of Accounts and Chattel Paper. Another aspect of sales of accounts and chattel paper also was implicit, and equally obvious, under former Article 9: If the buyer's security interest is unperfected, then for purposes of determining the rights of certain third parties, the seller (debtor) is deemed to have all rights and title that the seller sold. The seller is deemed to have these rights even though, as between the parties, it has sold all its rights to the buyer. Subsection (b) makes this explicit. As a consequence of subsection (b), if the buyer's security interest is unperfected, the seller can transfer, and the creditors of the seller can reach, the account or chattel paper as if it had not been sold. Example: Debtor sells accounts or chattel paper to Buyer-1 and retains no interest in them. Buyer-1 does not le a nancing statement. Debtor then sells the same receivables to Buyer-2. Buyer-2 les a proper nancing statement. Having sold the receivables to Buyer-1, Debtor would not have any rights in the collateral so as to permit Buyer-2's security (ownership) interest to attach. Nevertheless, under this section, for purposes of determining the rights of purchasers for value from Debtor, Debtor is deemed to have the rights that Debtor sold. Accordingly, Buyer-2's security interest attaches, is perfected by the ling, and, under Section 9-322, is senior to Buyer-1's interest. 4. Eect of Perfection. If the security interest of a buyer of accounts or chattel paper is perfected the usual result would take eect: transferees from and creditors of the seller could not acquire an interest in the sold accounts or chattel paper. The same result generally would occur if payment intangibles or promissory notes were sold, inasmuch as the buyer's security interest is automatically perfected under Section 9-309. However, in certain circumstances a purchaser who takes possession of a promissory note will achieve priority, under Sections 9-330 or 9-331, over the security interest of an earlier buyer of the promissory note. It necessarily follows that the seller in those circumstances retains the power to transfer the promissory note, as if it had not been sold, to a purchaser who obtains priority under either of those sections. See Section 9-203(b)(3), Comment 6.

9-319. Rights and Title of Consignee With Respect to Creditors and Purchasers. (a) [Consignee has consignor's rights.] Except as otherwise provided in subsection (b), for purposes of determining the rights of creditors of, and purchasers for value of goods from, a consignee, while the goods are in the possession of the consignee, the consignee is deemed to have rights and title to the goods identical to those the consignor had or had power to transfer. (b) [Applicability of other law.] For purposes of determining the rights of a creditor of a consignee, law other than this article determines the rights and title of a consignee while goods are in the consignee's possession if, under this part, a perfected security interest held by the consignor would have priority over the rights of the creditor. Ocial Comment
1. Source. New. 2. Consignments. This section takes an approach to consignments similar to that taken by Section 9-318 with respect to buyers of accounts and chattel paper. Revised Section 1-201(37) denes security interest to include the interest of a consignor of goods under many true consignments. Section 9-319(a) provides that, for purposes of determining the rights of certain third parties, the consignee is deemed to acquire all rights and title that the consignor had, if the consignor's security interest is unperfected. The consignee acquires these rights even though, as between the parties, it purchases a limited interest in the 935

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goods (as would be the case in a true consignment, under which the consignee acquires only the interest of a bailee). As a consequence of this section, creditors of the consignee can acquire judicial liens and security interests in the goods. Insofar as creditors of the consignee are concerned, this Article to a considerable extent reformulates the former law, which appeared in former Sections 2-326 and 9-114, without changing the results. However, neither Article 2 nor former Article 9 specically addresses the rights of non-ordinary course buyers from the consignee. Former Section 9-114 contained priority rules applicable to security interests in consigned goods. Under this Article, the priority rules for purchase-money security interests in inventory apply to consignments. See Section 9-103(d). Accordingly, a special section containing priority rules for consignments no longer is needed. Section 9-317 determines whether the rights of a judicial lien creditor are senior to the interest of the consignor, Sections 9-322 and 9-324 govern competing security interests in consigned goods, and Sections 9-317, 9-315, and 9-320 determine whether a buyer takes free of the consignor's interest. The following example explains the operation of this section: Example 1: SP-1 delivers goods to Debtor in a transaction constituting a consignment as dened in Section 9-102. SP-1 does not le a nancing statement. Debtor then grants a security interest in the goods to SP-2. SP-2 les a proper nancing statement. Assuming Debtor is a mere bailee, as in a true consignment, Debtor would not have any rights in the collateral (beyond those of a bailee) so as to permit SP-2's security interest to attach to any greater rights. Nevertheless, under this section, for purposes of determining the rights of Debtor's creditors, Debtor is deemed to acquire SP-1's rights. Accordingly, SP-2's security interest attaches, is perfected by the ling, and, under Section 9-322, is senior to SP-1's interest. 3. Eect of Perfection. Subsection (b) contains a special rule with respect to consignments that are perfected. If application of this Article would result in the consignor having priority over a competing creditor, then other law determines the rights and title of the consignee. Example 2: SP-1 delivers goods to Debtor in a transaction constituting a consignment as dened in Section 9-102. SP-1 les a proper nancing statement. Debtor then grants a security interest in the goods to SP-2. Under Section 9-322, SP-1's security interest is senior to SP-2's. Subsection (b) indicates that, for purposes of determining SP2's rights, other law determines the rights and title of the consignee. If, for example, a consignee obtains only the special property of a bailee, then SP-2's security interest would attach only to that special property. Example 3: SP-1 obtains a security interest in all Debtor's existing and after-acquired inventory. SP-1 perfects its security interest with a proper ling. Then SP-2 delivers goods to Debtor in a transaction constituting a consignment as dened in Section 9-102. SP-2 les a proper nancing statement but does not send notication to SP-1 under Section 9-324(b). Accordingly, SP-2's security interest is junior to SP-1's under Section 9-322(a). Under Section 9-319(a), Debtor is deemed to have the consignor's rights and title, so that SP-1's security interest attaches to SP-2's ownership interest in the goods. Thereafter, Debtor grants a security interest in the goods to SP-3, and SP-3 perfects by ling. Because SP-2's perfected security interest is senior to SP-3's under Section 9-322(a), Section 9-319(b) applies: Other law determines Debtor's rights and title to the goods insofar as SP-3 is concerned, and SP-3's security interest attaches to those rights.

9-320. Buyer of Goods. (a) [Buyer in ordinary course of business.] Except as otherwise provided in subsection (e), a buyer in ordinary course of business, other than a person buying farm products from a person engaged in farming operations, takes free of a security interest created by the buyer's seller, even if the security interest is perfected and the buyer knows of its existence. (b) [Buyer of consumer goods.] Except as otherwise provided in subsection (e), a buyer of goods from a person who used or bought the goods for use primarily for personal, family, or household purposes takes free of a security interest, even if perfected, if the buyer buys:
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(1) without knowledge of the security interest; (2) for value; (3) primarily for the buyer's personal, family, or household purposes; and (4) before the ling of a nancing statement covering the goods. (c) [Eectiveness of ling for subsection (b).] To the extent that it aects the priority of a security interest over a buyer of goods under subsection (b), the period of eectiveness of a ling made in the jurisdiction in which the seller is located is governed by Section 9-316(a) and (b). (d) [Buyer in ordinary course of business at wellhead or minehead.] A buyer in ordinary course of business buying oil, gas, or other minerals at the wellhead or minehead or after extraction takes free of an interest arising out of an encumbrance. (e) [Possessory security interest not aected.] Subsections (a) and (b) do not aect a security interest in goods in the possession of the secured party under Section 9-313. Ocial Comment
1. Source. Former Section 9-307. 2. Scope of This Section. This section states when buyers of goods take free of a security interest even though perfected. Of course, a buyer who takes free of a perfected security interest takes free of an unperfected one. Section 9-317 should be consulted to determine what purchasers, in addition to the buyers covered in this section, take free of an unperfected security interest. Article 2 states general rules on purchase of goods from a seller with defective or voidable title (Section 2-403). 3. Buyers in Ordinary Course. Subsection (a) derives from former Section 9-307(1). The denition of buyer in ordinary course of business in Section 1-201 restricts its application to buyers from a person, other than a pawnbroker, in the business of selling goods of that kind. Thus subsection (a) applies primarily to inventory collateral. The subsection further excludes from its operation buyers of farm products(dened in Section 9-102) from a person engaged in farming operations. The buyer in ordinary course of business is dened as one who buys goods in good faith, without knowledge that the sale violates the rights of another person and in the ordinary course. Subsection (a) provides that such a buyer takes free of a security interest, even though perfected, and even though the buyer knows the security interest exists. Reading the denition together with the rule of law results in the buyer's taking free if the buyer merely knows that a security interest covers the goods but taking subject if the buyer knows, in addition, that the sale violates a term in an agreement with the secured party. As did former Section 9-307(1), subsection (a) applies only to security interests created by the seller of the goods to the buyer in ordinary course. However, under certain circumstances a buyer in ordinary course who buys goods that were encumbered with a security interest created by a person other than the seller may take free of the security interest, as Example 2 explains. See also Comment 6, below. Example 1: Manufacturer, who is in the business of manufacturing appliances, owns manufacturing equipment subject to a perfected security interest in favor of Lender. Manufacturer sells the equipment to Dealer, who is in the business of buying and selling used equipment. Buyer buys the equipment from Dealer. Even if Buyer qualies as a buyer in the ordinary course of business, Buyer does not take free of Lender's security interest under subsection (a), because Dealer did not create the security interest; Manufacturer did. Example 2: Manufacturer, who is in the business of manufacturing appliances, owns manufacturing equipment subject to a perfected security interest in favor of Lender. Manufacturer sells the equipment to Dealer, who is in the business of buying and selling used equipment. Lender learns of the sale but does nothing to assert its security interest. Buyer buys the equipment from Dealer. Inasmuch as Lender's acquiescence constitutes an entrusting of the goods to Dealer within the meaning of Section 2-403(3) Buyer 937

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takes free of Lender's security interest under Section 2-403(2) if Buyer qualies as a buyer in ordinary course of business. 4. Buyers of Farm Products. This section does not enable a buyer of farm products to take free of a security interest created by the seller, even if the buyer is a buyer in ordinary course of business. However, a buyer of farm products may take free of a security interest under Section 1324 of the Food Security Act of 1985, 7 U.S.C. 1631. 5. Buyers of Consumer Goods. Subsection (b), which derives from former Section 9-307(2), deals with buyers of collateral that the debtor-seller holds as consumer goods (dened in Section 9-102). Under Section 9-309(1), a purchase-money interest in consumer goods, except goods that are subject to a statute or treaty described in Section 9-311(a) (such as automobiles that are subject to a certicate-of-title statute), is perfected automatically upon attachment. There is no need to le to perfect. Under subsection (b) a buyer of consumer goods takes free of a security interest, even though perfected, if the buyer buys (1) without knowledge of the security interest, (2) for value, (3) primarily for the buyer's own personal, family, or household purposes, and (4) before a nancing statement is led. As to purchase money-security interests which are perfected without ling under Section 9-309(1): A secured party may le a nancing statement, although ling is not required for perfection. If the secured party does le, all buyers take subject to the security interest. If the secured party does not le, a buyer who meets the qualications stated in the preceding paragraph takes free of the security interest. As to security interests for which a perfection step is required: This category includes all non-purchase-money security interests, and all security interests, whether or not purchasemoney, in goods subject to a statute or treaty described in Section 9-311(a), such as automobiles covered by a certicate-of-title statute. As long as the required perfection step has not been taken and the security interest remains unperfected, not only the buyers described in subsection (b) but also the purchasers described in Section 9-317 will take free of the security interest. After a nancing statement has been led or the perfection requirements of the applicable certicate-of-title statute have been complied with (compliance is the equivalent of ling a nancing statement; see Section 9-311(b)), all subsequent buyers, under the rule of subsection (b), are subject to the security interest. The rights of a buyer under subsection (b) turn on whether a nancing statement has been led against consumer goods. Occasionally, a debtor changes his or her location after a ling is made. Subsection (c), which derives from former Section 9-103(1)(d)(iii), deals with the continued eectiveness of the ling under those circumstances. It adopts the rules of Sections 9-316(a) and (b). These rules are explained in the Comments to that section. 6. Authorized Dispositions. The limitations that subsections (a) and (b) impose on the persons who may take free of a security interest apply of course only to unauthorized sales by the debtor. If the secured party authorized the sale in an express agreement or otherwise, the buyer takes free under Section 9-315(a) without regard to the limitations of this section. (That section also states the right of a secured party to the proceeds of a sale, authorized or unauthorized.) Moreover, the buyer also takes free if the secured party waived or otherwise is precluded from asserting its security interest against the buyer. See Section 1-103. 7. Oil, Gas, and Other Minerals. Under subsection (d), a buyer in ordinary course of business of minerals at the wellhead or minehead or after extraction takes free of a security interest created by the seller. Specically, it provides that qualied buyers take free not only of Article 9 security interests but also of interests arising out of an encumbrance. As dened in Section 9-102, the term encumbrance means a right, other than an ownership interest, in real property. Thus, to the extent that a mortgage encumbers minerals not only before but also after extraction, subsection (d) enables a buyer in ordinary course of the minerals to take free of the mortgage. This subsection does not, however, enable these buyers to take free of interests arising out of ownership interests in the real property. This issue is signicant only in a minority of states. Several of them have adopted special statutes and nonuniform amendments to Article 9 to provide special protections to mineral owners, whose interests often are highly fractionalized in the case of oil and gas. See Terry I. Cross, Oil and Gas Product LiensStatutory Security Interests for Producers and Royalty Owners Under the Statutes of Kansas, New Mexico, Oklahoma, Texas and Wyoming, 50 Consumer Fin. L. Q. Rep. 418 (1996). Inasmuch as a complete resolution of the issue would require the addition of complex provisions to this Article, and there are good reasons to believe that a uniform solution would not be feasible, this Article leaves its resolution to 938

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other legislation. 8. Possessory Security Interests. Subsection (e) is new. It rejects the holding of Tanbro Fabrics Corp. v. Deering Milliken, Inc., 350 N.E.2d 590 (N.Y. 1976) and, together with Section 9-317(b), prevents a buyer of goods collateral from taking free of a security interest if the collateral is in the possession of the secured party. The secured party referred in subsection (e) is the holder of the security interest referred to in subsection (a) or (b). Section 9-313 determines whether a secured party is in possession for purposes of this section. Under some circumstances, Section 9-313 provides that a secured party is in possession of collateral even if the collateral is in the physical possession of a third party.

9-321. Licensee of General Intangible and Lessee of Goods in Ordinary Course of Business. (a) [Licensee in ordinary course of business.] In this section, licensee in ordinary course of business means a person that becomes a licensee of a general intangible in good faith, without knowledge that the license violates the rights of another person in the general intangible, and in the ordinary course from a person in the business of licensing general intangibles of that kind. A person becomes a licensee in the ordinary course if the license to the person comports with the usual or customary practices in the kind of business in which the licensor is engaged or with the licensor's own usual or customary practices. (b) [Rights of licensee in ordinary course of business.] A licensee in ordinary course of business takes its rights under a nonexclusive license free of a security interest in the general intangible created by the licensor, even if the security interest is perfected and the licensee knows of its existence. (c) [Rights of lessee in ordinary course of business.] A lessee in ordinary course of business takes its leasehold interest free of a security interest in the goods created by the lessor, even if the security interest is perfected and the lessee knows of its existence. Ocial Comment
1. Source. Derived from Sections 2A-103(1)(o), 2A-307(3). 2. Licensee in Ordinary Course. Like the analogous rules in Section 9-320(a) with respect to buyers in ordinary course and subsection (c) with respect to lessees in ordinary course, the new rule in subsection (b) reects the expectations of the parties and the marketplace: a licensee under a nonexclusive license takes subject to a security interest unless the secured party authorizes the license free of the security interest or other, controlling law such as that of this section (protecting ordinary-course licensees) dictates a contrary result. See Sections 9-201, 9-315. The denition of licensee in ordinary course of business in subsection (a) is modeled upon that of buyer in ordinary course of business. 3. Lessee in Ordinary Course. Subsection (c) contains the rule formerly found in Section 2A-307(3). The rule works in the same way as that of Section 9-320(a).

9-322. Priorities Among Conicting Security Interests in and Agricultural Liens on Same Collateral. (a) [General priority rules.] Except as otherwise provided in this section, priority among conicting security interests and agricultural liens in the same collateral is determined according to the following rules: (1) Conicting perfected security interests and agricultural liens rank according to priority in time of ling or perfection. Priority dates from the earlier of the time a ling covering the collateral is rst made or the security interest or agricultural lien is rst perfected, if there is no period thereafter when there is neither ling nor perfection.
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(2) A perfected security interest or agricultural lien has priority over a conicting unperfected security interest or agricultural lien. (3) The rst security interest or agricultural lien to attach or become eective has priority if conicting security interests and agricultural liens are unperfected. (b) [Time of perfection: proceeds and supporting obligations.] For the purposes of subsection (a)(1): (1) the time of ling or perfection as to a security interest in collateral is also the time of ling or perfection as to a security interest in proceeds; and (2) the time of ling or perfection as to a security interest in collateral supported by a supporting obligation is also the time of ling or perfection as to a security interest in the supporting obligation. (c) [Special priority rules: proceeds and supporting obligations.] Except as otherwise provided in subsection (f), a security interest in collateral which qualies for priority over a conicting security interest under Section 9-327, 9-328, 9-329, 9-330, or 9-331 also has priority over a conicting security interest in: (1) any supporting obligation for the collateral; and (2) proceeds of the collateral if: (A) the security interest in proceeds is perfected; (B) the proceeds are cash proceeds or of the same type as the collateral; and (C) in the case of proceeds that are proceeds of proceeds, all intervening proceeds are cash proceeds, proceeds of the same type as the collateral, or an account relating to the collateral. (d) [First-to-le priority rule for certain collateral.] Subject to subsection (e) and except as otherwise provided in subsection (f), if a security interest in chattel paper, deposit accounts, negotiable documents, instruments, investment property, or letter-of-credit rights is perfected by a method other than ling, conicting perfected security interests in proceeds of the collateral rank according to priority in time of ling. (e) [Applicability of subsection (d).] Subsection (d) applies only if the proceeds of the collateral are not cash proceeds, chattel paper, negotiable documents, instruments, investment property, or letter-of-credit rights. (f) [Limitations on subsections (a) through (e).] Subsections (a) through (e) are subject to: (1) subsection (g) and the other provisions of this part; (2) Section 4-210 with respect to a security interest of a collecting bank; (3) Section 5-118 with respect to a security interest of an issuer or nominated person; and (4) Section 9-110 with respect to a security interest arising under Article 2 or 2A. (g) [Priority under agricultural lien statute.] A perfected agricultural lien on collateral has priority over a conicting security interest in or agricultural lien on the same collateral if the statute creating the agricultural lien so provides.
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Ocial Comment
1. Source. Former Section 9-312(5), (6). 2. Scope of This Section. In a variety of situations, two or more people may claim a security interest in the same collateral. This section states general rules of priority among conicting security interests. As subsection (f) provides, the general rules in subsections (a) through (e) are subject to the rule in subsection (g) governing perfected agricultural liens and to the other rules in this Part of this Article. Rules that override this section include those applicable to purchase-money security interests (Section 9-324) and those qualifying for special priority in particular types of collateral. See, e.g., Section 9-327 (deposit accounts); Section 9-328 (investment property); Section 9-329 (letter-of-credit rights); Section 9-330 (chattel paper and instruments); Section 9-334 (xtures). In addition, the general rules of sections (a) through (e) are subject to priority rules governing security interests arising under Articles 2, 2A, 4, and 5. 3. General Rules. Subsection (a) contains three general rules. Subsection (a)(1) governs the priority of competing perfected security interests. Subsection (a)(2) governs the priority of competing security interests if one is perfected and the other is not. Subsection (a)(3) governs the priority of competing unperfected security interests. The rules may be regarded as adaptations of the idea, deeply rooted at common law, of a race of diligence among creditors. The rst two rules are based on precedence in the time as of which the competing secured parties either led their nancing statements or obtained perfected security interests. Under subsection (a)(1), the rst secured party who les or perfects has priority. Under subsection (a)(2), which is new, a perfected security interest has priority over an unperfected one. Under subsection (a)(3), if both security interests are unperfected, the rst to attach has priority. Note that Section 9-709(b) may aect the application of subsection (a) to a ling that occurred before the eective date of this Article and which would be ineffective to perfect a security interest under former Article 9 but eective under this Article. 4. Competing Perfected Security Interests. When there is more than one perfected security interest, the security interests rank according to priority in time of ling or perfection. Filing, of course, refers to the ling of an eective nancing statement. Perfection refers to the acquisition of a perfected security interest, i.e., one that has attached and as to which any required perfection step has been taken. See Sections 9-308 and 9-309. Example 1: On February 1, A les a nancing statement covering a certain item of Debtor's equipment. On March 1, B les a nancing statement covering the same equipment. On April 1, B makes a loan to Debtor and obtains a security interest in the equipment. On May 1, A makes a loan to Debtor and obtains a security interest in the same collateral. A has priority even though B's loan was made earlier and was perfected when made. It makes no dierence whether A knew of B's security interest when A made its advance. The problem stated in Example 1 is peculiar to a notice-ling system under which ling may occur before the security interest attaches (see Section 9-502). The justication for determining priority by order of ling lies in the necessity of protecting the ling system that is, of allowing the rst secured party who has led to make subsequent advances without each time having to check for subsequent lings as a condition of protection. Note, however, that this rst-to-le protection is not absolute. For example, Section 9-324 aords priority to certain purchase-money security interests, even if a competing secured party was the rst to le or perfect. Example 2: A and B make non-purchase-money advances secured by the same collateral. The collateral is in Debtor's possession, and neither security interest is perfected when the second advance is made. Whichever secured party rst perfects its security interest (by taking possession of the collateral or by ling) takes priority. It makes no dierence whether that secured party knows of the other security interest at the time it perfects its own. The rule of subsection (a)(1), aording priority to the rst to le or perfect, applies to security interests that are perfected by any method, including temporarily (Section 9-312) or upon attachment (Section 9-309), even though there may be no notice to creditors or subsequent purchasers and notwithstanding any common-law rule to the contrary. The form of the claim to priority, i.e., ling or perfection, may shift from time to time, and the rank will be based on the rst ling or perfection as long as there is no intervening period without ling or perfection. See Section 9-308(c). 941

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Example 3: On October 1, A acquires a temporarily perfected (20-day) security interest, unled, in a tangible negotiable document in the debtor's possession under Section 9-312(e). On October 5, B les and thereby perfects a security interest that previously had attached to the same document. On October 10, A les. A has priority, even after the 20-day period expires, regardless of whether A knows of B's security interest when A les. A was the rst to perfect and maintained continuous perfection or ling since the start of the 20-day period. However, the perfection of A's security interest extends only to the extent it arises for new value given. To the extent A's security interest secures advances made by A beyond the 20-day period, its security interest would be subordinate to B's, inasmuch as B was the rst to le. In general, the rule in subsection (a)(1) does not distinguish among various advances made by a secured party. The priority of every advance dates from the earlier of ling or perfection. However, in rare instances, the priority of an advance dates from the time the advance is made. See Example 3 and Section 9-323. 5. Priority in After-Acquired Property. The application of the priority rules to afteracquired property must be considered separately for each item of collateral. Priority does not depend only on time of perfection but may also be based on priority in ling before perfection. Example 4: On February 1, A makes advances to Debtor under a security agreement covering all Debtor's machinery, both existing and after-acquired. A promptly les a nancing statement. On April 1, B takes a security interest in all Debtor's machinery, existing and after-acquired, to secure an outstanding loan. The following day, B les a nancing statement. On May 1, Debtor acquires a new machine. When Debtor acquires rights in the new machine, both A and B acquire security interests in the machine simultaneously. Both security interests are perfected simultaneously. However, A has priority because A led before B. When after-acquired collateral is encumbered by more than one security interest, one of the security interests often is a purchase-money security interest that is entitled to special priority under Section 9-324. 6. Priority in Proceeds: General Rule. Subsection (b)(1) follows former Section 9-312(6). It provides that the baseline rules of subsection (a) apply generally to priority conicts in proceeds except where otherwise provided (e.g., as in subsections (c) through (e)). Under Section 9-203, attachment cannot occur (and therefore, under Section 9-308, perfection cannot occur) as to particular collateral until the collateral itself comes into existence and the debtor has rights in it. Thus, a security interest in proceeds of original collateral does not attach and is not perfected until the proceeds come into existence and the debtor acquires rights in them. Example 5: On April 1, Debtor authenticates a security agreement granting to A a security interest in all Debtor's existing and after-acquired inventory. The same day, A les a nancing statement covering inventory. On May 1, Debtor authenticates a security agreement granting B a security interest in all Debtor's existing and future accounts. On June 1, Debtor sells inventory to a customer on 30-day unsecured credit. When Debtor acquires the account, B's security interest attaches to it and is perfected by B's nancing statement. At the very same time, A's security interest attaches to the account as proceeds of the inventory and is automatically perfected. See Section 9-315. Under subsection (b) of this section, for purposes of determining A's priority in the account, the time of ling as to the original collateral (April 1, as to inventory) is also the time of ling as to proceeds (account). Accordingly, A's security interest in the account has priority over B's. Of course, had B led its nancing statement before A led (e.g., on March 1), then B would have priority in the accounts. Section 9-324 governs the extent to which a special purchase-money priority in goods or software carries over into the proceeds of the original collateral. 7. Priority in Proceeds: Special Rules. Subsections (c), (d), and (e), which are new, provide additional priority rules for proceeds of collateral in situations where the temporal (rst-in-time) rules of subsection (a)(1) are not appropriate. These new provisions distinguish what these Comments refer to as non-ling collateral from what they call ling collateral. As used in these Comments, non-ling collateral is collateral of a type for which perfection may be achieved by a method other than ling (possession or control, mainly) and for which secured parties who so perfect generally do not expect or need to conduct a ling search. More specically, non-ling collateral is chattel paper, deposit ac942

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counts, negotiable documents, instruments, investment property, and letter-of-credit rights. Other collateralaccounts, commercial tort claims, general intangibles, goods, nonnegotiable documents, and payment intangibles-is ling collateral. 8. Proceeds of Non-Filing Collateral: Non-Temporal Priority. Subsection (c)(2) provides a baseline priority rule for proceeds of non-ling collateral which applies if the secured party has taken the steps required for non-temporal priority over a conicting security interest in non-ling collateral (e.g., control, in the case of deposit accounts, letter-ofcredit rights, investment property, and in some cases, electronic negotiable documents, section 9-331). This rule determines priority in proceeds of non-ling collateral whether or not there exists an actual conicting security interest in the original non-ling collateral. Under subsection (c)(2), the priority in the original collateral continues in proceeds if the security interest in proceeds is perfected and the proceeds are cash proceeds or non-ling proceeds of the same type as the original collateral. As used in subsection (c)(2), type means a type of collateral dened in the Uniform Commercial Code and should be read broadly. For example, a security is of the same type as a security entitlement (i.e., investment property), and a promissory note is of the same type as a draft (i.e., an instrument). Example 6: SP-1 perfects its security interest in investment property by ling. SP-2 perfects subsequently by taking control of a certicated security. Debtor receives cash proceeds of the security (e.g., dividends deposited into Debtor's deposit account). If the rst-to-le-or-perfect rule of subsection (a)(1) were applied, SP-1's security interest in the cash proceeds would be senior, although SP-2's security interest continues perfected under Section 9-315 beyond the 20-day period of automatic perfection. This was the result under former Article 9. Under subsection (c), however, SP-2's security interest is senior. Note that a dierent result would obtain in Example 6 (i.e., SP-1's security interest would be senior) if SP-1 were to obtain control of the deposit-account proceeds. This is so because subsection (c) is subject to subsection (f), which in turn provides that the priority rules under subsections (a) through (e) are subject to the other provisions of this part. One of those other provisions is Section 9-327, which aords priority to a security interest perfected by control. See Section 9-327(1). Example 7: SP-1 perfects its security interest in investment property by ling. SP-2 perfects subsequently by taking control of a certicated security. Debtor receives proceeds of the security consisting of a new certicated security issued as a stock dividend on the original collateral. Although the new security is of the same type as the original collateral (i.e., investment property), once the 20-day period of automatic perfection expires (see Section 9-315(d)), SP-2's security interest is unperfected. (SP-2 has not led or taken delivery or control, and no temporary-perfection rule applies.) Consequently, once the 20day period expires, subsection (c) does not confer priority, and, under subsection (a)(2), SP-1's security interest in the security is senior. This was the result under former Article 9. Example 8: SP-1 perfects its security interest in investment property by ling. SP-2 perfects subsequently by taking control of a certicated security and also by ling against investment property. Debtor receives proceeds of the security consisting of a new certicated security issued as a stock dividend of the collateral. Because the new security is of the same type as the original collateral (i.e., investment property) and (unlike Example 7) SP-2's security interest is perfected by ling, SP-2's security interest is senior under subsection (c). If the new security were redeemed by the issuer upon surrender and yet another security were received by Debtor, SP-2's security interest would continue to enjoy priority under subsection (c). The new security would be proceeds of proceeds. Example 9: SP-1 perfects its security interest in investment property by ling. SP-2 subsequently perfects its security interest in investment property by taking control of a certicated security and also by ling against investment property. Debtor receives proceeds of the security consisting of a dividend check that it deposits to a deposit account. Because the check and the deposit account are cash proceeds, SP-1's and SP-2's security interests in the cash proceeds are perfected under Section 9-315 beyond the 20day period of automatic perfection. However, SP-2's security interest is senior under subsection (c). Example 10: SP-1 perfects its security interest in investment property by ling. SP-2 perfects subsequently by taking control of a certicated security and also by ling against investment property. Debtor receives an instrument as proceeds of the security. (Assume 943

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that the instrument is not cash proceeds.) Because the instrument is not of the same type as the original collateral (i.e., investment property), SP-2's security interest, although perfected by ling, does not achieve priority under subsection (c). Under the rst-to-leor-perfect rule of subsection (a)(1), SP-1's security interest in the proceeds is senior. The proceeds of proceeds are themselves proceeds. See Section 9-102 (dening proceeds and collateral). Sometimes competing security interests arise in proceeds that are several generations removed from the original collateral. As the following example explains, the applicability of subsection (c) may turn on the nature of the intervening proceeds. Example 11: SP-1 perfects its security interest in Debtor's deposit account by obtaining control. Thereafter, SP-2 les against inventory, (presumably) searches, nds no indication of a conicting security interest, and advances against Debtor's existing and after-acquired inventory. Debtor uses funds from the deposit account to purchase inventory, which SP-1 can trace as identiable proceeds of its security interest in Debtor's deposit account, and which SP-2 claims as original collateral. The inventory is sold and the proceeds deposited into another deposit account, as to which SP-1 has not obtained control. Subsection (c) does not govern priority in this other deposit account. This deposit account is cash proceeds and is also the same type of collateral as SP-1's original collateral, as required by subsections (c)(2)(A) and (B). However, SP-1's security interest does not satisfy subsection (c)(2)(C) because the inventory proceeds, which intervened between the original deposit account and the deposit account constituting the proceeds at issue, are not cash proceeds, proceeds of the same type as the collateral (original deposit account), or an account relating to the collateral. Stated otherwise, once proceeds other than cash proceeds, proceeds of the same type as the original collateral, or an account relating to the original collateral intervene in the chain of proceeds, priority under subsection (c) is thereafter unavailable. The special priority rule in subsection (d) also is inapplicable to this case. See Comment 9, Example 13, below. Instead, the general rst-tole-or-perfect rule of subsections (a) and (b) apply. Under that rule, SP-1 has priority unless its security interest in the inventory proceeds became unperfected under Section 9-315(d). Had SP-2 led against inventory before SP-1 obtained control of the original deposit account, the SP-2 would have had priority even if SP-1's security interest in the inventory proceeds remained perfected. 9. Proceeds of Non-Filing Collateral: Special Temporal Priority. Under subsections (d) and (e), if a security interest in non-ling collateral is perfected by a method other than ling (e.g., control or possession), it does not retain its priority over a conicting security interest in proceeds that are ling collateral. Moreover, it is not entitled to priority in proceeds under the rst-to le-or-perfect rule of subsections (a)(1) and (b). Instead, under subsection (d), priority is determined by a new rst-to-le rule. Example 12: SP-1 perfects its security interest in Debtor's deposit account by obtaining control. Thereafter, SP-2 les against equipment, (presumably) searches, nds no indication of a conicting security interest, and advances against Debtor's equipment. SP-1 then les against Debtor's equipment. Debtor uses funds from the deposit account to purchase equipment, which SP-1 can trace as proceeds of its security interest in Debtor's deposit account. If the rst-to-le-or-perfect rule were applied, SP-1's security interest would be senior under subsections (a)(1) and (b), because it was the rst to perfect in the original collateral and there was no period during which its security interest was unperfected. Under subsection (d), however, SP-2's security interest would be senior because it led rst. This corresponds with the likely expectations of the parties. Note that under subsection (e), the rst-to-le rule of subsection (d) applies only if the proceeds in question are other than non-ling collateral (i.e., if the proceeds are ling collateral). If the proceeds are non-ling collateral, either the rst-to-le-or-perfect rule under subsections (a) and (b) or the non-temporal priority rule in subsection (c) would apply, depending on the facts. Example 13: SP-1 perfects its security interest in Debtor's deposit account by obtaining control. Thereafter, SP-2 les against inventory, (presumably) searches, nds no indication of a conicting security interest, and advances against Debtor's existing and after-acquired inventory. Debtor uses funds from the deposit account to purchase inventory, which SP-1 can trace as identiable proceeds of its security interest in Debtor's deposit account, and which SP-2 claims as original collateral. The inventory is sold and the proceeds deposited into another deposit account, as to which SP-1 has not obtained control. As discussed above in Comment 8, Example 11, subsection (c) does not govern 944

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priority in this deposit account. Subsection (d) also does not govern, because the proceeds at issue (the deposit account) are cash proceeds. See subsection (e). Rather, the general rules of subsections (a) and (b) govern. 10. Priority in Supporting Obligations. Under subsections (b)(2) and (c)(1), a security interest having priority in collateral also has priority in a supporting obligation for that collateral. However, the rules in these subsections are subject to the special rule in Section 9-329 governing the priority of security interests in a letter-of-credit right. See subsection (f). Under Section 9-329, a secured party's failure to obtain control (Section 9-107) of a letter-of-credit right that serves as supporting collateral leaves its security interest exposed to a priming interest of a party who does take control. 11. Unperfected Security Interests. Under subsection (a)(3), if conicting security interests are unperfected, the rst to attach has priority. This rule may be of merely theoretical interest, inasmuch as it is hard to imagine a situation where the case would come into litigation without either secured party's having perfected its security interest. If neither security interest had been perfected at the time of the ling of a petition in bankruptcy, ordinarily neither would be good against the trustee in bankruptcy under the Bankruptcy Code. 12. Agricultural Liens. Statutes other than this Article may purport to grant priority to an agricultural lien as against a conicting security interest or agricultural lien. Under subsection (g), if another statute grants priority to an agricultural lien, the agricultural lien has priority only if the same statute creates the agricultural lien and the agricultural lien is perfected. Otherwise, subsection (a) applies the same priority rules to an agricultural lien as to a security interest, regardless of whether the agricultural lien conicts with another agricultural lien or with a security interest. Inasmuch as no agricultural lien on proceeds arises under this Article, subsections (b) through (e) do not apply to proceeds of agricultural liens. However, if an agricultural lien has priority under subsection (g) and the statute creating the agricultural lien gives the secured party a lien on proceeds of the collateral subject to the lien, a court should apply the principle of subsection (g) and award priority in the proceeds to the holder of the perfected agricultural lien.

As amended in 2000 and 2003.

See Appendix P for material relating to changes made in Ocial Comment in 2000. See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

9-323. Future Advances. (a) [When priority based on time of advance.] Except as otherwise provided in subsection (c), for purposes of determining the priority of a perfected security interest under Section 9-322(a)(1), perfection of the security interest dates from the time an advance is made to the extent that the security interest secures an advance that: (1) is made while the security interest is perfected only: (A) under Section 9-309 when it attaches; or (B) temporarily under Section 9-312(e), (f), or (g); and (2) is not made pursuant to a commitment entered into before or while the security interest is perfected by a method other than under Section 9-309 or 9-312(e), (f), or (g). (b) [Lien creditor.] Except as otherwise provided in subsection (c), a security interest is subordinate to the rights of a person that becomes a lien creditor to the extent that the security interest secures an advance made more than 45 days after the person becomes a lien creditor unless the advance is made: (1) without knowledge of the lien; or
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(2) pursuant to a commitment entered into without knowledge of the lien. (c) [Buyer of receivables.] Subsections (a) and (b) do not apply to a security interest held by a secured party that is a buyer of accounts, chattel paper, payment intangibles, or promissory notes or a consignor. (d) [Buyer of goods.] Except as otherwise provided in subsection (e), a buyer of goods other than a buyer in ordinary course of business takes free of a security interest to the extent that it secures advances made after the earlier of: (1) the time the secured party acquires knowledge of the buyer's purchase; or (2) 45 days after the purchase. (e) [Advances made pursuant to commitment: priority of buyer of goods.] Subsection (d) does not apply if the advance is made pursuant to a commitment entered into without knowledge of the buyer's purchase and before the expiration of the 45-day period. (f) [Lessee of goods.] Except as otherwise provided in subsection (g), a lessee of goods, other than a lessee in ordinary course of business, takes the leasehold interest free of a security interest to the extent that it secures advances made after the earlier of: (1) the time the secured party acquires knowledge of the lease; or (2) 45 days after the lease contract becomes enforceable. (g) [Advances made pursuant to commitment: priority of lessee of goods.] Subsection (f) does not apply if the advance is made pursuant to a commitment entered into without knowledge of the lease and before the expiration of the 45-day period. As amended in 1999.
See Appendix P for material relating to changes made in text in 1999.

Ocial Comment
1. Source. Former Sections 9-312(7), 9-301(4), 9-307(3), 2A-307(4). 2. Scope of This Section. A security agreement may provide that collateral secures future advances. See Section 9-204(c). This section collects all of the special rules dealing with the priority of advances made by a secured party after a third party acquires an interest in the collateral. Subsection (a) applies when the third party is a competing secured party. It replaces and claries former Section 9-312(7). Subsection (b) deals with lien creditors and replaces former Section 9-301(4). Subsections (d) and (e) deal with buyers and replace former Section 9-307(3). Subsections (f) and (g) deal with lessees and replace former Section 2A-307(4). 3. Competing Security Interests. Under a proper reading of the rst-to-le-or- perfect rule of Section 9-322(a)(1) (and former Section 9-312(5)), it is abundantly clear that the time when an advance is made plays no role in determining priorities among conicting security interests except when a nancing statement was not led and the advance is the giving of value as the last step for attachment and perfection. Thus, a secured party takes subject to all advances secured by a competing security interest having priority under Section 9-322(a)(1). This result generally obtains regardless of how the competing security interest is perfected and regardless of whether the advances are made pursuant to commitment (Section 9-102). Subsection (a) of this section states the only other instance when the time of an advance gures in the priority scheme in Section 9-322: when the security interest is perfected only automatically under Section 9-309 or temporarily under Section 9-312(e), (f), or (g), and the advance is not made pursuant to a commitment entered into while the security interest was perfected by another method. Thus, an advance has priority 946

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from the date it is made only in the rare case in which it is made without commitment and while the security interest is perfected only temporarily under Section 9-312. The new formulation in subsection (a) claries the result when the initial advance is paid and a new (future) advance is made subsequently. Under former Section 9-312(7), the priority of the new advance turned on whether it was made while a security interest is perfected. This section resolves any ambiguity by omitting the quoted phrase. Example 1: On February 1, A makes an advance secured by machinery in the debtor's possession and les a nancing statement. On March 1, B makes an advance secured by the same machinery and les a nancing statement. On April 1, A makes a further advance, under the original security agreement, against the same machinery. A was the rst to le and so, under the rst-to-le-or-perfect rule of Section 9-322(a)(1), A's security interest has priority over B's, both as to the February 1 and as to the April 1 advance. It makes no dierence whether A knows of B's intervening advance when A makes the second advance. Note that, as long as A was the rst to le or perfect, A would have priority with respect to both advances if either A or B had perfected by taking possession of the collateral. Likewise, A would have priority if A's April 1 advance was not made under the original agreement with the debtor, but was under a new agreement. Example 2: On October 1, A acquires a temporarily perfected (20-day) security interest, unled, in a tangible negotiable document in the debtor's possession under Section 9-312(e) or (f). The security interest secures an advance made on that day as well as future advances. On October 5, B les and thereby perfects a security interest that previously had attached to the same document. On October 8, A makes an additional advance. On October 10, A les. Under Section 9-322(a)(1), because A was the rst to perfect and maintained continuous perfection or ling since the start of the 20-day period, A has priority, even after the 20-day period expires. See Section 9-322, Comment 4, Example 3. However, under this section, for purposes of Section 9-322(a)(1), to the extent A's security interest secures the October 8 advance, the security interest was perfected on October 8. Inasmuch as B perfected on October 5, B has priority over the October 8 advance. The rule in subsection (a) is more liberal toward the priority of future advances than the corresponding rules applicable to intervening lien creditors (subsection (b)), buyers (subsections (d) and (e)), and lessees (subsections (f) and (g)). 4. Competing Lien Creditors. Subsection (b) replaces former Section 9-301(4). It addresses the problem considered by PEB Commentary No. 2 and removes the ambiguity that necessitated the Commentary. Former Section 9-301(4) appeared to state a general rule that a lien creditor has priority over a perfected security interest and is subject to the security interest only in specied circumstances. Because that section spoke to the making of an advance, it arguably implied that to the extent a security interest secured non-advances (expenses, interest, etc.), it was junior to the lien creditor's interest and addresses the rights of a lien creditor, as dened in Section 9-102. Under Section 9-317(a)(2), a perfected security interest is senior to the rights of a subsequent lien creditor a person who becomes a lien creditor, unless the person becomes a lien creditor before the security interest is perfected and before a nancing statement covering the collateral is led and Section 9-203(b)(3) is satised. Subsection (b) of this section eliminates the erroneous implication of former law by providing that a perfected provides that a security interest is subordinate only to those rights to the extent that the specied circumstances occur. Subsection (b) does not elevate the priority of a security interest that is subordinate to the rights of a lien creditor under Section 9-317(a)(2); it only subordinates.* As under former Section 9-301(4), a secured party's knowledge does not cut short the 45day period during which future advances can achieve priority over an intervening lien creditor's interest. Rather, because of the impact of the rule in subsection (b) on the question whether the security interest for future advances is protected under Section 6323(c)(2) and (d) of the Internal Revenue Code as amended by the Federal Tax Lien Act of 1966, the priority of the security interest for future advances over a lien creditor is made absolute for 45 days regardless of knowledge of the secured party concerning the lien. If, however, the [Section 9-323] *Amendments in italics approved by the Permanent Editorial Board for Uniform Commercial Code October 20, 1999. 947

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advance is made after the 45 days, the advance will not have priority unless it was made or committed without knowledge of the lien. 5. Sales of Receivables; Consignments. Subsections (a) and (b) do not apply to outright sales of accounts, chattel paper, payment intangibles, or promissory notes, nor do they apply to consignments. 6. Competing Buyers and Lessees. Under subsections (d) and (e), a buyer will not take subject to a security interest to the extent it secures advances made after the secured party has knowledge that the buyer has purchased the collateral or more than 45 days after the purchase unless the advances were made pursuant to a commitment entered into before the expiration of the 45-day period and without knowledge of the purchase. Subsections (f) and (g) provide an analogous rule for lessees. Of course, a buyer in ordinary course who takes free of the security interest under Section 9-320 and a lessee in ordinary course who takes free under Section 9-321 are not subject to any future advances. Subsections (d) and (e) replace former Section 9-307(3), and subsections (f) and (g) replace former Section 2A-307(4). No change in meaning is intended.

As amended in 1999, 2000 and 2003.

See Appendix P for material relating to changes made in Ocial Comment in 1999 and 2000. See Appendix I contained within revised Article 7 for material relating to changes made in Ocial Comment in 2003.

9-324. Priority of Purchase-Money Security Interests. (a) [General rule: purchase-money priority.] Except as otherwise provided in subsection (g), a perfected purchase-money security interest in goods other than inventory or livestock has priority over a conicting security interest in the same goods, and, except as otherwise provided in Section 9-327, a perfected security interest in its identiable proceeds also has priority, if the purchase-money security interest is perfected when the debtor receives possession of the collateral or within 20 days thereafter. (b) [Inventory purchase-money priority.] Subject to subsection (c) and except as otherwise provided in subsection (g), a perfected purchasemoney security interest in inventory has priority over a conicting security interest in the same inventory, has priority over a conicting security interest in chattel paper or an instrument constituting proceeds of the inventory and in proceeds of the chattel paper, if so provided in Section 9-330, and, except as otherwise provided in Section 9-327, also has priority in identiable cash proceeds of the inventory to the extent the identiable cash proceeds are received on or before the delivery of the inventory to a buyer, if: (1) the purchase-money security interest is perfected when the debtor receives possession of the inventory; (2) the purchase-money secured party sends an authenticated notication to the holder of the conicting security interest; (3) the holder of the conicting security interest receives the notication within ve years before the debtor receives possession of the inventory; and (4) the notication states that the person sending the notication has or expects to acquire a purchase-money security interest in inventory of the debtor and describes the inventory. (c) [Holders of conicting inventory security interests to be notied.] Subsections (b)(2) through (4) apply only if the holder of the
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conicting security interest had led a nancing statement covering the same types of inventory: (1) if the purchase-money security interest is perfected by ling, before the date of the ling; or (2) if the purchase-money security interest is temporarily perfected without ling or possession under Section 9-312(f), before the beginning of the 20-day period thereunder. (d) [Livestock purchase-money priority.] Subject to subsection (e) and except as otherwise provided in subsection (g), a perfected purchasemoney security interest in livestock that are farm products has priority over a conicting security interest in the same livestock, and, except as otherwise provided in Section 9-327, a perfected security interest in their identiable proceeds and identiable products in their unmanufactured states also has priority, if: (1) the purchase-money security interest is perfected when the debtor receives possession of the livestock; (2) the purchase-money secured party sends an authenticated notication to the holder of the conicting security interest; (3) the holder of the conicting security interest receives the notication within six months before the debtor receives possession of the livestock; and (4) the notication states that the person sending the notication has or expects to acquire a purchase-money security interest in livestock of the debtor and describes the livestock. (e) [Holders of conicting livestock security interests to be notied.] Subsections (d)(2) through (4) apply only if the holder of the conicting security interest had led a nancing statement covering the same types of livestock: (1) if the purchase-money security interest is perfected by ling, before the date of the ling; or (2) if the purchase-money security interest is temporarily perfected without ling or possession under Section 9-312(f), before the beginning of the 20-day period thereunder. (f) [Software purchase-money priority.] Except as otherwise provided in subsection (g), a perfected purchase-money security interest in software has priority over a conicting security interest in the same collateral, and, except as otherwise provided in Section 9-327, a perfected security interest in its identiable proceeds also has priority, to the extent that the purchase-money security interest in the goods in which the software was acquired for use has priority in the goods and proceeds of the goods under this section. (g) [Conicting purchase-money security interests.] If more than one security interest qualies for priority in the same collateral under subsection (a), (b), (d), or (f): (1) a security interest securing an obligation incurred as all or part of the price of the collateral has priority over a security interest securing an obligation incurred for value given to enable the debtor to acquire rights in or the use of collateral; and
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(2) in all other cases, Section 9-322(a) applies to the qualifying security interests. Ocial Comment
1. Source. Former Section 9-312(3), (4). 2. Priority of Purchase-Money Security Interests. This section contains the priority rules applicable to purchase-money security interests, as dened in Section 9-103. It aords a special, non-temporal priority to those purchase-money security interests that satisfy the statutory conditions. In most cases, priority will be over a security interest asserted under an after-acquired property clause. See Section 9-204 on the extent to which security interests in after-acquired property are validated. A purchase-money security interest can be created only in goods and software. See Section 9-103. Section 9-324(a), which follows former Section 9-312(4), contains the general rule for purchase-money security interests in goods. It is subject to subsections (b) and (c), which derive from former Section 9-312(3) and apply to purchase-money security interests in inventory, and subsections (d) and (e), which apply to purchase-money security interests in livestock that are farm products. Subsection (f) applies to purchase-money security interests in software. Subsection (g) deals with the relatively unusual case in which a debtor creates two purchase-money security interests in the same collateral and both security interests qualify for special priority under one of the other subsections. Former Section 9-312(2) contained a rule aording special priority to those who provided secured credit that enabled a debtor to produce crops. This rule proved unworkable and has been eliminated from this Article. Instead, model Section 9-324A contains a revised production-money priority rule. That section is a model, not uniform, provision. The sponsors of the UCC have taken no position as to whether it should be enacted, instead leaving the matter for state legislatures to consider if they are so inclined. 3. Purchase-Money Priority in Goods Other Than Inventory and Livestock. Subsection (a) states a general rule applicable to all types of goods except inventory and farm-products livestock: the purchase-money interest takes priority if it is perfected when the debtor receives possession of the collateral or within 20 days thereafter. (As to the 20day grace period, compare Section 9-317(e). Former Sections 9-312(4) and 9-301(2) contained a 10-day grace period.) The perfection requirement means that the purchasemoney secured party either has led a nancing statement before that time or has a temporarily perfected security interest in goods covered by documents under Section 9-312(e) and (f) which is continued in a perfected status by ling before the expiration of the 20-day period specied in that section. A purchase-money security interest qualies for priority under subsection (a), even if the purchase-money secured party knows that a conicting security interest has been created and/or that the holder of the conicting interest has led a nancing statement covering the collateral. Normally, there will be no question when the debtor receives possession of the collateral for purposes of subsection (a). However, sometimes a debtor buys goods and takes possession of them in stages, and then assembly and testing are completed (by the seller or debtor-buyer) at the debtor's location. Under those circumstances, the buyer takes possession within the meaning of subsection (a) when, after an inspection of the portion of the goods in the debtor's possession, it would be apparent to a potential lender to the debtor that the debtor has acquired an interest in the goods taken as a whole. A similar issue concerning the time when the debtor receives possession arises when a person acquires possession of goods under a transaction that is not governed by this Article and then later agrees to buy the goods on secured credit. For example, a person may take possession of goods as lessee under a lease contract and then exercise an option to purchase the goods from the lessor on secured credit. Under Section 2A-307(1), creditors of the lessee generally take subject to the lease contract; ling a nancing statement against the lessee is unnecessary to protect the lessor's leasehold or residual interest. Once the lease is converted to a security interest, ling a nancing statement is necessary to protect the seller's (former lessor's) security interest. Accordingly, the 20-day period in subsection (a) does not commence until the goods become collateral (dened in Section 9-102), i.e., until they are subject to a security interest. 4. Purchase-Money Security Interests in Inventory. Subsections (b) and (c) aord a means by which a purchase-money security interest in inventory can achieve priority over 950

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an earlier-led security interest in the same collateral. To achieve priority, the purchasemoney security interest must be perfected when the debtor receives possession of the inventory. For a discussion of when the debtor receives possession, see Comment 3, above. The 20-day grace period of subsection (a) does not apply. The arrangement between an inventory secured party and its debtor typically requires the secured party to make periodic advances against incoming inventory or periodic releases of old inventory as new inventory is received. A fraudulent debtor may apply to the secured party for advances even though it has already given a purchase-money security interest in the inventory to another secured party. For this reason, subsections (b)(2) through (4) and (c) impose a second condition for the purchase-money security interest's achieving priority: the purchase-money secured party must give notication to the holder of a conicting security interest who led against the same item or type of inventory before the purchasemoney secured party led or its security interest became perfected temporarily under Section 9-312(e) or (f). The notication requirement protects the non-purchase-money inventory secured party in such a situation: if the inventory secured party has received notication, it presumably will not make an advance; if it has not received notication (or if the other security interest does not qualify as purchase-money), any advance the inventory secured party may make ordinarily will have priority under Section 9-322. Inasmuch as an arrangement for periodic advances against incoming goods is unusual outside the inventory eld, subsection (a) does not contain a notication requirement. 5. Notication to Conicting Inventory Secured Party: Timing. Under subsection (b)(3), the perfected purchase-money security interest achieves priority over a conicting security interest only if the holder of the conicting security interest receives a notication within ve years before the debtor receives possession of the purchase-money collateral. If the debtor never receives possession, the ve-year period never begins, and the purchasemoney security interest has priority, even if notication is not given. However, where the purchase-money inventory nancing began by the purchase-money secured party's possession of a negotiable document of title, to retain priority the secured party must give the notication required by subsection (b) at or before the usual time, i.e., when the debtor gets possession of the inventory, even though the security interest remains perfected for 20 days under Section 9-312(e) or (f). Some people have mistakenly read former Section 9-312(3)(b) to require, as a condition of purchase-money priority in inventory, that the purchase-money secured party give the notication before it les a nancing statement. Read correctly, the before clauses compare (i) the time when the holder of the conicting security interest led a nancing statement with (ii) the time when the purchase-money security interest becomes perfected by ling or automatically perfected temporarily. Only if (i) occurs before (ii) must notication be given to the holder of the conicting security interest. Subsection (c) has been rewritten to clarify this point. 6. Notication to Conicting Inventory Secured Party: Address. Inasmuch as the address provided as that of the secured party on a led nancing statement is an address that is reasonable under the circumstances, the holder of a purchase-money security interest may satisfy the requirement to send notication to the holder of a conicting security interest in inventory by sending a notication to that address, even if the address is or becomes incorrect. See Section 9-102 (denition of send). Similarly, because the address is held out by [the holder of the conicting security interest] as the place for receipt of such communications [i.e., communications relating to security interests], the holder is deemed to have received a notication delivered to that address. See Section 1-201(26). 7. Consignments. Subsections (b) and (c) also determine the priority of a consignor's interest in consigned goods as against a security interest in the goods created by the consignee. Inasmuch as a consignment subject to this Article is dened to be a purchasemoney security interest, see Section 9-103(d), no inference concerning the nature of the transaction should be drawn from the fact that a consignor uses the term security interest in its notice under subsection (b)(4). Similarly, a notice stating that the consignor has delivered or expects to deliver goods, properly described, on consignment meets the requirements of subsection (b)(4), even if it does not contain the term security interest, and even if the transaction subsequently is determined to be a security interest. Cf. Section 9-505 (use of consignor and consignee in nancing statement). 8. Priority in Proceeds: General. When the purchase-money secured party has priority over another secured party, the question arises whether this priority extends to the 951

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proceeds of the original collateral. Subsections (a), (d), and (f) give an armative answer, but only as to proceeds in which the security interest is perfected (see Section 9-315). Although this qualication did not appear in former Section 9-312(4), it was implicit in that provision. In the case of inventory collateral under subsection (b), where nancing frequently is based on the resulting accounts, chattel paper, or other proceeds, the special priority of the purchase-money secured interest carries over into only certain types of proceeds. As under former Section 9-312(3), the purchase-money priority in inventory under subsection (b) carries over into identiable cash proceeds (dened in Section 9-102) received on or before the delivery of the inventory to a buyer. As a general matter, also like former Section 9-312(3), the purchase-money priority in inventory does not carry over into proceeds consisting of accounts or chattel paper. Many parties nancing inventory are quite content to protect their rst-priority security interest in the inventory itself. They realize that when the inventory is sold, someone else will be nancing the resulting receivables (accounts or chattel paper), and the priority for inventory will not run forward to the receivables constituting the proceeds. Indeed, the cash supplied by the receivables nancer often will be used to pay the inventory nancing. In some situations, the party nancing the inventory on a purchase-money basis makes contractual arrangements that the proceeds of receivables nancing by another be devoted to paying o the inventory security interest. However, the purchase-money priority in inventory does carry over to proceeds consisting of chattel paper and its proceeds (and also to instruments) to the extent provided in Section 9-330. Under Section 9-330(e), the holder of a purchase-money security interest in inventory is deemed to give new value for proceeds consisting of chattel paper. Taken together, Sections 9-324(b) and 9-330(e) enable a purchase-money inventory secured party to obtain priority in chattel paper constituting proceeds of the inventory, even if the secured party does not actually give new value for the chattel paper, provided the purchase-money secured party satises the other conditions for achieving priority. When the proceeds of original collateral (goods or software) consist of a deposit account, Section 9-327 governs priority to the extent it conicts with the priority rules of this section. 9. Priority in Accounts Constituting Proceeds of Inventory. The application of the priority rules in subsection (b) is shown by the following examples: Example 1: Debtor creates a security interest in its existing and after-acquired inventory in favor of SP-1, who les a nancing statement covering inventory. SP-2 subsequently takes a purchase-money security interest in certain inventory and, under subsection (b), achieves priority in this inventory over SP-1. This inventory is then sold, producing accounts. Accounts are not cash proceeds, and so the special purchase-money priority in the inventory does not control the priority in the accounts. Rather, the rstto-le-or-perfect rule of Section 9-322(a)(1) applies. The time of SP-1's ling as to the inventory is also the time of ling as to the accounts under Section 9-322(b). Assuming that each security interest in the accounts proceeds remains perfected under Section 9-315, SP-1 has priority as to the accounts. Example 2: In Example 1, if SP-2 had led directly against accounts, the date of that ling as to accounts would be compared with the date of SP-1's ling as to the inventory. The rst led would prevail under Section 9-322(a)(1). Example 3: If SP-3 had led against accounts in Example 1 before either SP-1 or SP-2 led against inventory, SP-3's ling against accounts would have priority over the lings of SP-1 and SP-2. This result obtains even though the lings against inventory are eective to continue the perfected status of SP-1's and SP-2's security interest in the accounts beyond the 20-day period of automatic perfection. See Section 9-315. SP-1's and SP-2's position as to the inventory does not give them a claim to accounts (as proceeds of the inventory) which is senior to someone who has led earlier against accounts. If, on the other hand, either SP-1's or SP-2's ling against the inventory preceded SP-3's ling against accounts, SP-1 or SP-2 would outrank SP-3 as to the accounts. 10. Purchase-Money Security Interests in Livestock. New subsections (d) and (e) provide a purchase-money priority rule for farm-products livestock. They are patterned on the purchase-money priority rule for inventory found in subsections (b) and (c) and include a requirement that the purchase-money secured party notify earlier-led parties. Two differences between subsections (b) and (d) are noteworthy. First, unlike the purchase-money 952

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inventory lender, the purchase-money livestock lender enjoys priority in all proceeds of the collateral. Thus, under subsection (d), the purchase-money secured party takes priority in accounts over an earlier-led accounts nancer. Second, subsection (d) aords priority in certain products of the collateral as well as proceeds. 11. Purchase-Money Security Interests in Aquatic Farm Products. Aquatic goods produced in aquacultural operations (e.g., catsh raised on a catsh farm) are farm products. See Section 9-102 (denition of farm products). The denition does not indicate whether aquatic goods are crops, as to which the model production money security interest priority in Section 9-324A applies, or livestock, as to which the purchase-money priority in subsection (d) of this section applies. This Article leaves courts free to determine the classication of particular aquatic goods on a case-by-case basis, applying whichever priority rule makes more sense in the overall context of the debtor's business. 12. Purchase-Money Security Interests in Software. Subsection (f) governs the priority of purchase-money security interests in software. Under Section 9-103(c), a purchase-money security interest arises in software only if the debtor acquires its interest in the software for the principal purpose of using the software in goods subject to a purchase-money security interest. Under subsection (f), a purchase-money security interest in software has the same priority as the purchase-money security interest in the goods in which the software was acquired for use. This priority is determined under subsections (b) and (c) (for inventory) or (a) (for other goods). 13. Multiple Purchase-Money Security Interests. New subsection (g) governs priority among multiple purchase-money security interests in the same collateral. It grants priority to purchase-money security interests securing the price of collateral (i.e., created in favor of the seller) over purchase-money security interests that secure enabling loans. Section 7.2(c) of the Restatement (3d) of the Law of Property (Mortgages) (1997) adopts this rule with respect to real property mortgages. As Comment d to that section explains:
the equities favor the vendor. Not only does the vendor part with specic real estate rather than money, but the vendor would never relinquish it at all except on the understanding that the vendor will be able to use it to satisfy the obligation to pay the price. This is the case even though the vendor may know that the mortgagor is going to nance the transaction in part by borrowing from a third party and giving a mortgage to secure that obligation. In the nal analysis, the law is more sympathetic to the vendor's hazard of losing real estate previously owned than to the third party lender's risk of being unable to collect from an interest in real estate that never previously belonged to it.

The rst-to-le-or-perfect rule of Section 9-322 applies to multiple purchase-money security interests securing enabling loans.

9-325. Priority of Security Interests in Transferred Collateral. (a) [Subordination of security interest in transferred collateral.] Except as otherwise provided in subsection (b), a security interest created by a debtor is subordinate to a security interest in the same collateral created by another person if: (1) the debtor acquired the collateral subject to the security interest created by the other person; (2) the security interest created by the other person was perfected when the debtor acquired the collateral; and (3) there is no period thereafter when the security interest is unperfected. (b) [Limitation of subsection (a) subordination.] Subsection (a) subordinates a security interest only if the security interest: (1) otherwise would have priority solely under Section 9-322(a) or 9-324; or (2) arose solely under Section 2-711(3) or 2A-508(5). Ocial Comment
1. Source. New. 2. Double Debtor Problem. This section addresses the double debtor problem, 953

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which arises when a debtor acquires property that is subject to a security interest created by another debtor. 3. Taking Subject to Perfected Security Interest. Consider the following scenario: Example 1: A owns an item of equipment subject to a perfected security interest in favor of SP-A. A sells the equipment to B, not in the ordinary course of business. B acquires its interest subject to SP-A's security interest. See Sections 9-201, 9-315(a)(1). Under this section, if B creates a security interest in the equipment in favor of SP-B, SPB's security interest is subordinate to SP-A's security interest, even if SP-B led against B before SP-A led against A, and even if SP-B took a purchase-money security interest. Normally, SP-B could have investigated the source of the equipment and discovered SPA's ling before making an advance against the equipment, whereas SP-A had no reason to search the lings against someone other than its debtor, A. 4. Taking Subject to Unperfected Security Interest. This section applies only if the security interest in the transferred collateral was perfected when the transferee acquired the collateral. See subsection (a)(2). If this condition is not met, then the normal priority rules apply. Example 2: A owns an item of equipment subject to an unperfected security interest in favor of SP-A. A sells the equipment to B, who gives value and takes delivery of the equipment without knowledge of the security interest. B takes free of the security interest. See Section 9-317(b). If B then creates a security interest in favor of SP-B, no priority issue arises; SP-B has the only security interest in the equipment. Example 3: The facts are as in Example 2, except that B knows of SP-A's security interest and therefore takes the equipment subject to it. If B creates a security interest in the equipment in favor of SP-B, this section does not determine the relative priority of the security interests. Rather, the normal priority rules govern. If SP-B perfects its security interest, then, under Section 9-322(a)(2), SP-A's unperfected security interest will be junior to SP-B's perfected security interest. The award of priority to SP-B is premised on the belief that SP-A's failure to le could have misled SP-B. 5. Taking Subject to Perfected Security Interest that Becomes Unperfected. This section applies only if the security interest in the transferred collateral did not become unperfected at any time after the transferee acquired the collateral. See subsection (a)(3). If this condition is not met, then the normal priority rules apply. Example 4: As in Example 1, A owns an item of equipment subject to a perfected security interest in favor of SP-A. A sells the equipment to B, not in the ordinary course of business. B acquires its interest subject to SP-A's security interest. See Sections 9-201, 9-315(a)(1). B creates a security interest in favor of SP-B, and SP-B perfects its security interest. This section provides that SP-A's security interest is senior to SP-B's. However, if SP-A's nancing statement lapses while SP-B's security interest is perfected, then the normal priority rules would apply, and SP-B's security interest would become senior to SP-A's security interest. See Sections 9-322(a)(2), 9-515(c). 6. Unusual Situations. The appropriateness of the rule of subsection (a) is most apparent when it works to subordinate security interests having priority under the basic priority rules of Section 9-322(a) or the purchase-money priority rules of Section 9-324. The rule also works properly when applied to the security interest of a buyer under Section 2-711(3) or a lessee under Section 2A-508(5). However, subsection (a) may provide an inappropriate resolution of the double debtor problem in some of the wide variety of other contexts in which the problem may arise. Although subsection (b) limits the application of subsection (a) to those cases in which subordination is known to be appropriate, courts should apply the rule in other settings, if necessary to promote the underlying purposes and policies of the Uniform Commercial Code. See Section 1-103(a).

As amended in 2005.
See Appendix V for material relating to changes made in Ocial Comment in 2005.

9-326. Priority of Security Interests Created by New Debtor. (a) [Subordination of security interest created by new debtor.] Subject to subsection (b), a security interest created by a new debtor which is perfected by a led nancing statement that is eective solely under
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Section 9-508 in collateral in which a new debtor has or acquires rights is subordinate to a security interest in the same collateral which is perfected other than by a led nancing statement that is eective solely under Section 9-508. (b) [Priority under other provisions; multiple original debtors.] The other provisions of this part determine the priority among conicting security interests in the same collateral perfected by led nancing statements that are eective solely under Section 9-508. However, if the security agreements to which a new debtor became bound as debtor were not entered into by the same original debtor, the conicting security interests rank according to priority in time of the new debtor's having become bound. Ocial Comment
1. Source. New. 2. Subordination of Security Interests Created by New Debtor. This section addresses the priority contests that may arise when a new debtor becomes bound by the security agreement of an original debtor and each debtor has a secured creditor. Subsection (a) subordinates the original debtor's secured party's security interest perfected against the new debtor solely under Section 9-508. The security interest is subordinated to security interests in the same collateral perfected by another method, e.g., by ling against the new debtor. As used in this section, a led nancing statement that is eective solely under Section 9-508 refers to a nancing statement led against the original debtor that continues to be eective under Section 9-508. It does not encompass a new initial nancing statement providing the name of the new debtor, even if the initial nancing statement is led to maintain the eectiveness of a nancing statement under the circumstances described in Section 9-508(b). Nor does it encompass a nancing statement led against the original debtor which remains eective against collateral transferred by the original debtor to the new debtor. See Section 9-508(c). Concerning priority contests involving transferred collateral, see Sections 9-325 and 9-507. Example 1: SP-X holds a perfected-by-ling security interest in X Corp's existing and after-acquired inventory, and SP-Z holds a perfected-by-possession security interest in an item of Z Corp's inventory. Z Corp becomes bound as debtor by X Corp's security agreement (e.g., Z Corp buys X Corp's assets and assumes its security agreement). See Section 9-203(d). Under Section 9-508, SP-X's nancing statement is eective to perfect a security interest in the item of inventory in which Z Corp has rights. However, subsection (a) provides that SP-X's security interest is subordinate to SP-Z's, regardless of whether SP-X's nancing statement was led before SP-Z perfected its security interest. Example 2: SP-X holds a perfected-by-ling security interest in X Corp's existing and after-acquired inventory, and SP-Z holds a perfected-by-ling security interest in Z Corp's existing and after-acquired inventory. Z Corp becomes bound as debtor by X Corp's security agreement. Subsequently, Z Corp acquires a new item of inventory. Under Section 9-508, SP-X's nancing statement is eective to perfect a security interest in the new item of inventory in which Z Corp has rights. However, because SP-Z's security interest was perfected by another method, subsection (a) provides that SP-X's security interest is subordinate to SP-Z's, regardless of which nancing statement was led rst. This would be the case even if SP-Z led after Z Corp became bound by X Corp's security agreement. 3. Other Priority Rules. Subsection (b) addresses the priority among security interests created by the original debtor (X Corp). By invoking the other priority rules of this subpart, as applicable, subsection (b) preserves the relative priority of security interests created by the original debtor. Example 3: Under the facts of Example 2, SP-Y also holds a perfected-by-ling security interest in X Corp's existing and after-acquired inventory. SP-Y led after SP-X. Inasmuch as both SP-X's and SP-Y's security interests in inventory acquired by Z Corp after it became bound are perfected solely under Section 9-508, the normal priority rules determine their relative priorities. Under the rst-to-le-or-perfect rule of Section 9-322(a)(1), SP-X has priority over SP-Y. Example 4: Under the facts of Example 3, after Z Corp became bound by X Corp's se955

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curity agreement, SP-Y promptly led a new initial nancing statement against Z Corp. At that time, SP-X's security interest was perfected only by virtue of its original ling against X Corp which was eective solely under Section 9-508. Because SP-Y's security interest no longer is perfected by a nancing statement that is eective solely under Section 9-508, this section does not apply to the priority contest. Rather, the normal priority rules apply. Under Section 9-322, because SP-Y's nancing statement was led against Z Corp, the new debtor, before SP-X's, SP-Y's security interest is senior to that of SP-X. Similarly, the normal priority rules would govern priority between SP-Y and SP-Z. The second sentence of subsection (b) eectively limits the applicability of the rst sentence to situations in which a new debtor has become bound by more than one security agreement entered into by the same original debtor. When the new debtor has become bound by security agreements entered into by dierent original debtors, the second sentence provides that priority is based on priority in time of the new debtor's becoming bound. Example 5: Under the facts of Example 2, SP-W holds a perfected-by-ling security interest in W Corp's existing and after-acquired inventory. After Z Corp became bound by X Corp's security agreement in favor of SP-X, Z Corp became bound by W Corp's security agreement. Under subsection (b), SP-W's security interest in inventory acquired by Z Corp is subordinate to that of SP-X, because Z Corp became bound under SP-X's security agreement before it became bound under SP-W's security agreement. This is the result regardless of which nancing statement (SP-X's or SP-W's) was led rst. The second sentence of subsection (b) reects the generally accepted view that priority based on the rst-to-le rule is inappropriate for resolving priority disputes when the lings were made against dierent debtors. Like subsection (a) and the rst sentence of subsection (b), however, the second sentence of subsection (b) relates only to priority conicts among security interests perfected by led nancing statements that are eective solely under Section 9-508. Example 6: Under the facts of Example 5, after Z Corp became bound by W Corp's security agreement, SP-W promptly led a new initial nancing statement against Z Corp. At that time, SP-X's security interest was perfected only pursuant to its original ling against X Corp which was eective solely under Section 9-508. Because SP-W's security interest is not perfected by a nancing statement that is eective solely under Section 9-508, this section does not apply to the priority contest. Rather, the normal priority rules apply. Under Section 9-322, because SP-W's nancing statement was the rst to be led against Z Corp, the new debtor, SP-W's security interest is senior to that of SP-X. Similarly, the normal priority rules would govern priority between SP-W and SP-Z.

9-327. Priority of Security Interests in Deposit Account. The following rules govern priority among conicting security interests in the same deposit account: (1) A security interest held by a secured party having control of the deposit account under Section 9-104 has priority over a conicting security interest held by a secured party that does not have control. (2) Except as otherwise provided in paragraphs (3) and (4), security interests perfected by control under Section 9-314 rank according to priority in time of obtaining control. (3) Except as otherwise provided in paragraph (4), a security interest held by the bank with which the deposit account is maintained has priority over a conicting security interest held by another secured party. (4) A security interest perfected by control under Section 9-104(a)(3) has priority over a security interest held by the bank with which the deposit account is maintained. Ocial Comment
1. Source. New; derived from former Section 9-115(5). 2. Scope of This Section. This section contains the rules governing the priority of 956

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conicting security interests in deposit accounts. It overrides conicting priority rules. See Sections 9-322(f)(1), 9-324(a), (b), (d), (f). This section does not apply to accounts evidenced by an instrument (e.g., certain certicates of deposit), which by denition are not deposit accounts. 3. Control. Under paragraph (1), security interests perfected by control (Sections 9-314, 9-104) take priority over those perfected otherwise, e.g., as identiable cash proceeds under Section 9-315. Secured parties for whom the deposit account is an integral part of the credit decision will, at a minimum, insist upon the right to immediate access to the deposit account upon the debtor's default (i.e., control). Those secured parties for whom the deposit account is less essential will not take control, thereby running the risk that the debtor will dispose of funds on deposit (either outright or for collateral purposes) after default but before the account can be frozen by court order or the secured party can obtain control. Paragraph (2) governs the case (expected to be very rare) in which a bank enters into a Section 9-104(a)(2) control agreement with more than one secured party. It provides that the security interests rank according to time of obtaining control. If the bank is solvent and the control agreements are well drafted, the bank will be liable to each secured party, and the priority rule will have no practical eect. 4. Priority of Bank. Under paragraph (3), the security interest of the bank with which the deposit account is maintained normally takes priority over all other conicting security interests in the deposit account, regardless of whether the deposit account constitutes the competing secured party's original collateral or its proceeds. A rule of this kind enables banks to extend credit to their depositors without the need to examine either the public record or their own records to determine whether another party might have a security interest in the deposit account. A secured party who takes a security interest in the deposit account as original collateral can protect itself against the results of this rule in one of two ways. It can take control of the deposit account by becoming the bank's customer. Under paragraph (4), this arrangement operates to subordinate the bank's security interest. Alternatively, the secured party can obtain a subordination agreement from the bank. See Section 9-339. A secured party who claims the deposit account as proceeds of other collateral can reduce the risk of becoming junior by obtaining the debtor's agreement to deposit proceeds into a specic cash-collateral account and obtaining the agreement of that bank to subordinate all its claims to those of the secured party. But if the debtor violates its agreement and deposits funds into a deposit account other than the cash-collateral account, the secured party risks being subordinated. 5. Priority in Proceeds of, and Funds Transferred from, Deposit Account. The priority aorded by this section does not extend to proceeds of a deposit account. Rather, Section 9-322(c) through (e) and the provisions referred to in Section 9-322(f) govern priorities in proceeds of a deposit account. Section 9-315(d) addresses continuation of perfection in proceeds of deposit accounts. As to funds transferred from a deposit account that serves as collateral, see Section 9-332.

9-328. Priority of Security Interests in Investment Property. The following rules govern priority among conicting security interests in the same investment property: (1) A security interest held by a secured party having control of investment property under Section 9-106 has priority over a security interest held by a secured party that does not have control of the investment property. (2) Except as otherwise provided in paragraphs (3) and (4), conicting security interests held by secured parties each of which has control under Section 9-106 rank according to priority in time of: (A) if the collateral is a security, obtaining control; (B) if the collateral is a security entitlement carried in a securities account and: (i) if the secured party obtained control under Section 8-106(d)(1),
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the secured party's becoming the person for which the securities account is maintained; (ii) if the secured party obtained control under Section 8-106(d)(2), the securities intermediary's agreement to comply with the secured party's entitlement orders with respect to security entitlements carried or to be carried in the securities account; or (iii) if the secured party obtained control through another person under Section 8-106(d)(3), the time on which priority would be based under this paragraph if the other person were the secured party; or (C) if the collateral is a commodity contract carried with a commodity intermediary, the satisfaction of the requirement for control specied in Section 9-106(b)(2) with respect to commodity contracts carried or to be carried with the commodity intermediary. (3) A security interest held by a securities intermediary in a security entitlement or a securities account maintained with the securities intermediary has priority over a conicting security interest held by another secured party. (4) A security interest held by a commodity intermediary in a commodity contract or a commodity account maintained with the commodity intermediary has priority over a conicting security interest held by another secured party. (5) A security interest in a certicated security in registered form which is perfected by taking delivery under Section 9-313(a) and not by control under Section 9-314 has priority over a conicting security interest perfected by a method other than control. (6) Conicting security interests created by a broker, securities intermediary, or commodity intermediary which are perfected without control under Section 9-106 rank equally. (7) In all other cases, priority among conicting security interests in investment property is governed by Sections 9-322 and 9-323. Ocial Comment
1. Source. Former Section 9-115(5). 2. Scope of This Section. This section contains the rules governing the priority of conicting security interests in investment property. Paragraph (1) states the most important general rulethat a secured party who obtains control has priority over a secured party who does not obtain control. Paragraphs (2) through (4) deal with conicting security interests each of which is perfected by control. Paragraph (5) addresses the priority of a security interest in a certicated security which is perfected by delivery but not control. Paragraph (6) deals with the relatively unusual circumstance in which a broker, securities intermediary, or commodity intermediary has created conicting security interests none of which is perfected by control. Paragraph (7) provides that the general priority rules of Sections 9-322 and 9-323 apply to cases not covered by the specic rules in this section. The principal application of this residual rule is that the usual rst in time of ling rule applies to conicting security interests that are perfected only by ling. Because the control priority rule of paragraph (1) provides for the ordinary cases in which persons purchase securities on margin credit from their brokers, there is no need for special rules for purchase-money security interests. See also Section 9-103 (limiting purchase-money collateral to goods and software). 3. General Rule: Priority of Security Interest Perfected by Control. Under paragraph (1), a secured party who obtains control has priority over a secured party who does not obtain control. The control priority rule does not turn on either temporal sequence or awareness of conicting security interests. Rather, it is a structural rule, based on the 958

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principle that a lender should be able to rely on the collateral without question if the lender has taken the necessary steps to assure itself that it is in a position where it can foreclose on the collateral without further action by the debtor. The control priority rule is necessary because the perfection rules provide considerable exibility in structuring secured nancing arrangements. For example, at the retail level, a secured lender to an investor who wants the full measure of protection can obtain control, but the creditor may be willing to accept the greater measure of risk that follows from perfection by ling. Similarly, at the wholesale level, a lender to securities rms can leave the collateral with the debtor and obtain a perfected security interest under the automatic perfection rule of Section 9-309(10), but a lender who wants to be entirely sure of its position will want to obtain control. The control priority rule of paragraph (1) is an essential part of this system of exibility. It is feasible to provide more than one method of perfecting security interests only if the rules ensure that those who take the necessary steps to obtain the full measure of protection do not run the risk of subordination to those who have not taken such steps. A secured party who is unwilling to run the risk that the debtor has granted or will grant a conicting control security interest should not make a loan without obtaining control of the collateral. As applied to the retail level, the control priority rule means that a secured party who obtains control has priority over a conicting security interest perfected by ling without regard to inquiry into whether the control secured party was aware of the led security interest. Prior to the 1994 revisions to Articles 8 and 9, Article 9 did not permit perfection of security interests in securities by ling. Accordingly, parties who deal in securities never developed a practice of searching the UCC les before conducting securities transactions. Although ling is now a permissible method of perfection, in order to avoid disruption of existing practices in this business it is necessary to give perfection by ling a dierent and more limited eect for securities than for some other forms of collateral. The priority rules are not based on the assumption that parties who perfect by the usual method of obtaining control will search the les. Quite the contrary, the control priority rule is intended to ensure that, with respect to investment property, secured parties who do obtain control are entirely unaected by lings. To state the point another way, perfection by ling is intended to aect only general creditors or other secured creditors who rely on ling. The rule that a security interest perfected by ling can be primed by a control security interest, without regard to awareness, is a consequence of the system of perfection and priority rules for investment property. These rules are designed to take account of the circumstances of the securities markets, where ling is not given the same eect as for some other forms of property. No implication is made about the eect of ling with respect to security interests in other forms of property, nor about other Article 9 rules, e.g., Section 9-330, which govern the circumstances in which security interests in other forms of property perfected by ling can be primed by subsequent perfected security interests. The following examples illustrate the application of the priority rule in paragraph (1): Example 1: Debtor borrows from Alpha and grants Alpha a security interest in a variety of collateral, including all of Debtor's investment property. At that time Debtor owns 1000 shares of XYZ Co. stock for which Debtor has a certicate. Alpha perfects by ling. Later, Debtor borrows from Beta and grants Beta a security interest in the 1000 shares of XYZ Co. stock. Debtor delivers the certicate, properly indorsed, to Beta. Alpha and Beta both have perfected security interests in the XYZ Co. stock. Beta has control, see Section 8-106(b)(1), and hence has priority over Alpha. Example 2: Debtor borrows from Alpha and grants Alpha a security interest in a variety of collateral, including all of Debtor's investment property. At that time Debtor owns 1000 shares of XYZ Co. stock, held through a securities account with Able & Co. Alpha perfects by ling. Later, Debtor borrows from Beta and grants Beta a security interest in the 1000 shares of XYZ Co. stock. Debtor instructs Able to have the 1000 shares transferred through the clearing corporation to Custodian Bank, to be credited to Beta's account with Custodian Bank. Alpha and Beta both have perfected security interests in the XYZ Co. stock. Beta has control, see Section 8-106(d)(1), and hence has priority over Alpha. Example 3: Debtor borrows from Alpha and grants Alpha a security interest in a variety of collateral, including all of Debtor's investment property. At that time Debtor owns 1000 shares of XYZ Co. stock, which is held through a securities account with Able & Co. Alpha perfects by ling. Later, Debtor borrows from Beta and grants Beta a security interest in the 1000 shares of XYZ Co. stock. Debtor, Able, and Beta enter into an 959

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agreement under which Debtor will continue to receive dividends and distributions, and will continue to have the right to direct dispositions, but Beta will also have the right to direct dispositions and receive the proceeds. Alpha and Beta both have perfected security interests in the XYZ Co. stock (more precisely, in the Debtor's security entitlement to the nancial asset consisting of the XYZ Co. stock). Beta has control, see Section 8-106(d)(2), and hence has priority over Alpha. Example 4: Debtor borrows from Alpha and grants Alpha a security interest in a variety of collateral, including all of Debtor's investment property. At that time Debtor owns 1000 shares of XYZ Co. stock, held through a securities account with Able & Co. Alpha perfects by ling. Debtor's agreement with Able & Co. provides that Able has a security interest in all securities carried in the account as security for any obligations of Debtor to Able. Debtor incurs obligations to Able and later defaults on the obligations to Alpha and Able. Able has control by virtue of the rule of Section 8-106(e) that if a customer grants a security interest to its own intermediary, the intermediary has control. Since Alpha does not have control, Able has priority over Alpha under the general control priority rule of paragraph (1). 4. Conicting Security Interests Perfected by Control: Priority of Securities Intermediary or Commodity Intermediary. Paragraphs (2) through (4) govern the priority of conicting security interests each of which is perfected by control. The following example explains the application of the rules in paragraphs (3) and (4): Example 5: Debtor holds securities through a securities account with Able & Co. Debtor's agreement with Able & Co. provides that Able has a security interest in all securities carried in the account as security for any obligations of Debtor to Able. Debtor borrows from Beta and grants Beta a security interest in 1000 shares of XYZ Co. stock carried in the account. Debtor, Able, and Beta enter into an agreement under which Debtor will continue to receive dividends and distributions and will continue to have the right to direct dispositions, but Beta will also have the right to direct dispositions and receive the proceeds. Debtor incurs obligations to Able and later defaults on the obligations to Beta and Able. Both Beta and Able have control, so the general control priority rule of paragraph (1) does not apply. Compare Example 4. Paragraph (3) provides that a security interest held by a securities intermediary in positions of its own customer has priority over a conicting security interest of an external lender, so Able has priority over Beta. (Paragraph (4) contains a parallel rule for commodity intermediaries.) The agreement among Able, Beta, and Debtor could, of course, determine the relative priority of the security interests of Able and Beta, see Section 9-339, but the fact that the intermediary has agreed to act on the instructions of a secured party such as Beta does not itself imply any agreement by the intermediary to subordinate. 5. Conicting Security Interests Perfected by Control: Temporal Priority. Former Section 9-115 introduced into Article 9 the concept of conicting security interests that rank equally. Paragraph (2) of this section governs priority in those circumstances in which more than one secured party (other than a broker, securities intermediary, or commodity intermediary) has control. It replaces the equal-priority rule for conicting security interests in investment property with a temporal rule. For securities, both certicated and uncerticated, under paragraph (2)(A) priority is based on the time that control is obtained. For security entitlements carried in securities accounts, the treatment is more complex. Paragraph (2)(B) bases priority on the timing of the steps taken to achieve control. The following example illustrates the application of paragraph (2). Example 6: Debtor borrows from Alpha and grants Alpha a security interest in a variety of collateral, including all of Debtor's investment property. At that time Debtor owns a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through a securities account with Able & Co. Debtor, Able, and Alpha enter into an agreement under which Debtor will continue to receive dividends and distributions, and will continue to have the right to direct dispositions, but Alpha will also have the right to direct dispositions and receive the proceeds. Later, Debtor borrows from Beta and grants Beta a security interest in all its investment property, existing and afteracquired. Debtor, Able, and Beta enter into an agreement under which Debtor will continue to receive dividends and distributions, and will continue to have the right to direct dispositions, but Beta will also have the right to direct dispositions and receive the proceeds. Alpha and Beta both have perfected-by-control security interests in the security entitlement to the XYZ Co. stock by virtue of their agreements with Able. See 960

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Sections 9-314(a), 9-106(a), 8-106(d)(2). Under paragraph (2)(B)(ii), the priority of each security interest dates from the time of the secured party's agreement with Able. Because Alpha's agreement was rst in time, Alpha has priority. This priority applies equally to security entitlements to nancial assets credited to the account after the agreement was entered into. The priority rule is analogous to rst-to-le priority under Section 9-322 with respect to after-acquired collateral. Paragraphs (2)(B)(i) and (2)(B)(iii) provide similar rules for security entitlements as to which control is obtained by other methods, and paragraph (2)(C) provides a similar rule for commodity contracts carried in a commodity account. Section 8-510 also has been revised to provide a temporal priority conforming to paragraph (2)(B). 6. Certicated Securities. A long-standing practice has developed whereby secured parties whose collateral consists of a security evidenced by a security certicate take possession of the security certicate. If the security certicate is in bearer form, the secured party's acquisition of possession constitutes delivery under Section 8-301(a)(1), and the delivery constitutes control under Section 8-106(a). Comment 5 discusses the priority of security interests perfected by control of investment property. If the security certicate is in registered form, the secured party will not achieve control over the security unless the security certicate contains an appropriate indorsement or is (re)registered in the secured party's name. See Section 8-106(b). However, the secured party's acquisition of possession constitutes delivery of the security certicate under Section 8-301 and serves to perfect the security interest under Section 9-313(a), even if the security certicate has not been appropriately indorsed and has not been (re)registered in the secured party's name. A security interest perfected by this method has priority over a security interest perfected other than by control (e.g., by ling). See paragraph (5). The priority rule stated in paragraph (5) may seem anomalous, in that it can aord less favorable treatment to purchasers who buy collateral outright that to those who take a security interest in it. For example, a buyer of a security certicate would cut o a security interest perfected by ling only if the buyer achieves the status of a protected purchaser under Section 8-303. The buyer would not be a protected purchaser, for example, if it does not obtain control under Section 8-106 (e.g., if it fails to obtain a proper indorsement of the certicate) or if it had notice of an adverse claim under Section 8-105. The apparent anomaly disappears, however, when one understands the priority rule not as one intended to protect careless or guilty parties, but as one that eliminates the need to conduct a search of the public records only insofar as necessary to serve the needs of the securities markets. 7. Secured Financing of Securities Firms. Priority questions concerning security interests granted by brokers and securities intermediaries are governed by the general control-beats-non-control priority rule of paragraph (1), as supplemented by the special rules set out in paragraphs (2) (temporal priorityrst to control), (3) (special priority for securities intermediary), and (6) (equal priority for non-control). The following examples illustrate the priority rules as applied to this setting. (In all cases it is assumed that the debtor retains sucient other securities to satisfy all customers' claims. This section deals with the relative rights of secured lenders to a securities rm. Disputes between a secured lender and the rm's own customers are governed by Section 8-511.) Example 7: Able & Co., a securities dealer, enters into nancing arrangements with two lenders, Alpha Bank and Beta Bank. In each case the agreements provide that the lender will have a security interest in the securities identied on lists provided to the lender on a daily basis, that the debtor will deliver the securities to the lender on demand, and that the debtor will not list as collateral any securities which the debtor has pledged to any other lender. Upon Able's insolvency it is discovered that Able has listed the same securities on the collateral lists provided to both Alpha and Beta. Alpha and Beta both have perfected security interests under the automatic-perfection rule of Section 9-309(10). Neither Alpha nor Beta has control. Paragraph (6) provides that the security interests of Alpha and Beta rank equally, because each of them has a noncontrol security interest granted by a securities rm. They share pro-rata. Example 8: Able enters into nancing arrangements, with Alpha Bank and Beta Bank as in Example 7. At some point, however, Beta decides that it is unwilling to continue to provide nancing on a non-control basis. Able directs the clearing corporation where it holds its principal inventory of securities to move specied securities into Beta's account. Upon Able's insolvency it is discovered that a list of collateral provided to Alpha includes securities that had been moved to Beta's account. Both Alpha and Beta have 961

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perfected security interests; Alpha under the automatic-perfection rule of Section 9-309(10), and Beta under that rule and also the perfection-by-control rule in Section 9-314(a). Beta has control but Alpha does not. Beta has priority over Alpha under paragraph (1). Example 9: Able & Co. carries its principal inventory of securities through Clearing Corporation, which oers a shared control facility whereby a participant securities rm can enter into an arrangement with a lender under which the securities rm will retain the power to trade and otherwise direct dispositions of securities carried in its account, but Clearing Corporation agrees that, at any time the lender so directs, Clearing Corporation will transfer any securities from the rm's account to the lender's account or otherwise dispose of them as directed by the lender. Able enters into nancing arrangements with two lenders, Alpha and Beta, each of which obtains such a control agreement from Clearing Corporation. The agreement with each lender provides that Able will designate specic securities as collateral on lists provided to the lender on a daily or other periodic basis, and that it will not pledge the same securities to dierent lenders. Upon Able's insolvency, it is discovered that Able has listed the same securities on the collateral lists provided to both Alpha and Beta. Both Alpha and Beta have control over the disputed securities. Paragraph (2) awards priority to whichever secured party rst entered into the agreement with Clearing Corporation. 8. Relation to Other Law. Section 1-103 provides that unless displaced by particular provisions of this Act, the principles of law and equity . . . shall supplement its provisions. There may be circumstances in which a secured party's action in acquiring a security interest that has priority under this section constitutes conduct that is wrongful under other law. Though the possibility of such resort to other law may provide an appropriate escape valve for cases of egregious conduct, care must be taken to ensure that this does not impair the certainty and predictability of the priority rules. Whether a court may appropriately look to other law to impose liability upon or estop a secured party from asserting its Article 9 priority depends on an assessment of the secured party's conduct under the standards established by such other law as well as a determination of whether the particular application of such other law is displaced by the UCC. Some circumstances in which other law is clearly displaced by the UCC rules are readily identiable. Common law rst in time, rst in right principles, or correlative tort liability rules such as common law conversion principles under which a purchaser may incur liability to a person with a prior property interest without regard to awareness of that claim, are necessarily displaced by the priority rules set out in this section since these rules determine the relative ranking of security interests in investment property. So too, Article 8 provides protections against adverse claims to certain purchasers of interests in investment property. In circumstances where a secured party not only has priority under Section 9-328, but also qualies for protection against adverse claims under Section 8-303, 8-502, or 8-510, resort to other law would be precluded. In determining whether it is appropriate in a particular case to look to other law, account must also be taken of the policies that underlie the commercial law rules on securities markets and security interests in securities. A principal objective of the 1994 revision of Article 8 and the provisions of Article 9 governing investment property was to ensure that secured nancing transactions can be implemented on a simple, timely, and certain basis. One of the circumstances that led to the revision was the concern that uncertainty in the application of the rules on secured transactions involving securities and other nancial assets could contribute to systemic risk by impairing the ability of nancial institutions to provide liquidity to the markets in times of stress. The control priority rule is designed to provide a clear and certain rule to ensure that lenders who have taken the necessary steps to establish control do not face a risk of subordination to other lenders who have not done so. The control priority rule does not turn on an inquiry into the state of a secured party's awareness of potential conicting claims because a rule under which a person's rights depended on that sort of after-the-fact inquiry could introduce an unacceptable measure of uncertainty. If an inquiry into awareness could provide a complete and satisfactory resolution of the problem in all cases, the priority rules of this section would have incorporated that test. The fact that they do not necessarily means that resort to other law based solely on that factor is precluded, though the question whether a control secured party induced or encouraged its nancing arrangement with actual knowledge that the debtor would be 962

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violating the rights of another secured party may, in some circumstances, appropriately be treated as a factor in determining whether the control party's action is the kind of egregious conduct for which resort to other law is appropriate.

9-329. Priority of Security Interests in Letter-of-Credit Right. The following rules govern priority among conicting security interests in the same letter-of-credit right: (1) A security interest held by a secured party having control of the letter-of-credit right under Section 9-107 has priority to the extent of its control over a conicting security interest held by a secured party that does not have control. (2) Security interests perfected by control under Section 9-314 rank according to priority in time of obtaining control. Ocial Comment
1. Source. New; loosely modeled after former Section 9-115(5). 2. General Rule. Paragraph (1) awards priority to a secured party who perfects a security interest directly in letter-of-credit rights (i.e., one that takes an assignment of proceeds and obtains consent of the issuer or any nominated person under Section 5-114(c)) over another conicting security interest (i.e., one that is perfected automatically in the letter-ofcredit rights as supporting obligations under Section 9-308(d)). This is consistent with international letter-of-credit practice and provides nality to payments made to recognized assignees of letter-of-credit proceeds. If an issuer or nominated person recognizes multiple security interests in a letter-of-credit right, resulting in multiple parties having control (Section 9-107), under paragraph (2) the security interests rank according to the time of obtaining control. 3. Drawing Rights; Transferee Beneciaries. Drawing under a letter of credit is personal to the beneciary and requires the beneciary to perform the conditions for drawing under the letter of credit. Accordingly, a beneciary's grant of a security interest in a letter of credit includes the beneciary's letter-of-credit right as dened in Section 9-102 and the right to proceeds of [the] letter of credit as dened in Section 5-114(a), but does not include the right to demand payment under the letter of credit. Section 5-114(e) provides that the [r]ights of a transferee beneciary or nominated person are independent of the beneciary's assignment of the proceeds of a letter of credit and are superior to the assignee's right to the proceeds. To the extent the rights of a transferee beneciary or nominated person are independent and superior, this Article does not apply. See Section 9-109(c). Under Article 5, there is in eect a novation upon the transfer with the issuer becoming bound on a new, independent obligation to the transferee. The rights of nominated persons and transferee beneciaries under a letter of credit include the right to demand payment from the issuer. Under Section 5-114(e), their rights to payment are independent of their obligations to the beneciary (or original beneciary) and superior to the rights of assignees of letter-of-credit proceeds (Section 5-114(c)) and others claiming a security interest in the beneciary's (or original beneciary's) letter-of-credit rights. A transfer of drawing rights under a transferable letter of credit establishes independent Article 5 rights in the transferee and does not create or perfect an Article 9 security interest in the transferred drawing rights. The denition of letter-of-credit right in Section 9-102 excludes a beneciary's drawing rights. The exercise of drawing rights by a transferee beneciary may breach a contractual obligation of the transferee to the original beneciary concerning when and how much the transferee may draw or how it may use the funds received under the letter of credit. If, for example, drawing rights are transferred to support a sale or loan from the transferee to the original beneciary, then the transferee would be obligated to the original beneciary under the sale or loan agreement to account for any drawing and for the use of any funds received. The transferee's obligation would be governed by the applicable law of contracts or restitution. 4. Secured Party-Transferee Beneciaries. As described in Comment 3, drawing rights under letters of credit are transferred in many commercial contexts in which the 963

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transferee is not a secured party claiming a security interest in an underlying receivable supported by the letter of credit. Consequently, a transfer of a letter of credit is not a method of perfection of a security interest. The transferee's independent right to draw under the letter of credit and to receive and retain the value thereunder (in eect, priority) is not based on Article 9 but on letter-of-credit law and the terms of the letter of credit. Assume, however, that a secured party does hold a security interest in a receivable that is owned by a beneciary-debtor and supported by a transferable letter of credit. Assume further that the beneciary-debtor causes the letter of credit to be transferred to the secured party, the secured party draws under the letter of credit, and, upon the issuer's payment to the secured party-transferee, the underlying account debtor's obligation to the original beneciary-debtor is satised. In this situation, the payment to the secured party-transferee is proceeds of the receivable collected by the secured party-transferee. Consequently, the secured party-transferee would have certain duties to the debtor and third parties under Article 9. For example, it would be obliged to collect under the letter of credit in a commercially reasonable manner and to remit any surplus pursuant to Sections 9-607 and 9-608. This scenario is problematic under letter-of-credit law and practice, inasmuch as a transferee beneciary collects in its own right arising from its own performance. Accordingly, under Section 5-114, the independent and superior rights of a transferee control over any inconsistent duties under Article 9. A transferee beneciary may take a transfer of drawing rights to avoid reliance on the original beneciary's credit and collateral, and it may consider any Article 9 rights superseded by its Article 5 rights. Moreover, it will not always be clear (i) whether a transferee beneciary has a security interest in the underlying collateral, (ii) whether any security interest is senior to the rights of others, or (iii) whether the transferee beneciary is aware that it holds a security interest. There will be clear cases in which the role of a transferee beneciary as such is merely incidental to a conventional secured nancing. There also will be cases in which the existence of a security interest may have little to do with the position of a transferee beneciary as such. In dealing with these cases and less clear cases involving the possible application of Article 9 to a nominated person or a transferee beneciary, the right to demand payment under a letter of credit should be distinguished from letter-of-credit rights. The courts also should give appropriate consideration to the policies and provisions of Article 5 and letter-of-credit practice as well as Article 9.

9-330. Priority of Purchaser of Chattel Paper or Instrument. (a) [Purchaser's priority: security interest claimed merely as proceeds.] A purchaser of chattel paper has priority over a security interest in the chattel paper which is claimed merely as proceeds of inventory subject to a security interest if: (1) in good faith and in the ordinary course of the purchaser's business, the purchaser gives new value and takes possession of the chattel paper or obtains control of the chattel paper under Section 9-105; and (2) the chattel paper does not indicate that it has been assigned to an identied assignee other than the purchaser. (b) [Purchaser's priority: other security interests.] A purchaser of chattel paper has priority over a security interest in the chattel paper which is claimed other than merely as proceeds of inventory subject to a security interest if the purchaser gives new value and takes possession of the chattel paper or obtains control of the chattel paper under Section 9-105 in good faith, in the ordinary course of the purchaser's business, and without knowledge that the purchase violates the rights of the secured party. (c) [Chattel paper purchaser's priority in proceeds.] Except as otherwise provided in Section 9-327, a purchaser having priority in chattel paper under subsection (a) or (b) also has priority in proceeds of the chattel paper to the extent that:
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(1) Section 9-322 provides for priority in the proceeds; or (2) the proceeds consist of the specic goods covered by the chattel paper or cash proceeds of the specic goods, even if the purchaser's security interest in the proceeds is unperfected. (d) [Instrument purchaser's priority.] Except as otherwise provided in Section 9-331(a), a purchaser of an instrument has priority over a security interest in the instrument perfected by a method other than possession if the purchaser gives value and takes possession of the instrument in good faith and without knowledge that the purchase violates the rights of the secured party. (e) [Holder of purchase-money security interest gives new value.] For purposes of subsections (a) and (b), the holder of a purchase-money security interest in inventory gives new value for chattel paper constituting proceeds of the inventory. (f) [Indication of assignment gives knowledge.] For purposes of subsections (b) and (d), if chattel paper or an instrument indicates that it has been assigned to an identied secured party other than the purchaser, a purchaser of the chattel paper or instrument has knowledge that the purchase violates the rights of the secured party. Ocial Comment
1. Source. Former Section 9-308. 2. Non-Temporal Priority. This Article permits a security interest in chattel paper or instruments to be perfected either by ling or by the secured party's taking possession. This section enables secured parties and other purchasers of chattel paper (both electronic and tangible) and instruments to obtain priority over earlier-perfected security interests. 3. Chattel Paper. Subsections (a) and (b) follow former Section 9-308 in distinguishing between earlier-perfected security interests in chattel paper that is claimed merely as proceeds of inventory subject to a security interest and chattel paper that is claimed other than merely as proceeds. Like former Section 9-308, this section does not elaborate upon the phrase merely as proceeds. For an elaboration, see PEB Commentary No. 8. This section makes explicit the good faith requirement and retains the requirements of the ordinary course of the purchaser's business and the giving of new value as conditions for priority. Concerning the last, this Article deletes former Section 9-108 and adds to Section 9-102 a completely dierent denition of the term new value. Under subsection (e), the holder of a purchase-money security interest in inventory is deemed to give new value for chattel paper constituting the proceeds of the inventory. Accordingly, the purchase-money secured party may qualify for priority in the chattel paper under subsection (a) or (b), whichever is applicable, even if it does not make an additional advance against the chattel paper. If a possessory security interest in tangible chattel paper or a perfected-by-control security interest in electronic chattel paper does not qualify for priority under this section, it may be subordinate to a perfected-by-ling security interest under Section 9-322(a)(1). 4. Possession. The priority aorded by this section turns in part on whether a purchaser takes possession of tangible chattel paper. Similarly, the governing law provisions in Section 9-301 address both possessory and nonpossessory security interests. Two common practices have raised particular concerns. First, in some cases the parties create more than one copy or counterpart of chattel paper evidencing a single secured obligation or lease. This practice raises questions as to which counterpart is the original and whether it is necessary for a purchaser to take possession of all counterparts in order to take possession of the chattel paper. Second, parties sometimes enter into a single master agreement. The master agreement contemplates that the parties will enter into separate schedules from time to time, each evidencing chattel paper. Must a purchaser of an obligation or lease evidenced by a single schedule also take possession of the master agreement as well as the schedule in order to take possession of the chattel paper? 965

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The problem raised by the rst practice is easily solved. The parties may in the terms of their agreement and by designation on the chattel paper identify only one counterpart as the original chattel paper for purposes of taking possession of the chattel paper. Concerns about the second practice also are easily solved by careful drafting. Each schedule should provide that it incorporates the terms of the master agreement, not the other way around. This will make it clear that each schedule is a stand alone document. 5. Chattel Paper Claimed Merely as Proceeds. Subsection (a) revises the rule in former Section 9-308(b) to eliminate reference to what the purchaser knows. Instead, a purchaser who meets the possession or control, ordinary course, and new value requirements takes priority over a competing security interest unless the chattel paper itself indicates that it has been assigned to an identied assignee other than the purchaser. Thus subsection (a) recognizes the common practice of placing a legend on chattel paper to indicate that it has been assigned. This approach, under which the chattel paper purchaser who gives new value in ordinary course can rely on possession of unlegended, tangible chattel paper without any concern for other facts that it may know, comports with the expectations of both inventory and chattel paper nancers. 6. Chattel Paper Claimed Other Than Merely as Proceeds. Subsection (b) eliminates the requirement that the purchaser take without knowledge that the specic paper is subject to the security interest and substitutes for it the requirement that the purchaser take without knowledge that the purchase violates the rights of the secured party. This standard derives from the denition of buyer in ordinary course of business in Section 1-201(9). The source of the purchaser's knowledge is irrelevant. Note, however, that knowledge means actual knowledge. Section 1-201(25). In contrast to a junior secured party in accounts, who may be required in some special circumstances to undertake a search under the good faith requirement, see Comment 5 to Section 9-331, a purchaser of chattel paper under this section is not required as a matter of good faith to make a search in order to determine the existence of prior security interests. There may be circumstances where the purchaser undertakes a search nevertheless, either on its own volition or because other considerations make it advisable to do so, e.g., where the purchaser also is purchasing accounts. Without more, a purchaser of chattel paper who has seen a nancing statement covering the chattel paper or who knows that the chattel paper is encumbered with a security interest, does not have knowledge that its purchase violates the secured party's rights. However, if a purchaser sees a statement in a nancing statement to the eect that a purchase of chattel paper from the debtor would violate the rights of the led secured party, the purchaser would have such knowledge. Likewise, under new subsection (f), if the chattel paper itself indicates that it had been assigned to an identied secured party other than the purchaser, the purchaser would have wrongful knowledge for purposes of subsection (b), thereby preventing the purchaser from qualifying for priority under that subsection, even if the purchaser did not have actual knowledge. In the case of tangible chattel paper, the indication normally would consist of a written legend on the chattel paper. In the case of electronic chattel paper, this Article leaves to developing market and technological practices the manner in which the chattel paper would indicate an assignment. 7. Instruments. Subsection (d) contains a special priority rule for instruments. Under this subsection, a purchaser of an instrument has priority over a security interest perfected by a method other than possession (e.g., by ling, temporarily under Section 9-312(e) or (g), as proceeds under Section 9-315(d), or automatically upon attachment under Section 9-309(4) if the security interest arises out of a sale of the instrument) if the purchaser gives value and takes possession of the instrument in good faith and without knowledge that the purchase violates the rights of the secured party. Generally, to the extent subsection (d) conicts with Section 3-306, subsection (d) governs. See Section 3-102(b). For example, notice of a conicting security interest precludes a purchaser from becoming a holder in due course under Section 3-302 and thereby taking free of all claims to the instrument under Section 3-306. However, a purchaser who takes even with knowledge of the security interest qualies for priority under subsection (d) if it takes without knowledge that the purchase violates the rights of the holder of the security interest. Likewise, a purchaser qualies for priority under subsection (d) if it takes for value as dened in Section 1-201, even if it does not take for value as dened in Section 3-303. Subsection (d) is subject to Section 9-331(a), which provides that Article 9 does not limit the rights of a holder in due course under Article 3. Thus, in the rare case in which the 966

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purchaser of an instrument qualies for priority under subsection (d), but another person has the rights of a holder in due course of the instrument, the other person takes free of the purchaser's claim. See Section 3-306. The rule in subsection (d) is similar to the rules in subsections (a) and (b), which govern priority in chattel paper. The observations in Comment 6 concerning the requirement of good faith and the phrase without knowledge that the purchase violates the rights of the secured party apply equally to purchasers of instruments. However, unlike a purchaser of chattel paper, to qualify for priority under this section a purchaser of an instrument need only give value as dened in Section 1-201; it need not give new value. Also, the purchaser need not purchase the instrument in the ordinary course of its business. Subsection (d) applies to checks as well as notes. For example, to collect and retain checks that are proceeds (collections) of accounts free of a senior secured party's claim to the same checks, a junior secured party must satisfy the good-faith requirement (honesty in fact and the observance of reasonable commercial standards of fair dealing) of this subsection. This is the same good-faith requirement applicable to holders in due course. See Section 9-331, Comment 5. 8. Priority in Proceeds of Chattel Paper. Subsection (c) sets forth the two circumstances under which the priority aorded to a purchaser of chattel paper under subsection (a) or (b) extends also to proceeds of the chattel paper. The rst is if the purchaser would have priority under the normal priority rules applicable to proceeds. The second, which the following Comments discuss in greater detail, is if the proceeds consist of the specic goods covered by the chattel paper. Former Article 9 generally was silent as to the priority of a security interest in proceeds when a purchaser qualies for priority under Section 9-308 (but see former Section 9-306(5)(b), concerning returned and repossessed goods). 9. Priority in Returned and Repossessed Goods. Returned and repossessed goods may constitute proceeds of chattel paper. The following Comments explain the treatment of returned and repossessed goods as proceeds of chattel paper. The analysis is consistent with that of PEB Commentary No. 5, which these Comments replace, and is based upon the following example: Example: SP-1 has a security interest in all the inventory of a dealer in goods (Dealer); SP-1's security interest is perfected by ling. Dealer sells some of its inventory to a buyer in the ordinary course of business (BIOCOB) pursuant to a conditional sales contract (chattel paper) that does not indicate that it has been assigned to SP-1. SP-2 purchases the chattel paper from Dealer and takes possession of the paper in good faith, in the ordinary course of business, and without knowledge that the purchase violates the rights of SP-1. Subsequently, BIOCOB returns the goods to Dealer because they are defective. Alternatively, Dealer acquires possession of the goods following BIOCOB's default. 10. Assignment of Non-Lease Chattel Paper. a. Loan by SP-2 to Dealer Secured by Chattel Paper (or Functional Equivalent Pursuant to Recourse Arrangement). (1) Returned Goods. If BIOCOB returns the goods to Dealer for repairs, Dealer is merely a bailee and acquires thereby no meaningful rights in the goods to which SP-1's security interest could attach. (Although SP-1's security interest could attach to Dealer's interest as a bailee, that interest is not likely to be of any particular value to SP-1.) Dealer is the owner of the chattel paper (i.e., the owner of a right to payment secured by a security interest in the goods); SP-2 has a security interest in the chattel paper, as does SP-1 (as proceeds of the goods under Section 9-315). Under Section 9-330, SP-2's security interest in the chattel paper is senior to that of SP-1. SP-2 enjoys this priority regardless of whether, or when, SP-2 led a nancing statement covering the chattel paper. Because chattel paper and goods represent dierent types of collateral, Dealer does not have any meaningful interest in goods to which either SP-1's or SP-2's security interest could attach in order to secure Dealer's obligations to either creditor. See Section 9-102 (dening chattel paper and goods). Now assume that BIOCOB returns the goods to Dealer under circumstances whereby Dealer once again becomes the owner of the goods. This would be the case, for example, if the goods were defective and BIOCOB was entitled to reject or revoke acceptance of the goods. See Sections 2-602 (rejection), 2-608 (revocation of acceptance). Unless BIOCOB has waived its defenses as against assignees of the chattel paper, SP-1's and SP-2's rights 967

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against BIOCOB would be subject to BIOCOB's claims and defenses. See Sections 9-403, 9-404. SP-1's security interest would attach again because the returned goods would be proceeds of the chattel paper. Dealer's acquisition of the goods easily can be characterized as proceeds consisting of an in kind collection on or distribution on account of the chattel paper. See Section 9-102 (denition of proceeds). Assuming that SP-1's security interest is perfected by ling against the goods and that the ling is made in the same oce where a ling would be made against the chattel paper, SP-1's security interest in the goods would remain perfected beyond the 20-day period of automatic perfection. See Section 9-315(d). Because Dealer's newly reacquired interest in the goods is proceeds of the chattel paper, SP-2's security interest also would attach in the goods as proceeds. If SP-2 had perfected its security interest in the chattel paper by ling (again, assuming that ling against the chattel paper was made in the same oce where a ling would be made against the goods), SP2's security interest in the reacquired goods would be perfected beyond 20 days. See Section 9-315(d). However, if SP-2 had relied only on its possession of the chattel paper for perfection and had not led against the chattel paper or the goods, SP-2's security interest would be unperfected after the 20-day period. See Section 9-315(d). Nevertheless, SP-2's unperfected security interest in the goods would be senior to SP-1's security interest under Section 9-330(c). The result in this priority contest is not aected by SP-2's acquiescence or non-acquiescence in the return of the goods to Dealer. (2) Repossessed Goods. As explained above, Dealer owns the chattel paper covering the goods, subject to security interests in favor of SP-1 and SP-2. In Article 9 parlance, Dealer has an interest in chattel paper, not goods. If Dealer, SP-1, or SP-2 repossesses the goods upon BIOCOB's default, whether the repossession is rightful or wrongful as among Dealer, SP-1, or SP-2, Dealer's interest will not change. The location of goods and the party who possesses them does not aect the fact that Dealer's interest is in chattel paper, not goods. The goods continue to be owned by BIOCOB. SP-1's security interest in the goods does not attach until such time as Dealer reacquires an interest (other than a bare possessory interest) in the goods. For example, Dealer might buy the goods at a foreclosure sale from SP-2 (whose security interest in the chattel paper is senior to that of SP-1); that disposition would cut o BIOCOB's rights in the goods. Section 9-617. In many cases the matter would end upon sale of the goods to Dealer at a foreclosure sale and there would be no priority contest between SP-1 and SP-2; Dealer would be unlikely to buy the goods under circumstances whereby SP-2 would retain its security interest. There can be exceptions, however. For example, Dealer may be obliged to purchase the goods from SP-2 and SP-2 may be obliged to convey the goods to Dealer, but Dealer may fail to pay SP-2. Or, one could imagine that SP-2, like SP-1, has a general security interest in the inventory of Dealer. In the latter case, SP-2 should not receive the benet of any special priority rule, since its interest in no way derives from priority under Section 9-330. In the former case, SP-2's security interest in the goods reacquired by Dealer is senior to SP-1's security interest under Section 9-330. b. Dealer's Outright Sale of Chattel Paper to SP-2. Article 9 also applies to a transaction whereby SP-2 buys the chattel paper in an outright sale transaction without recourse against Dealer. Sections 1-201(37), 9-109(a). Although Dealer does not, in such a transaction, retain any residual ownership interest in the chattel paper, the chattel paper constitutes proceeds of the goods to which SP-1's security interest will attach and continue following the sale of the goods. Section 9-315(a). Even though Dealer has not retained any interest in the chattel paper, as discussed above BIOCOB subsequently may return the goods to Dealer under circumstances whereby Dealer reacquires an interest in the goods. The priority contest between SP-1 and SP-2 will be resolved as discussed above; Section 9-330 makes no distinction among purchasers of chattel paper on the basis of whether the purchaser is an outright buyer of chattel paper or one whose security interest secures an obligation of Dealer. 11. Assignment of Lease Chattel Paper. As dened in Section 9-102, chattel paper includes not only writings that evidence security interests in specic goods but also those that evidence true leases of goods. The analysis with respect to lease chattel paper is similar to that set forth above with respect to non-lease chattel paper. It is complicated, however, by the fact that, unlike the case of chattel paper arising out of a sale, Dealer retains a residual interest in the goods. See Section 2A-103(1)(q) (dening lessor's residual interest); In re Leasing Consultants, 968

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Inc., 486 F.2d 367 (2d Cir. 1973) (lessor's residual interest under true lease is an interest in goods and is a separate type of collateral from lessor's interest in the lease). If Dealer leases goods to a lessee in ordinary course of business (LIOCOB), then LIOCOB takes its interest under the lease (i.e., its leasehold interest) free of the security interest of SP-1. See Sections 2A-307(3), 2A-103(1)(m) (dening leasehold interest), (1)(o) (dening lessee in ordinary course of business). SP-1 would, however, retain its security interest in the residual interest. In addition, SP-1 would acquire an interest in the lease chattel paper as proceeds. If Dealer then assigns the lease chattel paper to SP-2, Section 9-330 gives SP-2 priority over SP-1 with respect to the chattel paper, but not with respect to the residual interest in the goods. Consequently, assignees of lease chattel paper typically take a security interest in and le against the lessor's residual interest in goods, expecting their priority in the goods to be governed by the rst-to-le-or-perfect rule of Section 9-322. If the goods are returned to Dealer, other than upon expiration of the lease term, then the security interests of both SP-1 and SP-2 normally would attach to the goods as proceeds of the chattel paper. (If the goods are returned to Dealer at the expiration of the lease term and the lessee has made all payments due under the lease, however, then Dealer no longer has any rights under the chattel paper. Dealer's interest in the goods consists solely of its residual interest, as to which SP-2 has no claim.) This would be the case, for example, when the lessee rescinds the lease or when the lessor recovers possession in the exercise of its remedies under Article 2A. See, e.g., Section 2A-525. If SP-2 enjoyed priority in the chattel paper under Section 9-330, then SP-2 likewise would enjoy priority in the returned goods as proceeds. This does not mean that SP-2 necessarily is entitled to the entire value of the returned goods. The value of the goods represents the sum of the present value of (i) the value of their use for the term of the lease and (ii) the value of the residual interest. SP-2 has priority in the former, but SP-1 ordinarily would have priority in the latter. Thus, an allocation of a portion of the value of the goods to each component may be necessary. Where, as here, one secured party has a security interest in the lessor's residual interest and another has a priority security interest in the chattel paper, it may be advisable for the conicting secured parties to establish a method for making such an allocation and otherwise to determine their relative rights in returned goods by agreement.

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

9-331. Priority of Rights of Purchasers of Instruments, Documents, and Securities Under Other Articles; Priority of Interests in Financial Assets and Security Entitlements Under Article 8. (a) [Rights under Articles 3, 7, and 8 not limited.] This article does not limit the rights of a holder in due course of a negotiable instrument, a holder to which a negotiable document of title has been duly negotiated, or a protected purchaser of a security. These holders or purchasers take priority over an earlier security interest, even if perfected, to the extent provided in Articles 3, 7, and 8. (b) [Protection under Article 8.] This article does not limit the rights of or impose liability on a person to the extent that the person is protected against the assertion of a claim under Article 8. (c) [Filing not notice.] Filing under this article does not constitute notice of a claim or defense to the holders, or purchasers, or persons described in subsections (a) and (b). Ocial Comment
1. Source. Former Section 9-309. 2. Priority. In some provisions, this Article distinguishes between claimants that take collateral free of a security interest (in the sense that the security interest no longer 969

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encumbers the collateral) and those that take an interest in the collateral that is senior to a surviving security interest. See, e.g., Section 9-317. Whether a holder or purchaser referred to in this section takes free or is senior to a security interest depends on whether the purchaser is a buyer of the collateral or takes a security interest in it. The term priority is meant to encompass both scenarios, as it does in Section 9-330. 3. Rights Acquired by Purchasers. The rights to which this section refers are set forth in Sections 3-305 and 3-306 (holder in due course), 7-502 (holder to whom a negotiable document of title has been duly negotiated), and 8-303 (protected purchaser). The holders and purchasers referred to in this section do not always take priority over a security interest. See, e.g., Section 7-503 (aording paramount rights to certain owners and secured parties as against holder to whom a negotiable document of title has been duly negotiated). Accordingly, this section adds the clause, to the extent provided in Articles 3, 7, and 8 to former Section 9-309. 4. Financial Assets and Security Entitlements. New subsection (b) provides explicit protection for those who deal with nancial assets and security entitlements and who are immunized from liability under Article 8. See, e.g., Sections 8-502, 8-503(e), 8-510, 8-511. The new subsection makes explicit in Article 9 what is implicit in former Article 9 and explicit in several provisions of Article 8. It does not change the law. 5. Collections by Junior Secured Party. Under this section, a secured party with a junior security interest in receivables (accounts, chattel paper, promissory notes, or payment intangibles) may collect and retain the proceeds of those receivables free of the claim of a senior secured party to the same receivables, if the junior secured party is a holder in due course of the proceeds. In order to qualify as a holder in due course, the junior must satisfy the requirements of Section 3-302, which include taking in good faith. This means that the junior not only must act honestly but also must observe reasonable commercial standards of fair dealing under the particular circumstances. See Section 9-102(a). Although good faith does not impose a general duty of inquiry, e.g., a search of the records in ling oces, there may be circumstances in which reasonable commercial standards of fair dealing would require such a search. Consider, for example, a junior secured party in the business of nancing or buying accounts who fails to undertake a search to determine the existence of prior security interests. Because a search, under the usages of trade of that business, would enable it to know or learn upon reasonable inquiry that collecting the accounts violated the rights of a senior secured party, the junior may fail to meet the good-faith standard. See Utility Contractors Financial Services, Inc. v. Amsouth Bank, NA, 985 F.2d 1554 (11th Cir. 1993). Likewise, a junior secured party who collects accounts when it knows or should know under the particular circumstances that doing so would violate the rights of a senior secured party, because the debtor had agreed not to grant a junior security interest in, or sell, the accounts, may not meet the good-faith test. Thus, if a junior secured party conducted or should have conducted a search and a nancing statement led on behalf of the senior secured party states such a restriction, the junior's collection would not meet the good-faith standard. On the other hand, if there was a course of performance between the senior secured party and the debtor which placed no such restrictions on the debtor and allowed the debtor to collect and use the proceeds without any restrictions, the junior secured party may then satisfy the requirements for being a holder in due course. This would be more likely in those circumstances where the junior secured party was providing additional nancing to the debtor on an on-going basis by lending against or buying the accounts and had no notice of any restrictions against doing so. Generally, the senior secured party would not be prejudiced because the practical eect of such payment to the junior secured party is little dierent than if the debtor itself had made the collections and subsequently paid the secured party from the debtor's general funds. Absent collusion, the junior secured party would take the funds free of the senior security interests. See Section 9-332. In contrast, the senior secured party is likely to be prejudiced if the debtor is going out of business and the junior secured party collects the accounts by notifying the account debtors to make payments directly to the junior. Those collections may not be consistent with reasonable commercial standards of fair dealing. Whether the junior secured party qualies as a holder in due course is fact-sensitive and should be decided on a case-by-case basis in the light of those circumstances. Decisions such as Financial Management Services, Inc. v. Familian, 905 P.2d 506 (Ariz. App. Div. 1995) (nding holder in due course status) could be determined dierently under this ap970

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plication of the good-faith requirement. The concepts addressed in this Comment are also applicable to junior secured parties as purchasers of instruments under Section 9-330(d). See Section 9-330, Comment 7.

9-332. Transfer of Money; Transfer of Funds From Deposit Account. (a) [Transferee of money.] A transferee of money takes the money free of a security interest unless the transferee acts in collusion with the debtor in violating the rights of the secured party. (b) [Transferee of funds from deposit account.] A transferee of funds from a deposit account takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor in violating the rights of the secured party. Ocial Comment
1. Source. New. 2. Scope of This Section. This section aords broad protection to transferees who take funds from a deposit account and to those who take money. The term transferee is not dened; however, the debtor itself is not a transferee. Thus this section does not cover the case in which a debtor withdraws money (currency) from its deposit account or the case in which a bank debits an encumbered account and credits another account it maintains for the debtor. A transfer of funds from a deposit account, to which subsection (b) applies, normally will be made by check, by funds transfer, or by debiting the debtor's deposit account and crediting another depositor's account. Example 1: Debtor maintains a deposit account with Bank A. The deposit account is subject to a perfected security interest in favor of Lender. Debtor draws a check on the account, payable to Payee. Inasmuch as the check is not the proceeds of the deposit account (it is an order to pay funds from the deposit account), Lender's security interest in the deposit account does not give rise to a security interest in the check. Payee deposits the check into its own deposit account, and Bank A pays it. Unless Payee acted in collusion with Debtor in violating Lender's rights, Payee takes the funds (the credits running in favor of Payee) free of Lender's security interest. This is true regardless of whether Payee is a holder in due course of the check and even if Payee gave no value for the check. Example 2: Debtor maintains a deposit account with Bank A. The deposit account is subject to a perfected security interest in favor of Lender. At Bank B's suggestion, Debtor moves the funds from the account at Bank A to Debtor's deposit account with Bank B. Unless Bank B acted in collusion with Debtor in violating Lender's rights, Bank B takes the funds (the credits running in favor of Bank B) free from Lender's security interest. See subsection (b). However, inasmuch as the deposit account maintained with Bank B constitutes the proceeds of the deposit account at Bank A, Lender's security interest would attach to that account as proceeds. See Section 9-315. Subsection (b) also would apply if, in the example, Bank A debited Debtor's deposit account in exchange for the issuance of Bank A's cashier's check. Lender's security interest would attach to the cashier's check as proceeds of the deposit account, and the rules applicable to instruments would govern any competing claims to the cashier's check. See, e.g., Sections 3-306, 9-322, 9-330, 9-331. If Debtor withdraws money (currency) from an encumbered deposit account and transfers the money to a third party, then subsection (a), to the extent not displaced by federal law relating to money, applies. It contains the same rule as subsection (b). Subsection (b) applies to transfers of funds from a deposit account; it does not apply to transfers of the deposit account itself or of an interest therein. For example, this section does not apply to the creation of a security interest in a deposit account. Competing claims to the deposit account itself are dealt with by other Article 9 priority rules. See Sections 9-317(a), 9-327, 9-340, 9-341. Similarly, a corporate merger normally would not result in a transfer of funds from a deposit account. Rather, it might result in a transfer of the deposit account itself. If so, the normal rules applicable to transferred collateral would apply; this 971

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section would not. 3. Policy. Broad protection for transferees helps to ensure that security interests in deposit accounts do not impair the free ow of funds. It also minimizes the likelihood that a secured party will enjoy a claim to whatever the transferee purchases with the funds. Rules concerning recovery of payments traditionally have placed a high value on nality. The opportunity to upset a completed transaction, or even to place a completed transaction in jeopardy by bringing suit against the transferee of funds, should be severely limited. Although the giving of value usually is a prerequisite for receiving the ability to take free from third-party claims, where payments are concerned the law is even more protective. Thus, Section 3-418(c) provides that, even where the law of restitution otherwise would permit recovery of funds paid by mistake, no recovery may be had from a person who in good faith changed position in reliance on the payment. Rather than adopt this standard, this section eliminates all reliance requirements whatsoever. Payments made by mistake are relatively rare, but payments of funds from encumbered deposit accounts (e.g., deposit accounts containing collections from accounts receivable) occur with great regularity. In most cases, unlike payment by mistake, no one would object to these payments. In the vast proportion of cases, the transferee probably would be able to show a change of position in reliance on the payment. This section does not put the transferee to the burden of having to make this proof. 4. Bad Actors. To deal with the question of the bad actor, this section borrows collusion language from Article 8. See, e.g., Sections 8-115, 8-503(e). This is the most protective (i.e., least stringent) of the various standards now found in the UCC. Compare, e.g., Section 1-201(9) (without knowledge that the sale . . . is in violation of the . . . security interest); Section 1-201(19) (honesty in fact in the conduct or transaction concerned); Section 3-302(a)(2)(v) (without notice of any claim). 5. Transferee Who Does Not Take Free. This section sets forth the circumstances under which certain transferees of money or funds take free of security interests. It does not determine the rights of a transferee who does not take free of a security interest. Example 3: The facts are as in Example 2, but, in wrongfully moving the funds from the deposit account at Bank A to Debtor's deposit account with Bank B, Debtor acts in collusion with Bank B. Bank B does not take the funds free of Lender's security interest under this section. If Debtor grants a security interest to Bank B, Section 9-327 governs the relative priorities of Lender and Bank B. Under Section 9-327(3), Bank B's security interest in the Bank B deposit account is senior to Lender's security interest in the deposit account as proceeds. However, Bank B's senior security interest does not protect Bank B against any liability to Lender that might arise from Bank B's wrongful conduct.

9-333. Priority of Certain Liens Arising by Operation of Law. (a) [Possessory lien.] In this section, possessory lien means an interest, other than a security interest or an agricultural lien: (1) which secures payment or performance of an obligation for services or materials furnished with respect to goods by a person in the ordinary course of the person's business; (2) which is created by statute or rule of law in favor of the person; and (3) whose eectiveness depends on the person's possession of the goods. (b) [Priority of possessory lien.] A possessory lien on goods has priority over a security interest in the goods unless the lien is created by a statute that expressly provides otherwise. Ocial Comment
1. Source. Former Section 9-310. 2. Possessory Liens. This section governs the relative priority of security interests arising under this Article and possessory liens, i.e., common-law and statutory liens whose eectiveness depends on the lienor's possession of goods with respect to which the lienor provided services or furnished materials in the ordinary course of its business. As under former Section 9-310, the possessory lien has priority over a security interest unless 972

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the possessory lien is created by a statute that expressly provides otherwise. If the statute creating the possessory lien is silent as to its priority relative to a security interest, this section provides a rule of interpretation that the possessory lien takes priority, even if the statute has been construed judicially to make the possessory lien subordinate.

9-334. Priority of Security Interests in Fixtures and Crops. (a) [Security interest in xtures under this article.] A security interest under this article may be created in goods that are xtures or may continue in goods that become xtures. A security interest does not exist under this article in ordinary building materials incorporated into an improvement on land. (b) [Security interest in xtures under real-property law.] This article does not prevent creation of an encumbrance upon xtures under real property law. (c) [General rule: subordination of security interest in xtures.] In cases not governed by subsections (d) through (h), a security interest in xtures is subordinate to a conicting interest of an encumbrancer or owner of the related real property other than the debtor. (d) [Fixtures purchase-money priority.] Except as otherwise provided in subsection (h), a perfected security interest in xtures has priority over a conicting interest of an encumbrancer or owner of the real property if the debtor has an interest of record in or is in possession of the real property and: (1) the security interest is a purchase-money security interest; (2) the interest of the encumbrancer or owner arises before the goods become xtures; and (3) the security interest is perfected by a xture ling before the goods become xtures or within 20 days thereafter. (e) [Priority of security interest in xtures over interests in real property.] A perfected security interest in xtures has priority over a conicting interest of an encumbrancer or owner of the real property if: (1) the debtor has an interest of record in the real property or is in possession of the real property and the security interest: (A) is perfected by a xture ling before the interest of the encumbrancer or owner is of record; and (B) has priority over any conicting interest of a predecessor in title of the encumbrancer or owner; (2) before the goods become xtures, the security interest is perfected by any method permitted by this article and the xtures are readily removable: (A) factory or oce machines; (B) equipment that is not primarily used or leased for use in the operation of the real property; or (C) replacements of domestic appliances that are consumer goods; (3) the conicting interest is a lien on the real property obtained by legal or equitable proceedings after the security interest was perfected by any method permitted by this article; or (4) the security interest is:
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(A) created in a manufactured home in a manufactured-home transaction; and (B) perfected pursuant to a statute described in Section 9-311(a)(2). (f) [Priority based on consent, disclaimer, or right to remove.] A security interest in xtures, whether or not perfected, has priority over a conicting interest of an encumbrancer or owner of the real property if: (1) the encumbrancer or owner has, in an authenticated record, consented to the security interest or disclaimed an interest in the goods as xtures; or (2) the debtor has a right to remove the goods as against the encumbrancer or owner. (g) [Continuation of paragraph (f)(2) priority.] The priority of the security interest under paragraph (f)(2) continues for a reasonable time if the debtor's right to remove the goods as against the encumbrancer or owner terminates. (h) [Priority of construction mortgage.] A mortgage is a construction mortgage to the extent that it secures an obligation incurred for the construction of an improvement on land, including the acquisition cost of the land, if a recorded record of the mortgage so indicates. Except as otherwise provided in subsections (e) and (f), a security interest in xtures is subordinate to a construction mortgage if a record of the mortgage is recorded before the goods become xtures and the goods become xtures before the completion of the construction. A mortgage has this priority to the same extent as a construction mortgage to the extent that it is given to renance a construction mortgage. (i) [Priority of security interest in crops.] A perfected security interest in crops growing on real property has priority over a conicting interest of an encumbrancer or owner of the real property if the debtor has an interest of record in or is in possession of the real property. (j) [Subsection (i) prevails.] Subsection (i) prevails over any inconsistent provisions of the following statutes:
[List here any statutes containing provisions inconsistent with subsection (i).]
Legislative Note: States that amend statutes to remove provisions inconsistent with subsection (i) need not enact subsection (j).

Ocial Comment
1. Source. Former Section 9-313. 2. Scope of This Section. This section contains rules governing the priority of security interests in xtures and crops as against persons who claim an interest in real property. Priority contests with other Article 9 security interests are governed by the other priority rules of this Article. The provisions with respect to xtures follow those of former Section 9-313. However, they have been rewritten to conform to Section 2A-309 and to prevailing style conventions. Subsections (i) and (j), which apply to crops, are new. 3. Security Interests in Fixtures. Certain goods that are the subject of personalproperty (chattel) nancing become so axed or otherwise so related to real property that they become part of the real property. These goods are called xtures. See Section 9-102 (denition of xtures). Some xtures retain their personal-property nature: a security interest under this Article may be created in xtures and may continue in goods that become xtures. See subsection (a). However, if the goods are ordinary building materials incorporated into an improvement on land, no security interest in them exists. Rather, the priority of claims to the building materials are determined by the law governing claims to 974

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real property. (Of course, the fact that no security interest exists in ordinary building materials incorporated into an improvement on land does not prejudice any rights the secured party may have against the debtor or any other person who violated the secured party's rights by wrongfully incorporating the goods into real property.) Thus, this section recognizes three categories of goods: (1) those that retain their chattel character entirely and are not part of the real property; (2) ordinary building materials that have become an integral part of the real property and cannot retain their chattel character for purposes of nance; and (3) an intermediate class that has become real property for certain purposes, but as to which chattel nancing may be preserved. To achieve priority under certain provisions of this section, a security interest must be perfected by making a xture ling (dened in Section 9-102) in the real-property records. Because the question whether goods have become xtures often is a dicult one under applicable real-property law, a secured party may make a xture ling as a precaution. Courts should not infer from a xture ling that the secured party concedes that the goods are or will become xtures. 4. Priority in Fixtures: General. In considering priority problems under this section, one must rst determine whether real-property claimants per se have an interest in the crops or xtures as part of real property. If not, it is immaterial, so far as concerns real property parties as such, whether a security interest arising under this Article is perfected or unperfected. In no event does a real-property claimant (e.g., owner or mortgagee) acquire an interest in a pure chattel just because a security interest therein is unperfected. If on the other hand real-property law gives real-property parties an interest in the goods, a conict arises and this section states the priorities. 5. Priority in Fixtures: Residual Rule. Subsection (c) states the residual priority rule, which applies only if one of the other rules does not: A security interest in xtures is subordinate to a conicting interest of an encumbrancer or owner of the related real property other than the debtor. 6. Priority in Fixtures: First to File or Record. Subsection (e)(1), which follows former Section 9-313(4)(b), contains the usual priority rule of conveyancing, that is, the rst to le or record prevails. In order to achieve priority under this rule, however, the security interest must be perfected by a xture ling (dened in Section 9-102), i.e., a ling for record in the real property records and indexed therein, so that it will be found in a realproperty search.. The condition in subsection (e)(1)(B), that the security interest must have had priority over any conicting interest of a predecessor in title of the conicting encumbrancer or owner, appears to limit to the rst-in-time principle. However, this apparent limitation is nothing other than an expression of the usual rule that a person must be entitled to transfer what he has. Thus, if the xture security interest is subordinate to a mortgage, it is subordinate to an interest of an assignee of the mortgage, even though the assignment is a later recorded instrument. Similarly if the xture security interest is subordinate to the rights of an owner, it is subordinate to a subsequent grantee of the owner and likewise subordinate to a subsequent mortgagee of the owner. 7. Priority in Fixtures: Purchase-Money Security Interests. Subsection (d), which follows former Section 9-313(4)(a), contains the principal exception to the rst-to-le-orrecord rule of subsection (e)(1). It aords priority to purchase-money security interests in xtures as against prior recorded real-property interests, provided that the purchasemoney security interest is led as a xture ling in the real-property records before the goods become xtures or within 20 days thereafter. This priority corresponds to the purchase-money priority under Section 9-324(a). (Like other 10-day periods in former Article 9, the 10-day period in this section has been changed to 20 days.) It should be emphasized that this purchase-money priority with the 20-day grace period for ling is limited to rights against real-property interests that arise before the goods become xtures. There is no such priority with the 20-day grace period as against realproperty interests that arise subsequently. The xture security interest can defeat subsequent real-property interests only if it is led rst and prevails under the usual conveyancing rule in subsection (e)(1) or one of the other rules in this section. 8. Priority in Fixtures: Readily Removable Goods. Subsection (e)(2), which derives from Section 2A-309 and former Section 9-313(4)(d), contains another exception to the usual rst-to-le-or-perfect rule. It aords priority to the holders of security interests in certain types of readily removable goodsfactory and oce machines, equipment that is 975

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not primarily used or leased for use in the operation of the real property, and (as discussed below) certain replacements of domestic appliances. This rule is made necessary by the confusion in the law as to whether certain machinery, equipment, and appliances become xtures. It protects a secured party who, perhaps in the mistaken belief that the readily removable goods will not become xtures, makes a UCC ling (or otherwise perfects under this Article) rather than making a xture ling. Frequently, under applicable law, goods of the type described in subsection (e)(2) will not be considered to have become part of the real property. In those cases, the xture security interest does not conict with a real-property interest, and resort to this section is unnecessary. However, if the goods have become part of the real property, subsection (e)(2) enables a xture secured party to take priority over a conicting real-property interest if the xture security interest is perfected by a xture ling or by any other method permitted by this Article. If perfection is by xture ling, the xture security interest would have priority over subsequently recorded real-property interests under subsection (e)(1) and, if the xture security interest is a purchase-money security interest (a likely scenario), it would also have priority over most real property interests under the purchase-money priority of subsection (d). Note, however, that unlike the purchase-money priority rule in subsection (d), the priority rules in subsection (e) override the priority given to a construction mortgage under subsection (h). The rule in subsection (e)(2) is limited to readily removable replacements of domestic appliances. It does not apply to original installations. Moreover, it is limited to appliances that are consumer goods (dened in Section 9-102) in the hands of the debtor. The principal eect of the rule is to make clear that a secured party nancing occasional replacements of domestic appliances in noncommercial, owner-occupied contexts need not concern itself with real-property descriptions or records; indeed, for a purchase-money replacement of consumer goods, perfection without any ling will be possible. See Section 9-309(1). 9. Priority in Fixtures: Judicial Liens. Subsection (e)(3), which follows former Section 9-313(4)(d), adopts a rst-in-time rule applicable to conicts between a xture security interest and a lien on the real property obtained by legal or equitable proceedings. Such a lien is subordinate to an earlier-perfected security interest, regardless of the method by which the security interest was perfected. Judgment creditors generally are not reliance creditors who search real-property records. Accordingly, a perfected xture security interest takes priority over a subsequent judgment lien or other lien obtained by legal or equitable proceedings, even if no evidence of the security interest appears in the relevant realproperty records. Subsection (e)(3) thus protects a perfected xture security interest from avoidance by a trustee in bankruptcy under Bankruptcy Code Section 544(a), regardless of the method of perfection. 10. Priority in Fixtures: Manufactured Homes. A manufactured home may become a xture. New subsection (e)(4) contains a special rule granting priority to certain security interests created in a manufactured home as part of a manufactured-home transaction (both dened in Section 9-102). Under this rule, a security interest in a manufactured home that becomes a xture has priority over a conicting interest of an encumbrancer or owner of the real property if the security interest is perfected under a certicate-of-title statute (see Section 9-311). Subsection (e)(4) is only one of the priority rules applicable to security interests in a manufactured home that becomes a xture. Thus, a security interest in a manufactured home which does not qualify for priority under this subsection may qualify under another. 11. Priority in Fixtures: Construction Mortgages. The purchase-money priority presents a dicult problem in relation to construction mortgages. The latter ordinarily will have been recorded even before the commencement of delivery of materials to the job, and therefore would take priority over xture security interests were it not for the purchasemoney priority. However, having recorded rst, the holder of a construction mortgage reasonably expects to have rst priority in the improvement built using the mortgagee's advances. Subsection (g) expressly gives priority to the construction mortgage recorded before the ling of the purchase-money security interest in xtures. A renancing of a construction mortgage has the same priority as the construction mortgage itself. The phrase an obligation incurred for the construction of an improvement covers both optional advances and advances pursuant to commitment. Both types of advances have the same priority under subsection (g). 976

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The priority under this subsection applies only to goods that become xtures during the construction period leading to the completion of the improvement. The construction priority will not apply to additions to the building made long after completion of the improvement, even if the additions are nanced by the real-property mortgagee under an open-end clause of the construction mortgage. In such case, subsections (d), (e), and (f) govern. Although this subsection aords a construction mortgage priority over a purchase-money security interest that otherwise would have priority under subsection (d), the subsection is subject to the priority rules in subsections (e) and (f). Thus, a construction mortgage may be junior to a xture security interest perfected by a xture ling before the construction mortgage was recorded. See subsection (e)(1). 12. Crops. Growing crops are goods in which a security interest may be created and perfected under this Article. In some jurisdictions, a mortgage of real property may cover crops, as well. In the event that crops are encumbered by both a mortgage and an Article 9 security interest, subsection (i) provides that the security interest has priority. States whose real-property law provides otherwise should either amend that law directly or override it by enacting subsection (j).

9-335. Accessions. (a) [Creation of security interest in accession.] A security interest may be created in an accession and continues in collateral that becomes an accession. (b) [Perfection of security interest.] If a security interest is perfected when the collateral becomes an accession, the security interest remains perfected in the collateral. (c) [Priority of security interest.] Except as otherwise provided in subsection (d), the other provisions of this part determine the priority of a security interest in an accession. (d) [Compliance with certicate-of-title statute.] A security interest in an accession is subordinate to a security interest in the whole which is perfected by compliance with the requirements of a certicate-of-title statute under Section 9-311(b). (e) [Removal of accession after default.] After default, subject to Part 6, a secured party may remove an accession from other goods if the security interest in the accession has priority over the claims of every person having an interest in the whole. (f) [Reimbursement following removal.] A secured party that removes an accession from other goods under subsection (e) shall promptly reimburse any holder of a security interest or other lien on, or owner of, the whole or of the other goods, other than the debtor, for the cost of repair of any physical injury to the whole or the other goods. The secured party need not reimburse the holder or owner for any diminution in value of the whole or the other goods caused by the absence of the accession removed or by any necessity for replacing it. A person entitled to reimbursement may refuse permission to remove until the secured party gives adequate assurance for the performance of the obligation to reimburse. Ocial Comment
1. Source. Former Section 9-314. 2. Accession. This section applies to an accession, as dened in Section 9-102, regardless of the cost or diculty of removing the accession from the other goods, and regardless of whether the original goods have come to form an integral part of the other goods. This section does not apply to goods whose identity has been lost. Goods of that kind are commingled goods governed by Section 9-336. Neither this section nor the following 977

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one addresses the case of collateral that changes form without the addition of other goods. 3. Accession vs. Other Goods. This section distinguishes among the accession, the other goods, and the whole. The last term refers to the combination of the accession and the other goods. If one person's collateral becomes physically united with another person's collateral, each is an accession. Example 1: SP-1 holds a security interest in the debtor's tractors (which are not subject to a certicate-of-title statute), and SP-2 holds a security interest in a particular tractor engine. The engine is installed in a tractor. From the perspective of SP-1, the tractor becomes an accession and the engine is the other goods. From the perspective of SP-2, the engine is the accession and the tractor is the other goods. The completed tractortractor cum engineconstitutes the whole. 4. Scope. This section governs only a few issues concerning accessions. Subsection (a) contains rules governing continuation of a security interest in an accession. Subsection (b) contains a rule governing continued perfection of a security interest in goods that become an accession. Subsection (d) contains a special priority rule governing accessions that become part of a whole covered by a certicate of title. Subsections (e) and (f) govern enforcement of a security interest in an accession. 5. Matters Left to Other Provisions of This Article: Attachment and Perfection. Other provisions of this Article often govern accession-related issues. For example, this section does not address whether a secured party acquires a security interest in the whole if its collateral becomes an accession. Normally this will turn on the description of the collateral in the security agreement. Example 2: Debtor owns a computer subject to a perfected security interest in favor of SP-1. Debtor acquires memory and installs it in the computer. Whether SP-1's security interest attaches to the memory depends on whether the security agreement covers it. Similarly, this section does not determine whether perfection against collateral that becomes an accession is eective to perfect a security interest in the whole. Other provisions of this Article, including the requirements for indicating the collateral covered by a nancing statement, resolve that question. 6. Matters Left to Other Provisions of This Article: Priority. With one exception, concerning goods covered by a certicate of title (see subsection (d)), the other provisions of this Part, including the rules governing purchase-money security interests, determine the priority of most security interests in an accession, including the relative priority of a security interest in an accession and a security interest in the whole. See subsection (c). Example 3: Debtor owns an oce computer subject to a security interest in favor of SP-1. Debtor acquires memory and grants a perfected security interest in the memory to SP-2. Debtor installs the memory in the computer, at which time (one assumes) SP-1's security interest attaches to the memory. The rst-to-le-or-perfect rule of Section 9-322 governs priority in the memory. If, however, SP-2's security interest is a purchase-money security interest, Section 9-324(a) would aord priority in the memory to SP-2, regardless of which security interest was perfected rst. 7. Goods Covered by Certicate of Title. This section does govern the priority of a security interest in an accession that is or becomes part of a whole that is subject to a security interest perfected by compliance with a certicate-of-title statute. Subsection (d) provides that a security interest in the whole, perfected by compliance with a certicate-oftitle statute, takes priority over a security interest in the accession. It enables a secured party to rely upon a certicate of title without having to check the UCC les to determine whether any components of the collateral may be encumbered. The subsection imposes a corresponding risk upon those who nance goods that may become part of goods covered by a certicate of title. In doing so, it reverses the priority that appeared reasonable to most pre-UCC courts. Example 4: Debtor owns an automobile subject to a security interest in favor of SP-1. The security interest is perfected by notation on the certicate of title. Debtor buys tires subject to a perfected-by-ling purchase-money security interest in favor of SP-2 and mounts the tires on the automobile's wheels. If the security interest in the automobile attaches to the tires, then SP-1 acquires priority over SP-2. The same result would obtain if SP-1's security interest attached to the automobile and was perfected after the tires had been mounted on the wheels. 978

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9-336. Commingled Goods. (a) [Commingled goods.] In this section, commingled goods means goods that are physically united with other goods in such a manner that their identity is lost in a product or mass. (b) [No security interest in commingled goods as such.] A security interest does not exist in commingled goods as such. However, a security interest may attach to a product or mass that results when goods become commingled goods. (c) [Attachment of security interest to product or mass.] If collateral becomes commingled goods, a security interest attaches to the product or mass. (d) [Perfection of security interest.] If a security interest in collateral is perfected before the collateral becomes commingled goods, the security interest that attaches to the product or mass under subsection (c) is perfected. (e) [Priority of security interest.] Except as otherwise provided in subsection (f), the other provisions of this part determine the priority of a security interest that attaches to the product or mass under subsection (c). (f) [Conicting security interests in product or mass] If more than one security interest attaches to the product or mass under subsection (c), the following rules determine priority: (1) A security interest that is perfected under subsection (d) has priority over a security interest that is unperfected at the time the collateral becomes commingled goods. (2) If more than one security interest is perfected under subsection (d), the security interests rank equally in proportion to the value of the collateral at the time it became commingled goods. Ocial Comment
1. Source. Former Section 9-315. 2. Commingled Goods. Subsection (a) denes commingled goods. It is meant to include not only goods whose identity is lost through manufacturing or production (e.g., our that has become part of baked goods) but also goods whose identity is lost by commingling with other goods from which they cannot be distinguished (e.g., ball bearings). 3. Consequences of Becoming Commingled Goods. By denition, the identity of the original collateral cannot be determined once the original collateral becomes commingled goods. Consequently, the security interest in the specic original collateral alone is lost once the collateral becomes commingled goods, and no security interest in the original collateral can be created thereafter except as a part of the resulting product or mass. See subsection (b). Once collateral becomes commingled goods, the secured party's security interest is transferred from the original collateral to the product or mass. See subsection (c). If the security interest in the original collateral was perfected, the security interest in the product or mass is a perfected security interest. See subsection (d). This perfection continues until lapse. 4. Priority of Perfected Security Interests That Attach Under This Section. This section governs the priority of competing security interests in a product or mass only when both security interests arise under this section. In that case, if both security interests are perfected by operation of this section (see subsections (c) and (d)), then the security interests rank equally, in proportion to the value of the collateral at the time it became commingled goods. See subsection (f)(2). Example 1: SP-1 has a perfected security interest in Debtor's eggs, which have a value of $300 and secure a debt of $400, and SP-2 has a perfected security interest in 979

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Debtor's our, which has a value of $500 and secures a debt of $700. Debtor uses the our and eggs to make cakes, which have a value of $1000. The two security interests rank equally and share in the ratio of 3:5. Applying this ratio to the entire value of the product, SP-1 would be entitled to $375 (i.e., 3/8 $1000), and SP-2 would be entitled to $625 (i.e., 5/8 $1000). Example 2: Assume the facts of Example 1, except that SP-1's collateral, worth $300, secures a debt of $200. Recall that, if the cake is worth $1000, then applying the ratio of 3:5 would entitle SP-1 to $375 and SP-2 to $625. However, SP-1 is not entitled to collect from the product more than it is owed. Accordingly, SP-1's share would be only $200, SP-2 would receive the remaining value, up to the amount it is owed ($700). Example 3: Assume that the cakes in the previous examples have a value of only $600. Again, the parties share in the ratio of 3:5. If, as in Example 1, SP-1 is owed $400, then SP-1 is entitled to $225 (i.e., 3/8 $600), and SP-2 is entitled to $375 (i.e., 5/8 $600). Debtor receives nothing. If, however, as in Example 2, SP-1 is owed only $200, then SP-2 receives $400. The results in the foregoing examples remain the same, regardless of whether SP-1 or SP-2 (or each) has a purchase-money security interest. 5. Perfection: Unperfected Security Interests. The rule explained in the preceding Comment applies only when both security interests in original collateral are perfected when the goods become commingled goods. If a security interest in original collateral is unperfected at the time the collateral becomes commingled goods, subsection (f)(1) applies. Example 4: SP-1 has a perfected security interest in the debtor's eggs, and SP-2 has an unperfected security interest in the debtor's our. Debtor uses the our and eggs to make cakes. Under subsection (c), both security interests attach to the cakes. But since SP-1's security interest was perfected at the time of commingling and SP-2's was not, only SP-1's security interest in the cakes is perfected. See subsection (d). Under subsection (f)(1) and Section 9-322(a)(2), SP-1's perfected security interest has priority over SP2's unperfected security interest. If both security interests are unperfected, the rule of Section 9-322(a)(3) would apply. 6. Multiple Security Interests. On occasion, a single input may be encumbered by more than one security interest. In those cases, the multiple secured parties should be treated like a single secured party for purposes of determining their collective share under subsection (f)(2). The normal priority rules would determine how that share would be allocated between them. Consider the following example, which is a variation on Example 1 above: Example 5: SP-1A has a perfected, rst-priority security interest in Debtor's eggs. SP-1B has a perfected, second-priority security interest in the same collateral. The eggs have a value of $300. Debtor owes $200 to SP-1A and $200 to SP-1B. SP-2 has a perfected security interest in Debtor's our, which has a value of $500 and secures a debt of $600. Debtor uses the our and eggs to make cakes, which have a value of $1000. For purposes of subsection (f)(2), SP-1A and SP-1B should be treated like a single secured party. The collective security interest would rank equally with that of SP-2. Thus, the secured parties would share in the ratio of 3 (for SP-1A and SP-1B combined) to 5 (for SP-2). Applying this ratio to the entire value of the product, SP-1A and SP-1B in the aggregate would be entitled to $375 (i.e., 3/8 $1000), and SP-2 would be entitled to $625 (i.e., 5/8 $1000). SP-1A and SP-1B would share the $375 in accordance with their priority, as established under other rules. Inasmuch as SP-1A has rst priority, it would receive $200, and SP-1B would receive $175. 7. Priority of Security Interests That Attach Other Than by Operation of This Section. Under subsection (e), the normal priority rules determine the priority of a security interest that attaches to the product or mass other than by operation of this section. For example, assume that SP-1 has a perfected security interest in Debtor's existing and after-acquired baked goods, and SP-2 has a perfected security interest in Debtor's our. When the our is processed into cakes, subsections (c) and (d) provide that SP-2 acquires a perfected security interest in the cakes. If SP-1 led against the baked goods before SP-2 led against the our, then SP-1 will enjoy priority in the cakes. See Section 9-322 (rst-tole-or-perfect). But if SP-2 led against the our before SP-1 led against the baked goods, then SP-2 will enjoy priority in the cakes to the extent of its security interest. 980

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9-337. Priority of Security Interests in Goods Covered by Certicate of Title. If, while a security interest in goods is perfected by any method under the law of another jurisdiction, this State issues a certicate of title that does not show that the goods are subject to the security interest or contain a statement that they may be subject to security interests not shown on the certicate: (1) a buyer of the goods, other than a person in the business of selling goods of that kind, takes free of the security interest if the buyer gives value and receives delivery of the goods after issuance of the certicate and without knowledge of the security interest; and (2) the security interest is subordinate to a conicting security interest in the goods that attaches, and is perfected under Section 9-311(b), after issuance of the certicate and without the conicting secured party's knowledge of the security interest. Ocial Comment
1. Source. Derived from former Section 9-103(2)(d). 2. Protection for Buyers and Secured Parties. This section aords protection to certain good-faith purchasers for value who are likely to have relied on a clean certicate of title, i.e., one that neither shows that the goods are subject to a particular security interest nor contains a statement that they may be subject to security interests not shown on the certicate. Under this section, a buyer can take free of, and the holder of a conicting security interest can acquire priority over, a security interest that is perfected by any method under the law of another jurisdiction. The fact that the security interest has been reperfected by possession under Section 9-313 does not of itself disqualify the holder of a conicting security interest from protection under paragraph (2).

9-338. Priority of Security Interest or Agricultural Lien Perfected by Filed Financing Statement Providing Certain Incorrect Information. If a security interest or agricultural lien is perfected by a led nancing statement providing information described in Section 9-516(b)(5) which is incorrect at the time the nancing statement is led: (1) the security interest or agricultural lien is subordinate to a conicting perfected security interest in the collateral to the extent that the holder of the conicting security interest gives value in reasonable reliance upon the incorrect information; and (2) a purchaser, other than a secured party, of the collateral takes free of the security interest or agricultural lien to the extent that, in reasonable reliance upon the incorrect information, the purchaser gives value and, in the case of tangible chattel paper, tangible documents, goods, instruments, or a security certicate, receives delivery of the collateral. As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Source. New. 2. Eect of Incorrect Information in Financing Statement. Section 9-520(a) requires the ling oce to reject nancing statements that do not contain information concerning the debtor as specied in Section 9-516(b)(5). An error in this information does 981

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not render the nancing statement ineective. On rare occasions, a subsequent purchaser of the collateral (i.e., a buyer or secured party) may rely on the misinformation to its detriment. This section subordinates a security interest or agricultural lien perfected by an eective, but awed, nancing statement to the rights of a buyer or holder of a perfected security interest to the extent that, in reasonable reliance on the incorrect information, the purchaser gives value and, in the case of tangible collateral, receives delivery of the collateral. A purchaser who has not made itself aware of the information in the ling oce with respect to the debtor cannot act in reasonable reliance upon incorrect information. 3. Relationship to Section 9-507. This section applies to nancing statements that contain information that is incorrect at the time of ling and imposes a small risk of subordination on the ler. In contrast, Section 9-507 deals with nancing statements containing information that is correct at the time of ling but which becomes incorrect later. Except as provided in Section 9-507 with respect to changes in the debtor's name, an otherwise eective nancing statement does not become ineective if the information contained in it becomes inaccurate.

9-339. Priority Subject to Subordination. This article does not preclude subordination by agreement by a person entitled to priority. Ocial Comment
1. Source. Former Section 9-316. 2. Subordination by Agreement. The preceding sections deal elaborately with questions of priority. This section makes it entirely clear that a person entitled to priority may eectively agree to subordinate its claim. Only the person entitled to priority may make such an agreement: a person's rights cannot be adversely aected by an agreement to which the person is not a party.

[SUBPART 4. RIGHTS OF BANK] 9-340. Eectiveness of Right of Recoupment or Set-O Against Deposit Account. (a) [Exercise of recoupment or set-o.] Except as otherwise provided in subsection (c), a bank with which a deposit account is maintained may exercise any right of recoupment or set-o against a secured party that holds a security interest in the deposit account. (b) [Recoupment or set-o not aected by security interest.] Except as otherwise provided in subsection (c), the application of this article to a security interest in a deposit account does not aect a right of recoupment or set-o of the secured party as to a deposit account maintained with the secured party. (c) [When set-o ineective.] The exercise by a bank of a set-o against a deposit account is ineective against a secured party that holds a security interest in the deposit account which is perfected by control under Section 9-104(a)(3), if the set-o is based on a claim against the debtor. Ocial Comment
1. Source. New; subsection (b) is based on a nonuniform Illinois amendment. 2. Set-o vs. Security Interest. This section resolves the conict between a security interest in a deposit account and the bank's rights of recoupment and set-o. Subsection (a) states the general rule and provides that the bank may eectively exercise rights of recoupment and set-o against the secured party. Subsection (c) contains an exception: if the secured party has control under Section 9-104(a)(3) (i.e., if it has become the bank's customer), then any set-o exercised by the bank against a debt owed by the 982

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debtor (as opposed to a debt owed to the bank by the secured party) is ineective. The bank may, however, exercise its recoupment rights eectively. This result is consistent with the priority rule in Section 9-327(4), under which the security interest of a bank in a deposit account is subordinate to that of a secured party who has control under Section 9-104(a)(3). This section deals with rights of set-o and recoupment that a bank may have under other law. It does not create a right of set-o or recoupment, nor is it intended to override any limitations or restrictions that other law imposes on the exercise of those rights. 3. Preservation of Set-O Right. Subsection (b) makes clear that a bank may hold both a right of set-o against, and an Article 9 security interest in, the same deposit account. By holding a security interest in a deposit account, a bank does not impair any right of set-o it would otherwise enjoy. This subsection does not pertain to accounts evidenced by an instrument (e.g., certain certicates of deposit), which are excluded from the denition of deposit accounts.

9-341. Bank's Rights and Duties With Respect to Deposit Account. Except as otherwise provided in Section 9-340(c), and unless the bank otherwise agrees in an authenticated record, a bank's rights and duties with respect to a deposit account maintained with the bank are not terminated, suspended, or modied by: (1) the creation, attachment, or perfection of a security interest in the deposit account; (2) the bank's knowledge of the security interest; or (3) the bank's receipt of instructions from the secured party. Ocial Comment
1. Source. New. 2. Free Flow of Funds. This section is designed to prevent security interests in deposit accounts from impeding the free ow of funds through the payment system. Subject to two exceptions, it leaves the bank's rights and duties with respect to the deposit account and the funds on deposit unaected by the creation or perfection of a security interest or by the bank's knowledge of the security interest. In addition, the section permits the bank to ignore the instructions of the secured party unless it had agreed to honor them or unless other law provides to the contrary. A secured party who wishes to deprive the debtor of access to funds on deposit or to appropriate those funds for itself needs to obtain the agreement of the bank, utilize the judicial process, or comply with procedures set forth in other law. Section 4-303(a), concerning the eect of notice on a bank's right and duty to pay items, is not to the contrary. That section addresses only whether an otherwise eective notice comes too late; it does not determine whether a timely notice is otherwise eective. 3. Operation of Rule. The general rule of this section is subject to Section 9-340(c), under which a bank's right of set-o may not be exercised against a deposit account in the secured party's name if the right is based on a claim against the debtor. This result reects current law in many jurisdictions and does not appear to have unduly disrupted banking practices or the payments system. The more important function of this section, which is not impaired by Section 9-340, is the bank's right to follow the debtor's (customer's) instructions (e.g., by honoring checks, permitting withdrawals, etc.) until such time as the depository institution is served with judicial process or receives instructions with respect to the funds on deposit from a secured party who has control over the deposit account. 4. Liability of Bank. This Article does not determine whether a bank that pays out funds from an encumbered deposit is liable to the holder of a security interest. Although the fact that a secured party has control over the deposit account and the manner by which control was achieved may be relevant to the imposition of liability, whatever rule applies generally when a bank pays out funds in which a third party has an interest would determine liability to a secured party. Often, this rule is found in a non-UCC adverse claim statute. 5. Certicates of Deposit. This section does not address the obligations of banks that issue instruments evidencing deposits (e.g., certain certicates of deposit). 983

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9-342. Bank's Right to Refuse to Enter Into or Disclose Existence of Control Agreement. This article does not require a bank to enter into an agreement of the kind described in Section 9-104(a)(2), even if its customer so requests or directs. A bank that has entered into such an agreement is not required to conrm the existence of the agreement to another person unless requested to do so by its customer. Ocial Comment
1. Source. New; derived from Section 8-106(g). 2. Protection for Bank. This section protects banks from the need to enter into agreements against their will and from the need to respond to inquiries from persons other than their customers.

PART 4. RIGHTS OF THIRD PARTIES

9-401. Alienability of Debtor's Rights. (a) [Other law governs alienability; exceptions.] Except as otherwise provided in subsection (b) and Sections 9-406, 9-407, 9-408, and 9-409, whether a debtor's rights in collateral may be voluntarily or involuntarily transferred is governed by law other than this article. (b) [Agreement does not prevent transfer.] An agreement between the debtor and secured party which prohibits a transfer of the debtor's rights in collateral or makes the transfer a default does not prevent the transfer from taking eect. Ocial Comment
1. Source. Former Section 9-311. 2. Scope of This Part. This Part deals with several issues aecting third parties (i.e., parties other than the debtor and the secured party). These issues are not addressed in Part 3, Subpart 3, which deals with priorities. This Part primarily addresses the rights and duties of account debtors and other persons obligated on collateral who are not, themselves, parties to a secured transaction. 3. Governing Law. There was some uncertainty under former Article 9 as to which jurisdiction's law (usually, which jurisdiction's version of Article 9) applied to the matters that this Part addresses. Part 3, Subpart 1, does not determine the law governing these matters because they do not relate to perfection, the eect of perfection or nonperfection, or priority. However, it might be inappropriate for a designation of applicable law by a debtor and secured party under Section 1-105 to control the law applicable to an independent transaction or relationship between the debtor and an account debtor. Consider an example under Section 9-408. Example 1: State X has adopted this Article; former Article 9 is the law of State Y. A general intangible (e.g., a franchise agreement) between a debtor-franchisee, D, and an account debtor-franchisor, AD, is governed by the law of State Y. D grants to SP a security interest in its rights under the franchise agreement. The franchise agreement contains a term prohibiting D's assignment of its rights under the agreement. D and SP agree that their secured transaction is governed by the law of State X. Under State X's Section 9-408, the restriction on D's assignment is ineective to prevent the creation, attachment, or perfection of SP's security interest. State Y's former Section 9-318(4), however, does not address restrictions on the creation of security interests in general intangibles other than general intangibles for money due or to become due. Accordingly, it does not address restrictions on the assignment to SP of D's rights under the franchise agreement. The non-Article-9 law of State Y, which does address restrictions, provides that the prohibition on assignment is eective. This Article does not provide a specic answer to the question of which State's law applies to the restriction on assignment in the example. However, assuming that under non984

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UCC choice-of-law principles the eectiveness of the restriction would be governed by the law of State Y, which governs the franchise agreement, the fact that State X's Article 9 governs the secured transaction between SP and D would not override the otherwise applicable law governing the agreement. Of course, to the extent that jurisdictions eventually adopt identical versions of this Article and courts interpret it consistently, the inability to identify the applicable law in circumstances such as those in the example may be inconsequential. 4. Inalienability Under Other Law. Subsection (a) addresses the question whether property necessarily is transferable by virtue of its inclusion (i.e., its eligibility as collateral) within the scope of Article 9. It gives a negative answer, subject to the identied exceptions. The substance of subsection (a) was implicit under former Article 9. 5. Negative Pledge Covenant. Subsection (b) is an exception to the general rule in subsection (a). It makes clear that in secured transactions under this Article the debtor has rights in collateral (whether legal title or equitable) which it can transfer and which its creditors can reach. It is best explained with an example. Example 2: A debtor, D, grants to SP a security interest to secure a debt in excess of the value of the collateral. D agrees with SP that it will not create a subsequent security interest in the collateral and that any security interest purportedly granted in violation of the agreement will be void. Subsequently, in violation of its agreement with SP, D purports to grant a security interest in the same collateral to another secured party. Subsection (b) validates D's creation of the subsequent (prohibited) security interest, which might even achieve priority over the earlier security interest. See Comment 7. However, unlike some other provisions of this Part, such as Section 9-406, subsection (b) does not provide that the agreement restricting assignment itself is ineective. Consequently, the debtor's breach may create a default. 6. Rights of Lien Creditors. Dicult problems may arise with respect to attachment, levy, and other judicial procedures under which a debtor's creditors may reach collateral subject to a security interest. For example, an obligation may be secured by collateral worth many times the amount of the obligation. If a lien creditor has caused all or a portion of the collateral to be seized under judicial process, it may be dicult to determine the amount of the debtor's equity in the collateral that has been seized. The section leaves resolution of this problem to the courts. The doctrine of marshaling may be appropriate. 7. Sale of Receivables. If a debtor sells an account, chattel paper, payment intangible, or promissory note outright, as against the buyer the debtor has no remaining rights to transfer. If, however, the buyer fails to perfect its interest, then solely insofar as the rights of certain third parties are concerned, the debtor is deemed to retain its rights and title. See Section 9-318. The debtor has the power to convey these rights to a subsequent purchaser. If the subsequent purchaser (buyer or secured lender) perfects its interest, it will achieve priority over the earlier, unperfected purchaser. See Section 9-322(a)(1).

9-402. Secured Party Not Obligated on Contract of Debtor or in Tort. The existence of a security interest, agricultural lien, or authority given to a debtor to dispose of or use collateral, without more, does not subject a secured party to liability in contract or tort for the debtor's acts or omissions. Ocial Comment
1. Source. Former Section 9-317. 2. Nonliability of Secured Party. This section, like former Section 9-317, rejects theories on which a secured party might be held liable on a debtor's contracts or in tort merely because a security interest exists or because the debtor is entitled to dispose of or use collateral. This section expands former Section 9-317 to cover agricultural liens.

9-403. Agreement Not to Assert Defenses Against Assignee. (a) [Value.] In this section, value has the meaning provided in Section 3-303(a). (b) [Agreement not to assert claim or defense.] Except as otherwise
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provided in this section, an agreement between an account debtor and an assignor not to assert against an assignee any claim or defense that the account debtor may have against the assignor is enforceable by an assignee that takes an assignment: (1) for value; (2) in good faith; (3) without notice of a claim of a property or possessory right to the property assigned; and (4) without notice of a defense or claim in recoupment of the type that may be asserted against a person entitled to enforce a negotiable instrument under Section 3-305(a). (c) [When subsection (b) not applicable.] Subsection (b) does not apply to defenses of a type that may be asserted against a holder in due course of a negotiable instrument under Section 3-305(b). (d) [Omission of required statement in consumer transaction.] In a consumer transaction, if a record evidences the account debtor's obligation, law other than this article requires that the record include a statement to the eect that the rights of an assignee are subject to claims or defenses that the account debtor could assert against the original obligee, and the record does not include such a statement: (1) the record has the same eect as if the record included such a statement; and (2) the account debtor may assert against an assignee those claims and defenses that would have been available if the record included such a statement. (e) [Rule for individual under other law.] This section is subject to law other than this article which establishes a dierent rule for an account debtor who is an individual and who incurred the obligation primarily for personal, family, or household purposes. (f) [Other law not displaced.] Except as otherwise provided in subsection (d), this section does not displace law other than this article which gives eect to an agreement by an account debtor not to assert a claim or defense against an assignee. Ocial Comment
1. Source. Former Section 9-206. 2. Scope and Purpose. Subsection (b), like former Section 9-206, generally validates an agreement between an account debtor and an assignor that the account debtor will not assert against an assignee claims and defenses that it may have against the assignor. These agreements are typical in installment sale agreements and leases. However, this section expands former Section 9-206 to apply to all account debtors; it is not limited to account debtors that have bought or leased goods. This section applies only to the obligations of an account debtor, as dened in Section 9-102. Thus, it does not determine the circumstances under which and the extent to which a person who is obligated on a negotiable instrument is disabled from asserting claims and defenses. Rather, Article 3 must be consulted. See, e.g., Sections 3-305, 3-306. Article 3 governs even when the negotiable instrument constitutes part of chattel paper. See Section 9-102 (an obligor on a negotiable instrument constituting part of chattel paper is not an account debtor). 3. Conditions of Validation; Relationship to Article 3. Subsection (b) validates an account debtor's agreement only if the assignee takes an assignment for value, in good faith, and without notice of conicting claims to the property assigned or of certain claims or defenses of the account debtor. Like former Section 9-206, this section is designed to put 986

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the assignee in a position that is no better and no worse than that of a holder in due course of a negotiable instrument under Article 3. However, former Section 9-206 left open certain issues, e.g., whether the section incorporated the special Article 3 denition of value in Section 3-303 or the generally applicable denition in Section 1-201(44). Subsection (a) addresses this question; it provides that value has the meaning specied in Section 3-303(a). Similarly, subsection (c) provides that subsection (b) does not validate an agreement with respect to defenses that could be asserted against a holder in due course under Section 3-305(b) (the so-called real defenses). In 1990, the denition of holder in due course (Section 3-302) and the articulation of the rights of a holder in due course (Sections 3-305 and 3-306) were revised substantially. This section tracks more closely the rules of Sections 3-302, 3-305, and 3-306. 4. Relationship to Terms of Assigned Property. Former Section 9-206(2), concerning warranties accompanying the sale of goods, has been deleted as unnecessary. This Article does not regulate the terms of the account, chattel paper, or general intangible that is assigned, except insofar as the account, chattel paper, or general intangible itself creates a security interest (as often is the case with chattel paper). Thus, Article 2, and not this Article, determines whether a seller of goods makes or eectively disclaims warranties, even if the sale is secured. Similarly, other law, and not this Article, determines the effectiveness of an account debtor's undertaking to pay notwithstanding, and not to assert, any defenses or claims against an assignor-e.g., a hell-or-high-water provision in the underlying agreement that is assigned. If other law gives eect to this undertaking, then, under principles of nemo dat, the undertaking would be enforceable by the assignee (secured party). If other law prevents the assignor from enforcing the undertaking, this section nevertheless might permit the assignee to do so. The right of the assignee to enforce would depend upon whether, under the particular facts, the account debtor's undertaking fairly could be construed as an agreement that falls within the scope of this section and whether the assignee meets the requirements of this section. 5. Relationship to Federal Trade Commission Rule. Subsection (d) is new. It applies to rights evidenced by a record that is required to contain, but does not contain, the notice set forth in Federal Trade Commission Rule 433, 16 C.F.R. Part 433 (the Holder-in-DueCourse Regulations). Under this subsection, an assignee of such a record takes subject to the consumer account debtor's claims and defenses to the same extent as it would have if the writing had contained the required notice. Thus, subsection (d) eectively renders waiver-of-defense clauses ineective in the transactions with consumers to which it applies. 6. Relationship to Other Law. Like former Section 9-206(1), this section takes no position on the enforceability of waivers of claims and defenses by consumer account debtors, leaving that question to other law. However, the reference to law other than this article in subsection (e) encompasses administrative rules and regulations; the reference in former Section 9-206(1) that it replaces (statute or decision) arguably did not. This section does not displace other law that gives eect to a non-consumer account debtor's agreement not to assert defenses against an assignee, even if the agreement would not qualify under subsection (b). See subsection (f). It validates, but does not invalidate, agreements made by a non-consumer account debtor. This section also does not displace other law to the extent that the other law permits an assignee, who takes an assignment with notice of a claim of a property or possessory right, a defense, or a claim in recoupment, to enforce an account debtor's agreement not to assert claims and defenses against the assignor (e.g., a hell-or-high-water agreement). See Comment 4. It also does not displace an assignee's right to assert that an account debtor is estopped from asserting a claim or defense. Nor does this section displace other law with respect to waivers of potential future claims and defenses that are the subject of an agreement between the account debtor and the assignee. Finally, it does not displace Section 1-107, concerning waiver of a breach that allegedly already has occurred.

9-404. Rights Acquired by Assignee; Claims and Defenses Against Assignee. (a) [Assignee's rights subject to terms, claims, and defenses; exceptions.] Unless an account debtor has made an enforceable agreement not to assert defenses or claims, and subject to subsections (b) through (e), the rights of an assignee are subject to:
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(1) all terms of the agreement between the account debtor and assignor and any defense or claim in recoupment arising from the transaction that gave rise to the contract; and (2) any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives a notication of the assignment authenticated by the assignor or the assignee. (b) [Account debtor's claim reduces amount owed to assignee.] Subject to subsection (c) and except as otherwise provided in subsection (d), the claim of an account debtor against an assignor may be asserted against an assignee under subsection (a) only to reduce the amount the account debtor owes. (c) [Rule for individual under other law.] This section is subject to law other than this article which establishes a dierent rule for an account debtor who is an individual and who incurred the obligation primarily for personal, family, or household purposes. (d) [Omission of required statement in consumer transaction.] In a consumer transaction, if a record evidences the account debtor's obligation, law other than this article requires that the record include a statement to the eect that the account debtor's recovery against an assignee with respect to claims and defenses against the assignor may not exceed amounts paid by the account debtor under the record, and the record does not include such a statement, the extent to which a claim of an account debtor against the assignor may be asserted against an assignee is determined as if the record included such a statement. (e) [Inapplicability to health-care-insurance receivable.] This section does not apply to an assignment of a health-care-insurance receivable. Ocial Comment
1. Source. Former Section 9-318(1). 2. Purpose; Rights of Assignee in General. Subsection (a), like former Section 9-318(1), provides that an assignee generally takes an assignment subject to defenses and claims of an account debtor. Under subsection (a)(1), if the account debtor's defenses on an assigned claim arise from the transaction that gave rise to the contract with the assignor, it makes no dierence whether the defense or claim accrues before or after the account debtor is notied of the assignment. Under subsection (a)(2), the assignee takes subject to other defenses or claims only if they accrue before the account debtor has been notied of the assignment. Of course, an account debtor may waive its right to assert defenses or claims against an assignee under Section 9-403 or other applicable law. Subsection (a) tracks Section 3-305(a)(3) more closely than its predecessor. 3. Limitation on Armative Claims. Subsection (b) is new. It limits the claim that the account debtor may assert against an assignee. Borrowing from Section 3-305(a)(3) and cases construing former Section 9-318, subsection (b) generally does not aord the account debtor the right to an armative recovery from an assignee. 4. Consumer Account Debtors; Relationship to Federal Trade Commission Rule. Subsections (c) and (d) also are new. Subsection (c) makes clear that the rules of this section are subject to other law establishing special rules for consumer account debtors. An account debtor who is an individual as used in subsection (c) includes individuals who are jointly or jointly and severally obligated. Subsection (d) applies to rights evidenced by a record that is required to contain, but does not contain, the notice set forth in Federal Trade Commission Rule 433, 16 C.F.R. Part 433 (the Holder-in-Due-Course Regulations). Under subsection (d), a consumer account debtor has the same right to an armative recovery from an assignee of such a record as the consumer would have had against the assignee had the record contained the required notice. 5. Scope; Application to Account Debtor. This section deals only with the rights 988

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and duties of account debtorsand for the most part only with account debtors on accounts, chattel paper, and payment intangibles. Subsection (e) provides that the obligation of an insurer with respect to a health-care-insurance receivable is governed by other law. References in this section to an account debtor include account debtors on collateral that is proceeds. Neither this section nor any other provision of this Article, including Sections 9-408 and 9-409, provides analogous regulation of the rights and duties of other obligors on collateral, such as the maker of a negotiable instrument (governed by Article 3), the issuer of or nominated person under a letter of credit (governed by Article 5), or the issuer of a security (governed by Article 8). Article 9 leaves those rights and duties untouched; however, Section 9-409 deals with the special case of letters of credit. When chattel paper is composed in part of a negotiable instrument, the obligor on the instrument is not an account debtor, and Article 3 governs the rights of the assignee of the chattel paper with respect to the issues that this section addresses. See, e.g., Section 3-601 (dealing with discharge of an obligation to pay a negotiable instrument).

9-405. Modication of Assigned Contract. (a) [Eect of modication on assignee.] A modication of or substitution for an assigned contract is eective against an assignee if made in good faith. The assignee acquires corresponding rights under the modied or substituted contract. The assignment may provide that the modication or substitution is a breach of contract by the assignor. This subsection is subject to subsections (b) through (d). (b) [Applicability of subsection (a).] Subsection (a) applies to the extent that: (1) the right to payment or a part thereof under an assigned contract has not been fully earned by performance; or (2) the right to payment or a part thereof has been fully earned by performance and the account debtor has not received notication of the assignment under Section 9-406(a). (c) [Rule for individual under other law.] This section is subject to law other than this article which establishes a dierent rule for an account debtor who is an individual and who incurred the obligation primarily for personal, family, or household purposes. (d) [Inapplicability to health-care-insurance receivable.] This section does not apply to an assignment of a health-care-insurance receivable. Ocial Comment
1. Source. Former Section 9-318(2). 2. Modication of Assigned Contract. The ability of account debtors and assignors to modify assigned contracts can be important, especially in the case of government contracts and complex contractual arrangements (e.g., construction contracts) with respect to which modications are customary. Subsections (a) and (b) provide that good-faith modications of assigned contracts are binding against an assignee to the extent that (i) the right to payment has not been fully earned or (ii) the right to payment has been earned and notication of the assignment has not been given to the account debtor. Former Section 9-318(2) did not validate modications of fully-performed contracts under any circumstances, whether or not notication of the assignment had been given to the account debtor. Subsection (a) protects the interests of assignees by (i) limiting the eectiveness of modications to those made in good faith, (ii) aording the assignee with corresponding rights under the contract as modied, and (iii) recognizing that the modication may be a breach of the assignor's agreement with the assignee. 3. Consumer Account Debtors. Subsection (c) is new. It makes clear that the rules of this section are subject to other law establishing special rules for consumer account debtors. 4. Account Debtors on Health-Care-Insurance Receivables. Subsection (d) also is new. It provides that this section does not apply to an assignment of a heath-care-insurance 989

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receivable. The obligation of an insurer with respect to a health-care-insurance receivable is governed by other law.

9-406. Discharge of Account Debtor; Notication of Assignment; Identication and Proof of Assignment; Restrictions on Assignment of Accounts, Chattel Paper, Payment Intangibles, and Promissory Notes Ineective. (a) [Discharge of account debtor; eect of notication.] Subject to subsections (b) through (i), an account debtor on an account, chattel paper, or a payment intangible may discharge its obligation by paying the assignor until, but not after, the account debtor receives a notication, authenticated by the assignor or the assignee, that the amount due or to become due has been assigned and that payment is to be made to the assignee. After receipt of the notication, the account debtor may discharge its obligation by paying the assignee and may not discharge the obligation by paying the assignor. (b) [When notication ineective.] Subject to subsection (h), notication is ineective under subsection (a): (1) if it does not reasonably identify the rights assigned; (2) to the extent that an agreement between an account debtor and a seller of a payment intangible limits the account debtor's duty to pay a person other than the seller and the limitation is eective under law other than this article; or (3) at the option of an account debtor, if the notication noties the account debtor to make less than the full amount of any installment or other periodic payment to the assignee, even if: (A) only a portion of the account, chattel paper, or payment intangible has been assigned to that assignee; (B) a portion has been assigned to another assignee; or (C) the account debtor knows that the assignment to that assignee is limited. (c) [Proof of assignment.] Subject to subsection (h), if requested by the account debtor, an assignee shall seasonably furnish reasonable proof that the assignment has been made. Unless the assignee complies, the account debtor may discharge its obligation by paying the assignor, even if the account debtor has received a notication under subsection (a). (d) [Term restricting assignment generally ineective.] Except as otherwise provided in subsection (e) and Sections 2A-303 and 9-407, and subject to subsection (h), a term in an agreement between an account debtor and an assignor or in a promissory note is ineective to the extent that it: (1) prohibits, restricts, or requires the consent of the account debtor or person obligated on the promissory note to the assignment or transfer of, or the creation, attachment, perfection, or enforcement of a security interest in, the account, chattel paper, payment intangible, or promissory note; or (2) provides that the assignment or transfer or the creation, attachment, perfection, or enforcement of the security interest may give rise to a default, breach, right of recoupment, claim, defense, termination, right
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of termination, or remedy under the account, chattel paper, payment intangible, or promissory note. (e) [Inapplicability of subsection (d) to certain sales.] Subsection (d) does not apply to the sale of a payment intangible or promissory note. (f) [Legal restrictions on assignment generally ineective.] Except as otherwise provided in Sections 2A-303 and 9-407 and subject to subsections (h) and (i), a rule of law, statute, or regulation that prohibits, restricts, or requires the consent of a government, governmental body or ocial, or account debtor to the assignment or transfer of, or creation of a security interest in, an account or chattel paper is ineective to the extent that the rule of law, statute, or regulation: (1) prohibits, restricts, or requires the consent of the government, governmental body or ocial, or account debtor to the assignment or transfer of, or the creation, attachment, perfection, or enforcement of a security interest in the account or chattel paper; or (2) provides that the assignment or transfer or the creation, attachment, perfection, or enforcement of the security interest may give rise to a default, breach, right of recoupment, claim, defense, termination, right of termination, or remedy under the account or chattel paper. (g) [Subsection (b)(3) not waivable.] Subject to subsection (h), an account debtor may not waive or vary its option under subsection (b)(3). (h) [Rule for individual under other law.] This section is subject to law other than this article which establishes a dierent rule for an account debtor who is an individual and who incurred the obligation primarily for personal, family, or household purposes. (i) [Inapplicability to health-care-insurance receivable.] This section does not apply to an assignment of a health-care-insurance receivable. (j) [Section prevails over specied inconsistent law.] This section prevails over any inconsistent provisions of the following statutes, rules, and regulations:
[List here any statutes, rules, and regulations containing provisions inconsistent with this section.] Legislative Note: States that amend statutes, rules, and regulations to remove provisions inconsistent with this section need not enact subsection (j)

As amended in 1999 and 2000.

See Appendix O for material relating to changes made in text in 1999 and 2000.

Ocial Comment
1. Source. Former Section 9-318(3), (4). 2. Account Debtor's Right to Pay Assignor Until Notication. Subsection (a) provides the general rule concerning an account debtor's right to pay the assignor until the account debtor receives appropriate notication. The revision makes clear that once the account debtor receives the notication, the account debtor cannot discharge its obligation by paying the assignor. It also makes explicit that payment to the assignor before notication, or payment to the assignee after notication, discharges the obligation. No change in meaning from former Section 9-318 is intended. Nothing in this section conditions the eectiveness of a notication on the identity of the person who gives it. An account debtor that doubts whether the right to payment has been assigned may avail itself of the procedures in subsection (c). See Comment 4. An eective notication under subsection (a) must be authenticated. This requirement 991

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normally could be satised by sending notication on the notifying person's letterhead or on a form on which the notifying person's name appears. In each case the printed name would be a symbol adopted by the notifying person for the purpose of identifying the person and adopting the notication. See Section 9-102 (dening authenticate). Subsection (a) applies only to account debtors on accounts, chattel paper, and payment intangibles. (Section 9-102 denes the term account debtor more broadly, to include those obligated on all general intangibles.) Although subsection (a) is more precise than its predecessor, it probably does not change the rule that applied under former Article 9. Former Section 9-318(3) referred to the account debtor's obligation to pay, indicating that the subsection was limited to account debtors on accounts, chattel paper, and other payment obligations. 3. Limitations on Eectiveness of Notication. Subsection (b) contains some special rules concerning the eectiveness of a notication under subsection (a). Subsection (b)(1) tracks former Section 9-318(3) by making ineective a notication that does not reasonably identify the rights assigned. A reasonable identication need not identify the right to payment with specicity, but what is reasonable also is not left to the arbitrary decision of the account debtor. If an account debtor has doubt as to the adequacy of a notication, it may not be safe in disregarding the notication unless it noties the assignee with reasonable promptness as to the respects in which the account debtor considers the notication defective. Subsection (b)(2), which is new, applies only to sales of payment intangibles. It makes a notication ineective to the extent that other law gives eect to an agreement between an account debtor and a seller of a payment intangible that limits the account debtor's duty to pay a person other than the seller. Payment intangibles are substantially less fungible than accounts and chattel paper. In some (e.g., commercial bank loans), account debtors customarily and legitimately expect that they will not be required to pay any person other than the nancial institution that has advanced funds. It has become common in nancing transactions to assign interests in a single obligation to more than one assignee. Requiring an account debtor that owes a single obligation to make multiple payments to multiple assignees would be unnecessarily burdensome. Thus, under subsection (b)(3), an account debtor that is notied to pay an assignee less than the full amount of any installment or other periodic payment has the option to treat the notication as ineective, ignore the notice, and discharge the assigned obligation by paying the assignor. Some account debtors may not realize that the law aords them the right to ignore certain notices of assignment with impunity. By making the notication ineective at the account debtor's option, subsection (b)(3) permits an account debtor to pay the assignee in accordance with the notice and thereby to satisfy its obligation pro tanto. Under subsection (g), the rights and duties created by subsection (b)(3) cannot be waived or varied. 4. Proof of Assignment. Subsection (c) links payment with discharge, as in subsection (a). It follows former Section 9-318(3) in referring to the right of the account debtor to pay the assignor if the requested proof of assignment is not seasonably forthcoming. Even if the proof is not forthcoming, the notication of assignment would remain eective, so that, in the absence of reasonable proof of the assignment, the account debtor could discharge the obligation by paying either the assignee or the assignor. Of course, if the assignee did not in fact receive an assignment, the account debtor cannot discharge its obligation by paying a putative assignee who is a stranger. The observations in Comment 3 concerning the reasonableness of an identication of a right to payment also apply here. An account debtor that questions the adequacy of proof submitted by an assignee would be well advised to promptly inform the assignee of the defects. An account debtor may face another problem if its obligation becomes due while the account debtor is awaiting reasonable proof of the assignment that it has requested from the assignee. This section does not excuse the account debtor from timely compliance with its obligations. Consequently, an account debtor that has received a notication of assignment and who has requested reasonable proof of the assignment may discharge its obligation by paying the assignor at the time (or even earlier if reasonably necessary to avoid risk of default) when a payment is due, even if the account debtor has not yet received a response to its request for proof. On the other hand, after requesting reasonable proof of the assignment, an account debtor may not discharge its obligation by paying the assignor 992

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substantially in advance of the time that the payment is due unless the assignee has failed to provide the proof seasonably. 5. Contractual Restrictions on Assignment. Former Section 9-318(4) rendered ineffective an agreement between an account debtor and an assignor which prohibited assignment of an account (whether outright or to secure an obligation) or prohibited a security assignment of a general intangible for the payment of money due or to become due. Subsection (d) essentially follows former Section 9-318(4), but expands the rule of free assignability to chattel paper (subject to Sections 2A-303 and 9-407) and promissory notes and explicitly overrides both restrictions and prohibitions of assignment. The policies underlying the ineffectiveness of contractual restrictions under this section build on common-law developments that essentially have eliminated legal restrictions on assignments of rights to payment as security and other assignments of rights to payment such as accounts and chattel paper. Any that might linger for accounts and chattel paper are addressed by new subsection (f). See Comment 6. Former Section 9-318(4) did not apply to a sale of a payment intangible (as described in the former provision, a general intangible for money due or to become due) but did apply to an assignment of a payment intangible for security. Subsection (e) continues this approach and also makes subsection (d) inapplicable to sales of promissory notes. Section 9-408 addresses anti-assignment clauses with respect to sales of payment intangibles and promissory notes. Like former Section 9-318(4), subsection (d) provides that anti-assignment clauses are ineective. The quoted term means that the clause is of no eect whatsoever; the clause does not prevent the assignment from taking eect between the parties and the prohibited assignment does not constitute a default under the agreement between the account debtor and assignor. However, subsection (d) does not override terms that do not directly prohibit, restrict, or require consent to an assignment but which might, nonetheless, present a practical impairment of the assignment. Properly read, however, subsection (d) reaches only covenants that prohibit, restrict, or require consents to assignments; it does not override all terms that might impair an assignment in fact. Example: Buyer enters into an agreement with Seller to buy equipment that Seller is to manufacture according to Buyer's specications. Buyer agrees to make a series of prepayments during the construction process. In return, Seller agrees to set aside the prepaid funds in a special account and to use the funds solely for the manufacture of the designated equipment. Seller also agrees that it will not assign any of its rights under the sale agreement with Buyer. Nevertheless, Seller grants to Secured Party a security interest in its accounts. Seller's anti-assignment agreement is ineective under subsection (d); its agreement concerning the use of prepaid funds, which is not a restriction or prohibition on assignment, is not. However, if Secured Party noties Buyer to make all future payments directly to Secured Party, Buyer will be obliged to do so under subsection (a) if it wishes the payments to discharge its obligation. Unless Secured Party releases the funds to Seller so that Seller can comply with its use-of-funds covenant, Seller will be in breach of that covenant. In the example, there appears to be a plausible business purpose for the use-of-funds covenant. However, a court may conclude that a covenant with no business purpose other than imposing an impediment to an assignment actually is a direct restriction that is rendered ineective by subsection (d). 6. Legal Restrictions on Assignment. Former Section 9-318(4), like subsection (d) of this section, addressed only contractual restrictions on assignment. The former section was grounded on the reality that legal, as opposed to contractual, restrictions on assignments of rights to payment had largely disappeared. New subsection (f) codies this principle of free assignability for accounts and chattel paper. For the most part the discussion of contractual restrictions in Comment 5 applies as well to legal restrictions rendered ineective under subsection (f). 7. Multiple Assignments. This section, like former Section 9-318, is not a complete codication of the law of assignments of rights to payment. In particular, it is silent concerning many of the ramications for an account debtor in cases of multiple assignments of the same right. For example, an assignor might assign the same receivable to multiple assignees (which assignments could be either inadvertent or wrongful). Or, the assignor could assign the receivable to assignee-1, which then might re-assign it to assignee-2, and so forth. The rights and duties of an account debtor in the face of multiple assignments and in other 993

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circumstances not resolved in the statutory text are left to the common-law rules. See, e.g., Restatement (2d), Contracts 338(3), 339. The failure of former Article 9 to codify these rules does not appear to have caused problems. 8. Consumer Account Debtors. Subsection (h) is new. It makes clear that the rules of this section are subject to other law establishing special rules for consumer account debtors. 9. Account Debtors on Health-Care-Insurance Receivables. Subsection (i) also is new. The obligation of an insurer with respect to a health-care-insurance receivable is governed by other law. Section 9-408 addresses contractual and legal restrictions on the assignment of a health-care-insurance receivable.

9-407. Restrictions on Creation or Enforcement of Security Interest in Leasehold Interest or in Lessor's Residual Interest. (a) [Term restricting assignment generally ineective.] Except as otherwise provided in subsection (b), a term in a lease agreement is ineffective to the extent that it: (1) prohibits, restricts, or requires the consent of a party to the lease to the assignment or transfer of, or the creation, attachment, perfection, or enforcement of a security interest in an interest of a party under the lease contract or in the lessor's residual interest in the goods; or (2) provides that the assignment or transfer or the creation, attachment, perfection, or enforcement of the security interest may give rise to a default, breach, right of recoupment, claim, defense, termination, right of termination, or remedy under the lease. (b) [Eectiveness of certain terms.] Except as otherwise provided in Section 2A-303(7), a term described in subsection (a)(2) is eective to the extent that there is: (1) a transfer by the lessee of the lessee's right of possession or use of the goods in violation of the term; or (2) a delegation of a material performance of either party to the lease contract in violation of the term. (c) [Security interest not material impairment.] The creation, attachment, perfection, or enforcement of a security interest in the lessor's interest under the lease contract or the lessor's residual interest in the goods is not a transfer that materially impairs the lessee's prospect of obtaining return performance or materially changes the duty of or materially increases the burden or risk imposed on the lessee within the purview of Section 2A-303(4) unless, and then only to the extent that, enforcement actually results in a delegation of material performance of the lessor. As amended in 1999.
See Appendix P for material relating to changes made in text in 1999.

Ocial Comment
1. Source. Section 2A-303. 2. Restrictions on Assignment Generally Ineective. Under subsection (a), as under former Section 2A-303(3), a term in a lease agreement which prohibits or restricts the creation of a security interest generally is ineective. This reects the general policy of Section 9-406(d) and former Section 9-318(4). This section has been conformed in several respects to analogous provisions in Sections 9-406, 9-408, and 9-409, including the substitution of 994

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ineective for not enforceable and the substitution of assignment or transfer of, or the* creation, attachment, perfection, or enforcement of a security interest for creation or enforcement of a security interest. 3. Exceptions for Certain Transfers and Delegations. Subsection (b) provides exceptions to the general ineectiveness of restrictions under subsection (a). A term that otherwise is ineective under subsection (a)(2) is eective to the extent that a lessee transfers its right to possession and use of goods or if either party delegates material performance of the lease contract in violation of the term. However, under subsection (c), as under former Section 2A-303(3), a lessor's creation of a security interest in its interest in a lease contract or its residual interest in the leased goods is not a material impairment under Section 2A-303(4) (former Section 2A-303(5)), absent an actual delegation of the lessor's material performance. The terms of the lease contract determine whether the lessor, in fact, has any remaining obligations to perform. If it does, it is then necessary to determine whether there has been an actual delegation of material performance. See Section 2A-303, Comments 3 and 4.

As amended in 1999.
See Appendix P for material relating to changes made in Ocial Comment in 1999.

9-408. Restrictions on Assignment of Promissory Notes, HealthCare-Insurance Receivables, and Certain General Intangibles Ineective. (a) [Term restricting assignment generally ineective.] Except as otherwise provided in subsection (b), a term in a promissory note or in an agreement between an account debtor and a debtor which relates to a health-care-insurance receivable or a general intangible, including a contract, permit, license, or franchise, and which term prohibits, restricts, or requires the consent of the person obligated on the promissory note or the account debtor to, the assignment or transfer of, or creation, attachment, or perfection of a security interest in, the promissory note, healthcare-insurance receivable, or general intangible, is ineective to the extent that the term: (1) would impair the creation, attachment, or perfection of a security interest; or (2) provides that the assignment or transfer or the creation, attachment, or perfection of the security interest may give rise to a default, breach, right of recoupment, claim, defense, termination, right of termination, or remedy under the promissory note, health-care-insurance receivable, or general intangible. (b) [Applicability of subsection (a) to sales of certain rights to payment.] Subsection (a) applies to a security interest in a payment intangible or promissory note only if the security interest arises out of a sale of the payment intangible or promissory note. (c) [Legal restrictions on assignment generally ineective.] A rule of law, statute, or regulation that prohibits, restricts, or requires the consent of a government, governmental body or ocial, person obligated on a promissory note, or account debtor to the assignment or transfer of, or creation of a security interest in, a promissory note, health-care-insurance
[Section 9-407] *Amendments in italics approved by the Permanent Editorial Board for Uniform Commercial Code October 20, 1999. 995

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receivable, or general intangible, including a contract, permit, license, or franchise between an account debtor and a debtor, is ineective to the extent that the rule of law, statute, or regulation: (1) would impair the creation, attachment, or perfection of a security interest; or (2) provides that the assignment or transfer or the creation, attachment, or perfection of the security interest may give rise to a default, breach, right of recoupment, claim, defense, termination, right of termination, or remedy under the promissory note, health-care-insurance receivable, or general intangible. (d) [Limitation on ineectiveness under subsections (a) and (c).] To the extent that a term in a promissory note or in an agreement between an account debtor and a debtor which relates to a health-careinsurance receivable or general intangible or a rule of law, statute, or regulation described in subsection (c) would be eective under law other than this article but is ineective under subsection (a) or (c), the creation, attachment, or perfection of a security interest in the promissory note, health-care-insurance receivable, or general intangible: (1) is not enforceable against the person obligated on the promissory note or the account debtor; (2) does not impose a duty or obligation on the person obligated on the promissory note or the account debtor; (3) does not require the person obligated on the promissory note or the account debtor to recognize the security interest, pay or render performance to the secured party, or accept payment or performance from the secured party; (4) does not entitle the secured party to use or assign the debtor's rights under the promissory note, health-care-insurance receivable, or general intangible, including any related information or materials furnished to the debtor in the transaction giving rise to the promissory note, health-care-insurance receivable, or general intangible; (5) does not entitle the secured party to use, assign, possess, or have access to any trade secrets or condential information of the person obligated on the promissory note or the account debtor; and (6) does not entitle the secured party to enforce the security interest in the promissory note, health-care-insurance receivable, or general intangible. (e) [Section prevails over specied inconsistent law.] This section prevails over any inconsistent provisions of the following statutes, rules, and regulations:
[List here any statutes, rules, and regulations containing provisions inconsistent with this section.] Legislative Note: States that amend statutes, rules, and regulations to remove provisions inconsistent with this section need not enact subsection (e).

As amended in 1999.
See Appendix P for material relating to changes made in text in 1999.

Ocial Comment
1. Source. New. 2. Free Assignability. This section makes ineective any attempt to restrict the assign996

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ment of a general intangible, health-care-insurance receivable, or promissory note, whether the restriction appears in the terms of a promissory note or the agreement between an account debtor and a debtor (subsection (a)) or in a rule of law, including a statute or governmental rule or regulation (subsection (c)). This result allows the creation, attachment, and perfection of a security interest in a general intangible, such as an agreement for the nonexclusive license of software, as well as sales of certain receivables, such as a health-care-insurance receivable (which is an account), payment intangible, or promissory note, without giving rise to a default or breach by the assignor or from triggering a remedy of the account debtor or person obligated on a promissory note. This enhances the ability of certain debtors to obtain credit. On the other hand, subsection (d) protects the other partythe account debtor on a general intangible or the person obligated on a promissory notefrom adverse eects arising from the security interest. It leaves the account debtor's or obligated person's rights and obligations unaected in all material respects if a restriction rendered ineective by subsection (a) or (c) would be eective under law other than Article 9. Example 1: A term of an agreement for the nonexclusive license of computer software prohibits the licensee from assigning any of its rights as licensee with respect to the software. The agreement also provides that an attempt to assign rights in violation of the restriction is a default entitling the licensor to terminate the license agreement. The licensee, as debtor, grants to a secured party a security interest in its rights under the license and in the computers in which it is installed. Under this section, the term prohibiting assignment and providing for a default upon an attempted assignment is ineective to prevent the creation, attachment, or perfection of the security interest or entitle the licensor to terminate the license agreement. However, under subsection (d), the secured party (absent the licensor's agreement) is not entitled to enforce the license or to use, assign, or otherwise enjoy the benets of the licensed software, and the licensor need not recognize (or pay any attention to) the secured party. Even if the secured party takes possession of the computers on the debtor's default, the debtor would remain free to remove the software from the computer, load it on another computer, and continue to use it, if the license so permits. If the debtor does not remove the software, other law may require the secured party to remove it before disposing of the computer. Disposition of the software with the computer could violate an eective prohibition on enforcement of the security interest. See subsection (d). 3. Nature of Debtor's Interest. Neither this section nor any other provision of this Article determines whether a debtor has a property interest. The denition of the term security interest provides that it is an interest in personal property. See Section 1-201(37). Ordinarily, a debtor can create a security interest in collateral only if it has rights in the collateral. See Section 9-203(b). Other law determines whether a debtor has a property interest (rights in the collateral) and the nature of that interest. For example, the nonexclusive license addressed in Example 1 may not create any property interest whatsoever in the intellectual property (e.g., copyright) that underlies the license and that eectively enables the licensor to grant the license. The debtor's property interest may be conned solely to its interest in the promises made by the licensor in the license agreement (e.g., a promise not to sue the debtor for its use of the software). 4. Scope: Sales of Payment Intangibles and Other General Intangibles; Assignments Unaected by this Section. Subsections (a) and (c) render ineective restrictions on assignments only to the extent that the assignments restrict the creation, attachment, or perfection of a security interest, including sales of payment intangibles and promissory notes. This section does not render ineective a restriction on an assignment that does not create a security interest. For example, if the debtor in Comment 2, Example 1 purported to assign the license to another entity that would use the computer software itself, other law would govern the eectiveness of the anti-assignment provisions. Subsection (a) applies to a security interest in payment intangibles only if the security interest arises out of sale of the payment intangibles. Contractual restrictions directed to security interests in payment intangibles which secure an obligation are subject to Section 9-406(d). Subsection (a) also deals with sales of promissory notes which also create security interests. See Section 9-109(a). Subsection (c) deals with all security interests in payment intangibles or promissory notes, whether or not arising out of a sale. Subsection (a) does not render ineective any term, and subsection (c) does not render ineective any law, statute or regulation, that restricts outright sales of general intangibles 997

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other than payment intangibles. They deal only with restrictions on security interests. The only sales of general intangibles that create security interests are sales of payment intangibles. 5. Terminology: Account Debtor; Person Obligated on a Promissory Note. This section uses the term account debtor as it is dened in Section 9-102. The term refers to the party, other than the debtor, to a general intangible, including a permit, license, franchise, or the like, and the person obligated on a health-care-insurance receivable, which is a type of account. The denition of account debtor does not limit the term to persons who are obligated to pay under a general intangible. Rather, the term includes all persons who are obligated on a general intangible, including those who are obligated to render performance in exchange for payment. In some cases, e.g., the creation of a security interest in a franchisee's rights under a franchise agreement, the principal payment obligation may be owed by the debtor (franchisee) to the account debtor (franchisor). This section also refers to a person obligated on a promissory note, inasmuch as those persons do not fall within the denition of account debtor. Example 2: A licensor and licensee enter into an agreement for the nonexclusive license of computer software. The licensee's interest in the license agreement is a general intangible. If the licensee grants to a secured party a security interest in its rights under the license agreement, the licensee is the debtor and the licensor is the account debtor. On the other hand, if the licensor grants to a secured party a security interest in its right to payment (an account) under the license agreement, the licensor is the debtor and the licensee is the account debtor. (This section applies to the security interest in the general intangible but not to the security interest in the account, which is not a health-care-insurance receivable.) 6. Eects on Account Debtors and Persons Obligated on Promissory Notes. Subsections (a) and (c) aect two classes of persons. These subsections aect account debtors on general intangibles and health-care-insurance receivables and persons obligated on promissory notes. Subsection (c) also aects governmental entities that enact or determine rules of law. However, subsection (d) ensures that these aected persons are not aected adversely. That provision removes any burdens or adverse eects on these persons for which any rational basis could exist to restrict the eectiveness of an assignment or to exercise any remedies. For this reason, the eects of subsections (a) and (c) are immaterial insofar as those persons are concerned. Subsection (a) does not override terms that do not directly prohibit, restrict, or require consent to an assignment but which might, nonetheless, present a practical impairment of the assignment. Properly read, however, this section, like Section 9-406(d), reaches only covenants that prohibit, restrict, or require consents to assignments; it does not override all terms that might impair an assignment in fact. Example 3: A licensor and licensee enter into an agreement for the nonexclusive license of valuable business software. The license agreement includes terms (i) prohibiting the licensee from assigning its rights under the license, (ii) prohibiting the licensee from disclosing to anyone certain information relating to the software and the licensor, and (iii) deeming prohibited assignments and prohibited disclosures to be defaults. The licensee wishes to obtain nancing and, in exchange, is willing to grant a security interest in its rights under the license agreement. The secured party, reasonably, refuses to extend credit unless the licensee discloses the information that it is prohibited from disclosing under the license agreement. The secured party cannot determine the value of the proposed collateral in the absence of this information. Under this section, the terms of the license prohibiting the assignment (grant of the security interest) and making the assignment a default are ineective. However, the nondisclosure covenant is not a term that prohibits the assignment or creation of a security interest in the license. Consequently, the nondisclosure term is enforceable even though the practical eect is to restrict the licensee's ability to use its rights under the license agreement as collateral. The nondisclosure term also would be eective in the factual setting of Comment 2, Example 1. If the secured party's possession of the computers loaded with software would put it in a position to discover condential information that the debtor was prohibited from disclosing, the licensor should be entitled to enforce its rights against the secured party. Moreover, the licensor could have required the debtor to obtain the secured party's agreement that (i) it would immediately return all copies of software loaded on the computers and that (ii) it would not examine or otherwise acquire any information contained in the software. This 998

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section does not prevent an account debtor from protecting by agreement its independent interests that are unrelated to the creation, attachment, or perfection of a security interest. In Example 1, moreover, the secured party is not in possession of copies of software by virtue of its security interest or in connection with enforcing its security interest in the debtor's license of the software. Its possession is incidental to its possession of the computers, in which it has a security interest. Enforcing against the secured party a restriction relating to the software in no way interferes with its security interest in the computers. 7. Eect in Assignor's Bankruptcy. This section could have a substantial eect if the assignor enters bankruptcy. Roughly speaking, Bankruptcy Code Section 552 invalidates security interests in property acquired after a bankruptcy petition is led, except to the extent that the postpetition property constitutes proceeds of prepetition collateral. Example 4: A debtor is the owner of a cable television franchise that, under applicable law, cannot be assigned without the consent of the municipal franchisor. A lender wishes to extend credit to the debtor, provided that the credit is secured by the debtor's going business value. To secure the loan, the debtor grants a security interest in all its existing and after-acquired property. The franchise represents the principal value of the business. The municipality refuses to consent to any assignment for collateral purposes. If other law were given eect, the security interest in the franchise would not attach; and if the debtor were to enter bankruptcy and sell the business, the secured party would receive but a fraction of the business's value. Under this section, however, the security interest would attach to the franchise. As a result, the security interest would attach to the proceeds of any sale of the franchise while a bankruptcy is pending. However, this section would protect the interests of the municipality by preventing the secured party from enforcing its security interest to the detriment of the municipality. 8. Eect Outside of Bankruptcy. The principal eects of this section will take place outside of bankruptcy. Compared to the relatively few debtors that enter bankruptcy, there are many more that do not. By making available previously unavailable property as collateral, this section should enable debtors to obtain additional credit. For purposes of determining whether to extend credit, under some circumstances a secured party may ascribe value to the collateral to which its security interest has attached, even if this section precludes the secured party from enforcing the security interest without the agreement of the account debtor or person obligated on the promissory note. This may be the case where the secured party sees a likelihood of obtaining that agreement in the future. This may also be the case where the secured party anticipates that the collateral will give rise to a type of proceeds as to which this section would not apply. Example 5: Under the facts of Example 4, the debtor does not enter bankruptcy. Perhaps in exchange for a fee, the municipality agrees that the debtor may transfer the franchise to a buyer. As consideration for the transfer, the debtor receives from the buyer its check for part of the purchase price and its promissory note for the balance. The security interest attaches to the check and promissory note as proceeds. See Section 9-315(a)(2). This section does not apply to the security interest in the check, which is not a promissory note, health-care-insurance receivable, or general intangible. Nor does it apply to the security interest in the promissory note, inasmuch as it was not sold to the secured party. 9. Contrary Federal Law. This section does not override federal law to the contrary. However, it does reect an important policy judgment that should provide a template for future federal law reforms.

9-409. Restrictions on Assignment of Letter-of-Credit Rights Ineective. (a) [Term or law restricting assignment generally ineective.] A term in a letter of credit or a rule of law, statute, regulation, custom, or practice applicable to the letter of credit which prohibits, restricts, or requires the consent of an applicant, issuer, or nominated person to a beneciary's assignment of or creation of a security interest in a letter-ofcredit right is ineective to the extent that the term or rule of law, statute, regulation, custom, or practice: (1) would impair the creation, attachment, or perfection of a security interest in the letter-of-credit right; or
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(2) provides that the assignment or the creation, attachment, or perfection of the security interest may give rise to a default, breach, right of recoupment, claim, defense, termination, right of termination, or remedy under the letter-of-credit right. (b) [Limitation on ineectiveness under subsection (a).] To the extent that a term in a letter of credit is ineective under subsection (a) but would be eective under law other than this article or a custom or practice applicable to the letter of credit, to the transfer of a right to draw or otherwise demand performance under the letter of credit, or to the assignment of a right to proceeds of the letter of credit, the creation, attachment, or perfection of a security interest in the letter-of-credit right: (1) is not enforceable against the applicant, issuer, nominated person, or transferee beneciary; (2) imposes no duties or obligations on the applicant, issuer, nominated person, or transferee beneciary; and (3) does not require the applicant, issuer, nominated person, or transferee beneciary to recognize the security interest, pay or render performance to the secured party, or accept payment or other performance from the secured party. As amended in 1999.
See Appendix P for material relating to changes made in text in 1999.

Ocial Comment
1. Source. New. 2. Purpose and Relevance. This section, patterned on Section 9-408, limits the effectiveness of attempts to restrict the creation, attachment, or perfection of a security interest in letter-of-credit rights, whether the restriction appears in the letter of credit or a rule of law, custom, or practice applicable to the letter of credit. It protects the creation, attachment, and perfection of a security interest while preventing these events from giving rise to a default or breach by the assignor or from triggering a remedy or defense of the issuer or other person obligated on a letter of credit. Letter-of-credit rights are a type of supporting obligation. See Section 9-102. Under Sections 9-203 and 9-308, a security interest in a supporting obligation attaches and is perfected automatically if the security interest in the supported obligation attaches and is perfected. See Section 9-107, Comment 5. The automatic attachment and perfection under Article 9 would be anomalous or misleading if, under other law (e.g., Article 5), a restriction on transfer or assignment were eective to block attachment and perfection. 3. Relationship to Letter-of-Credit Law. Although restrictions on an assignment of a letter of credit are ineective to prevent creation, attachment, and perfection of a security interest, subsection (b) protects the issuer and other parties from any adverse eects of the security interest by preserving letter-of-credit law and practice that limits the right of a beneciary to transfer its right to draw or otherwise demand performance (Section 5-112) and limits the obligation of an issuer or nominated person to recognize a beneciary's assignment of letter-of-credit proceeds (Section 5-114). Thus, this section's treatment of letter-of-credit rights diers from this Article's treatment of instruments and investment property. Moreover, under Section 9-109(c)(4), this Article does not apply to the extent that the rights of a transferee beneciary or nominated person are independent and superior under Section 5-114, thereby preserving the independence principle of letter-of-credit law.

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PART 5. FILING
[SUBPART 1. FILING OFFICE; CONTENTS AND EFFECTIVENESS OF FINANCING STATEMENT] 9-501. Filing Oce. (a) [Filing oces.] Except as otherwise provided in subsection (b), if the local law of this State governs perfection of a security interest or agricultural lien, the oce in which to le a nancing statement to perfect the security interest or agricultural lien is: (1) the oce designated for the ling or recording of a record of a mortgage on the related real property, if: (A) the collateral is as-extracted collateral or timber to be cut; or (B) the nancing statement is led as a xture ling and the collateral is goods that are or are to become xtures; or (2) the oce of [ ] [or any oce duly authorized by [ ]], in all other cases, including a case in which the collateral is goods that are or are to become xtures and the nancing statement is not led as a xture ling. (b) [Filing oce for transmitting utilities.] The oce in which to le a nancing statement to perfect a security interest in collateral, including xtures, of a transmitting utility is the oce of [ ]. The nancing statement also constitutes a xture ling as to the collateral indicated in the nancing statement which is or is to become xtures.
Legislative Note: The State should designate the ling oce where the brackets appear. The ling oce may be that of a governmental ocial (e.g., the Secretary of State) or a private party that maintains the State's ling system.

Ocial Comment
1. Source. Derived from former Section 9-401. 2. Where to File. Subsection (a) indicates where in a given State a nancing statement is to be led. Former Article 9 aorded each State three alternative approaches, depending on the extent to which the State desires central ling (usually with the Secretary of State), local ling (usually with a county oce), or both. As Comment 1 to former Section 9-401 observed, The principal advantage of state-wide ling is ease of access to the credit information which the les exist to provide. Consider for example the national distributor who wishes to have current information about the credit standing of the thousands of persons he sells to on credit. The more completely the les are centralized on a state-wide basis, the easier and cheaper it becomes to procure credit information; the more the les are scattered in local ling units, the more burdensome and costly. Local ling increases the net costs of secured transactions also by increasing uncertainty and the number of required lings. Any benet that local ling may have had in the 1950's is now insubstantial. Accordingly, this Article dictates central ling for most situations, while retaining local ling for real-estate-related collateral and special ling provisions for transmitting utilities. 3. Minerals and Timber. Under subsection (a)(1), a ling in the oce where a record of a mortgage on the related real property would be led will perfect a security interest in asextracted collateral. Inasmuch as the security interest does not attach until extraction, the ling continues to be eective after extraction. A dierent result occurs with respect to timber to be cut, however. Unlike as-extracted collateral, standing timber may be goods before it is cut. See Section 9-102 (dening goods). Once cut, however, it is no longer timber to be cut, and the ling in the real-property-mortgage oce ceases to be eective. The timber then becomes ordinary goods, and ling in the oce specied in subsection (a)(2) is necessary for perfection. Note also that after the timber is cut the law of the debtor's location, not the location of the timber, governs perfection under Section 9-301. 1001

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4. Fixtures. There are two ways in which a secured party may le a nancing statement to perfect a security interest in goods that are or are to become xtures. It may le in the Article 9 records, as with most other goods. See subsection (a)(2). Or it may le the nancing statement as a xture ling, dened in Section 9-102, in the oce in which a record of a mortgage on the related real property would be led. See subsection(a)(1)(B). 5. Transmitting Utilities. The usual ling rules do not apply well for a transmitting utility (dened in Section 9-102). Many pre-UCC statutes provided special ling rules for railroads and in some cases for other public utilities, to avoid the requirements for ling with legal descriptions in every county in which such debtors had property. Former Section 9-401(5) recreated and broadened these provisions, and subsection (b) follows this approach. The nature of the debtor will inform persons searching the record as to where to make a search.

9-502. Contents of Financing Statement; Record of Mortgage as Financing Statement; Time of Filing Financing Statement. (a) [Suciency of nancing statement.] Subject to subsection (b), a nancing statement is sucient only if it: (1) provides the name of the debtor; (2) provides the name of the secured party or a representative of the secured party; and (3) indicates the collateral covered by the nancing statement. (b) [Real-property-related nancing statements.] Except as otherwise provided in Section 9-501(b), to be sucient, a nancing statement that covers as-extracted collateral or timber to be cut, or which is led as a xture ling and covers goods that are or are to become xtures, must satisfy subsection (a) and also: (1) indicate that it covers this type of collateral; (2) indicate that it is to be led [for record] in the real property records; (3) provide a description of the real property to which the collateral is related [sucient to give constructive notice of a mortgage under the law of this State if the description were contained in a record of the mortgage of the real property]; and (4) if the debtor does not have an interest of record in the real property, provide the name of a record owner. (c) [Record of mortgage as nancing statement.] A record of a mortgage is eective, from the date of recording, as a nancing statement led as a xture ling or as a nancing statement covering as-extracted collateral or timber to be cut only if: (1) the record indicates the goods or accounts that it covers; (2) the goods are or are to become xtures related to the real property described in the record or the collateral is related to the real property described in the record and is as-extracted collateral or timber to be cut; (3) the record satises the requirements for a nancing statement in this section other than an indication that it is to be led in the real property records; and (4) the record is [duly] recorded. (d) [Filing before security agreement or attachment.] A nancing statement may be led before a security agreement is made or a security interest otherwise attaches.
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Legislative Note: Language in brackets is optional. Where the State has any special recording system for real property other than the usual grantor-grantee index (as, for instance, a tract system or a title registration or Torrens system) local adaptations of subsection (b) and Section 9-519(d) and (e) may be necessary. See, e.g., Mass. Gen. Laws Chapter 106, Section 9-410.

Ocial Comment
1. Source. Former Section 9-402(1), (5), (6). 2. Notice Filing. This section adopts the system of notice ling. What is required to be led is not, as under pre-UCC chattel mortgage and conditional sales acts, the security agreement itself, but only a simple record providing a limited amount of information (nancing statement). The nancing statement may be led before the security interest attaches or thereafter. See subsection (d). See also Section 9-308(a) (contemplating situations in which a nancing statement is led before a security interest attaches). The notice itself indicates merely that a person may have a security interest in the collateral indicated. Further inquiry from the parties concerned will be necessary to disclose the complete state of aairs. Section 9-210 provides a statutory procedure under which the secured party, at the debtor's request, may be required to make disclosure. However, in many cases, information may be forthcoming without the need to resort to the formalities of that section. Notice ling has proved to be of great use in nancing transactions involving inventory, accounts, and chattel paper, because it obviates the necessity of reling on each of a series of transactions in a continuing arrangement under which the collateral changes from day to day. However, even in the case of lings that do not necessarily involve a series of transactions (e.g., a loan secured by a single item of equipment), a nancing statement is eective to encompass transactions under a security agreement not in existence and not contemplated at the time the notice was led, if the indication of collateral in the nancing statement is sucient to cover the collateral concerned. Similarly, a nancing statement is eective to cover after-acquired property of the type indicated and to perfect with respect to future advances under security agreements, regardless of whether after-acquired property or future advances are mentioned in the nancing statement and even if not in the contemplation of the parties at the time the nancing statement was authorized to be led. 3. Debtor's Signature; Required Authorization. Subsection (a) sets forth the simple formal requirements for an eective nancing statement. These requirements are: (1) the debtor's name; (2) the name of a secured party or representative of the secured party; and (3) an indication of the collateral. Whereas former Section 9-402(1) required the debtor's signature to appear on a nancing statement, this Article contains no signature requirement. The elimination of the signature requirement facilitates paperless ling. (However, as PEB Commentary No. 15 indicates, a paperless nancing statement was sucient under former Article 9.) Elimination of the signature requirement also makes the exceptions provided by former Section 9-402(2) unnecessary. The fact that this Article does not require that an authenticating symbol be contained in the public record does not mean that all lings are authorized. Rather, Section 9-509(a) entitles a person to le an initial nancing statement, an amendment that adds collateral, or an amendment that adds a debtor only if the debtor authorizes the ling, and Section 9-509(d) entitles a person other than the debtor to le a termination statement only if the secured party of record authorizes the ling. Of course, a ling has legal eect only to the extent it is authorized. See Section 9-510. Law other than this Article, including the law with respect to ratication of past acts, generally determines whether a person has the requisite authority to le a record under this Article. See Sections 1-103 and 9-509, Comment 3. However, under Section 9-509(b), the debtor's authentication of (or becoming bound by) a security agreement ipso facto constitutes the debtor's authorization of the ling of a nancing statement covering the collateral described in the security agreement. The secured party need not obtain a separate authorization. Section 9-625 provides a remedy for unauthorized lings. Making an unauthorized ling also may give rise to civil or criminal liability under other law. In addition, this Article contains provisions that assist in the discovery of unauthorized lings and the amelioration of their practical eect. For example, Section 9-518 provides a procedure whereby a person 1003

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may add to the public record a statement to the eect that a nancing statement indexed under the person's name was wrongfully led, and Section 9-509(d) entitles any person to le a termination statement if the secured party of record fails to comply with its obligation to le or send one to the debtor, the debtor authorizes the ling, and the termination statement so indicates. However, the ling oce is neither obligated nor permitted to inquire into issues of authorization. See Section 9-520(a). 4. Certain Other Requirements. Subsection (a) deletes other provisions of former Section 9-402(1) because they seems unwise (real-property description for nancing statements covering crops), unnecessary (adequacy of copies of nancing statements), or both (copy of security agreement as nancing statement). In addition, the ling oce must reject a nancing statement lacking certain other information formerly required as a condition of perfection (e.g., an address for the debtor or secured party). See Sections 9-516(b), 9-520(a). However, if the ling oce accepts the record, it is eective nevertheless. See Section 9-520(c). 5. Real-Property-Related Filings. Subsection (b) contains the requirements for nancing statements led as xture lings and nancing statements covering timber to be cut or minerals and minerals-related accounts constituting as-extracted collateral. A description of the related real property must be sucient to reasonably identify it. See Section 9-108. This formulation rejects the view that the real property description must be by metes and bounds, or otherwise conforming to traditional real-property practice in conveyancing, but, of course, the incorporation of such a description by reference to the recording data of a deed, mortgage or other instrument containing the description should suce under the most stringent standards. The proper test is that a description of real property must be sufcient so that the nancing statement will t into the real-property search system and be found by a real-property searcher. Under the optional language in subsection (b)(3), the test of adequacy of the description is whether it would be adequate in a record of a mortgage of the real property. As suggested in the Legislative Note, more detail may be required if there is a tract indexing system or a land registration system. If the debtor does not have an interest of record in the real property, a real-propertyrelated nancing statement must show the name of a record owner, and Section 9-519(d) requires the nancing statement to be indexed in the name of that owner. This requirement also enables nancing statements covering as-extracted collateral or timber to be cut and nancing statements led as xture lings to t into the real-property search system. 6. Record of Mortgage Eective as Financing Statement. Subsection (c) explains when a record of a mortgage is eective as a nancing statement led as a xture ling or to cover timber to be cut or as-extracted collateral. Use of the term record of a mortgage recognizes that in some systems the record actually led is not the record pursuant to which a mortgage is created. Moreover, mortgage is dened in Section 9-102 as an interest in real property, not as the record that creates or evidences the mortgage or the record that is led in the public recording systems. A record creating a mortgage may also create a security interest with respect to xtures (or other goods) in conformity with this Article. A single agreement creating a mortgage on real property and a security interest in chattels is common and useful for certain purposes. Under subsection (c), the recording of the record evidencing a mortgage (if it satises the requirements for a nancing statement) constitutes the ling of a nancing statement as to the xtures (but not, of course, as to other goods). Section 9-515(g) makes the usual ve-year maximum life for nancing statements inapplicable to mortgages that operate as xture lings under Section 9-502(c). Such mortgages are eective for the duration of the real-property recording. Of course, if a combined mortgage covers chattels that are not xtures, a regular nancing statement ling is necessary with respect to the chattels, and subsection (c) is inapplicable. Likewise, a nancing statement led as a xture lingis not eective to perfect a security interest in personal property other than xtures. In some cases it may be dicult to determine whether goods are or will become xtures. Nothing in this Part prohibits the ling of a precautionary xture ling, which would provide protection in the event goods are determined to be xtures. The fact of ling should not be a factor in the determining whether goods are xtures. Cf. Section 9-505(b).

9-503. Name of Debtor and Secured Party. (a) [Suciency of debtor's name.] A nancing statement suciently provides the name of the debtor:
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(1) if the debtor is a registered organization, only if the nancing statement provides the name of the debtor indicated on the public record of the debtor's jurisdiction of organization which shows the debtor to have been organized; (2) if the debtor is a decedent's estate, only if the nancing statement provides the name of the decedent and indicates that the debtor is an estate; (3) if the debtor is a trust or a trustee acting with respect to property held in trust, only if the nancing statement: (A) provides the name specied for the trust in its organic documents or, if no name is specied, provides the name of the settlor and additional information sucient to distinguish the debtor from other trusts having one or more of the same settlors; and (B) indicates, in the debtor's name or otherwise, that the debtor is a trust or is a trustee acting with respect to property held in trust; and (4) in other cases: (A) if the debtor has a name, only if it provides the individual or organizational name of the debtor; and (B) if the debtor does not have a name, only if it provides the names of the partners, members, associates, or other persons comprising the debtor. (b) [Additional debtor-related information.] A nancing statement that provides the name of the debtor in accordance with subsection (a) is not rendered ineective by the absence of: (1) a trade name or other name of the debtor; or (2) unless required under subsection (a)(4)(B), names of partners, members, associates, or other persons comprising the debtor. (c) [Debtor's trade name insucient.] A nancing statement that provides only the debtor's trade name does not suciently provide the name of the debtor. (d) [Representative capacity.] Failure to indicate the representative capacity of a secured party or representative of a secured party does not aect the suciency of a nancing statement. (e) [Multiple debtors and secured parties.] A nancing statement may provide the name of more than one debtor and the name of more than one secured party. Ocial Comment
1. Source. Subsections (a)(4)(A), (b), and (c) derive from former Section 9-402(7); otherwise, new. 2. Debtor's Name. The requirement that a nancing statement provide the debtor's name is particularly important. Financing statements are indexed under the name of the debtor, and those who wish to nd nancing statements search for them under the debtor's name. Subsection (a) explains what the debtor's name is for purposes of a nancing statement. If the debtor is a registered organization (dened in Section 9-102 so as to ordinarily include corporations, limited partnerships, and limited liability companies), then the debtor's name is the name shown on the public records of the debtor's jurisdiction of organization (also dened in Section 9-102). Subsections (a)(2) and (a)(3) contain special rules for decedent's estates and common-law trusts. (Subsection (a)(1) applies to business trusts that are registered organizations.) Subsection (a)(4)(A) essentially follows the rst sentence of former Section 9-402(7). 1005

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Section 1-201(28) denes the term organization, which appears in subsection (a)(4), very broadly, to include all legal and commercial entities as well as associations that lack the status of a legal entity. Thus, the term includes corporations, partnerships of all kinds, business trusts, limited liability companies, unincorporated associations, personal trusts, governments, and estates. If the organization has a name, that name is the correct name to put on a nancing statement. If the organization does not have a name, then the nancing statement should name the individuals or other entities who comprise the organization. Together with subsections (b) and (c), subsection (a) reects the view prevailing under former Article 9 that the actual individual or organizational name of the debtor on a nancing statement is both necessary and sucient, whether or not the nancing statement provides trade or other names of the debtor and, if the debtor has a name, whether or not the nancing statement provides the names of the partners, members, or associates who comprise the debtor. Note that, even if the name provided in an initial nancing statement is correct, the ling oce nevertheless must reject the nancing statement if it does not identify an individual debtor's last name (e.g., if it is not clear whether the debtor's name is Perry Mason or Mason Perry). See Section 9-516(b)(3)(C). 3. Secured Party's Name. New subsection (d) makes clear that when the secured party is a representative, a nancing statement is sucient if it names the secured party, whether or not it indicates any representative capacity. Similarly, a nancing statement that names a representative of the secured party is sucient, even if it does not indicate the representative capacity. Example: Debtor creates a security interest in favor of Bank X, Bank Y, and Bank Z, but not to their representative, the collateral agent (Bank A). The collateral agent is not itself a secured party. See Section 9-102. Under Sections 9-502(a) and 9-503(d), however, a nancing statement is eective if it names as secured party Bank A and not the actual secured parties, even if it omits Bank A's representative capacity. Each person whose name is provided in an initial nancing statement as the name of the secured party or representative of the secured party is a secured party of record. See Section 9-511. 4. Multiple Names. Subsection (e) makes explicit what is implicit under former Article 9: a nancing statement may provide the name of more than one debtor and secured party. See Section 1-102(5)(a) (words in the singular include the plural). With respect to records relating to more than one debtor, see Section 9-520(d). With respect to nancing statements providing the name of more than one secured party, see Sections 9-509(e) and 9-510(b).

9-504. Indication of Collateral. A nancing statement suciently indicates the collateral that it covers if the nancing statement provides: (1) a description of the collateral pursuant to Section 9-108; or (2) an indication that the nancing statement covers all assets or all personal property. As amended in 1999.
See Appendix P for material relating to changes made in text in 1999.

Ocial Comment
1. Source. Former Section 9-402(1). 2. Indication of Collateral. To comply with Section 9-502(a), a nancing statement must indicate the collateral it covers. A nancing statement suciently indicates collateral claimed to be covered by the nancing statement if it satises the purpose of conditioning perfection on the ling of a nancing statement, i.e., if it provides notice that a person may have a security interest in the collateral claimed. See Section 9-502, Comment 2. In particular, an indication of collateral that would have satised the requirements of former Section 9-402(1) (i.e., a statement indicating the types, or describing the items, of collateral) suces under Section 9502(a). An indication may satisfy the requirements of Section 9-502(a), even if it would not have satised the requirements of former Section 9-402(1). This section provides two safe harbors. Under paragraph (1), a description of the collat1006

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eral (as the term is explained in Section 9-108) suces as an indication for purposes of the suciency of a nancing statement. Debtors sometimes create a security interest in all, or substantially all, of their assets. To accommodate this practice, paragraph (2) expands the class of sucient collateral references to embrace an indication that the nancing statement covers all assets or all personal property. If the property in question belongs to the debtor and is personal property, any searcher will know that the property is covered by the nancing statement. Of course, regardless of its breadth, a nancing statement has no eect with respect to property indicated but to which a security interest has not attached. Note that a broad statement of this kind (e.g., all debtor's personal property) would not be a sucient description for purposes of a security agreement. See Sections 9-203(b)(3)(A), 9-108. It follows that a somewhat narrower description than all assets, e.g., all assets other than automobiles, is sufcient for purposes of this section, even if it does not suce for purposes of a security agreement.

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

9-505. Filing and Compliance With Other Statutes and Treaties for Consignments, Leases, Other Bailments, and Other Transactions. (a) [Use of terms other than debtor and secured party.] A consignor, lessor, or other bailor of goods, a licensor, or a buyer of a payment intangible or promissory note may le a nancing statement, or may comply with a statute or treaty described in Section 9-311(a), using the terms consignor, consignee, lessor, lessee, bailor, bailee, licensor, licensee, owner, registered owner, buyer, seller, or words of similar import, instead of the terms secured party and debtor. (b) [Eect of nancing statement under subsection (a).] This part applies to the ling of a nancing statement under subsection (a) and, as appropriate, to compliance that is equivalent to ling a nancing statement under Section 9-311(b), but the ling or compliance is not of itself a factor in determining whether the collateral secures an obligation. If it is determined for another reason that the collateral secures an obligation, a security interest held by the consignor, lessor, bailor, licensor, owner, or buyer which attaches to the collateral is perfected by the ling or compliance. Ocial Comment
1. Source. Former Section 9-408. 2. Precautionary Filing. Occasionally, doubts arise concerning whether a transaction creates a relationship to which this Article or its ling provisions apply. For example, questions may arise over whether a lease of equipment in fact creates a security interest or whether the sale of payment intangibles in fact secures an obligation, thereby requiring action to perfect the security interest. This section, which derives from former Section 9-408, aords the option of ling of a nancing statement with appropriate changes of terminology but without aecting the substantive question of classication of the transaction. 3. Changes from Former Section 9-408. This section expands the rule of Section 9-408 to embrace more generally other bailments and transactions, as well as sales transactions, primarily sales of payment intangibles and promissory notes. It provides the same benets for compliance with a statute or treaty described in Section 9-311(a) that former Section 9-408 provided for ling, in connection with the use of terms such as lessor, consignor, etc. The references to owner and registered owner are intended to address, for example, the situation where a putative lessor is the registered owner of an automobile covered by a 1007

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certicate of title and the transaction is determined to create a security interest. Although this section provides that the security interest is perfected, the relevant certicate-of-title statute may expressly provide to the contrary or may be ambiguous. If so, it may be necessary or advisable to amend the certicate-of-title statute to ensure that perfection of the security interest will be achieved. As does Section 1-201, former Article 9 referred to transactions, including leases and consignments, intended as security. This misleading phrase created the erroneous impression that the parties to a transaction can dictate how the law will classify it (e.g., as a bailment or as a security interest) and thus aect the rights of third parties. This Article deletes the phrase wherever it appears. Subsection (b) expresses the principle more precisely by referring to a security interest that secures an obligation. 4. Consignments. Although a true consignment is a bailment, the ling and priority provisions of former Article 9 applied to true consignments. See former Sections 2-326(3), 9-114. A consignment intended as security created a security interest that was in all respects subject to former Article 9. This Article subsumes most true consignments under the rubric of security interest. See Sections 9-102 (denition of consignment), 9-109(a) (4), 1-201(37) (denition of security interest). Nevertheless, it maintains the distinction between a (true) consignment, as to which only certain aspects of Article 9 apply, and a so-called consignment that actually secures an obligation, to which Article 9 applies in full. The revisions to this section reect the change in terminology.

9-506. Eect of Errors or Omissions. (a) [Minor errors and omissions.] A nancing statement substantially satisfying the requirements of this part is eective, even if it has minor errors or omissions, unless the errors or omissions make the nancing statement seriously misleading. (b) [Financing statement seriously misleading.] Except as otherwise provided in subsection (c), a nancing statement that fails suciently to provide the name of the debtor in accordance with Section 9-503(a) is seriously misleading. (c) [Financing statement not seriously misleading.] If a search of the records of the ling oce under the debtor's correct name, using the ling oce's standard search logic, if any, would disclose a nancing statement that fails suciently to provide the name of the debtor in accordance with Section 9-503(a), the name provided does not make the nancing statement seriously misleading. (d) [Debtor's correct name.] For purposes of Section 9-508(b), the debtor's correct name in subsection (c) means the correct name of the new debtor. Ocial Comment
1. Source. Former Section 9-402(8). 2. Errors. Like former Section 9-402(8), subsection (a) is in line with the policy of this Article to simplify formal requisites and ling requirements. It is designed to discourage the fanatical and impossibly rened reading of statutory requirements in which courts occasionally have indulged themselves. Subsection (a) provides the standard applicable to indications of collateral. Subsections (b) and (c), which are new, concern the eectiveness of nancing statements in which the debtor's name is incorrect. Subsection (b) contains the general rule: a nancing statement that fails suciently to provide the debtor's name in accordance with Section 9-503(a) is seriously misleading as a matter of law. Subsection (c) provides an exception: If the nancing statement nevertheless would be discovered in a search under the debtor's correct name, using the ling oce's standard search logic, if any, then as a matter of law the incorrect name does not make the nancing statement seriously misleading. A nancing statement that is seriously misleading under this section is ineective even if it is disclosed by (i) using a search logic other than that of the ling oce to search the ocial records, or (ii) using the ling oce's standard search logic to 1008

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search a data base other than that of the ling oce. In addition to requiring the debtor's name and an indication of the collateral, Section 9-502(a) requires a nancing statement to provide the name of the secured party or a representative of the secured party. Inasmuch as searches are not conducted under the secured party's name, and no ling is needed to continue the perfected status of security interest after it is assigned, an error in the name of the secured party or its representative will not be seriously misleading. However, in an appropriate case, an error of this kind may give rise to an estoppel in favor of a particular holder of a conicting claim to the collateral. See Section 1-103. 3. New Debtors. Subsection (d) provides that, in determining the extent to which a nancing statement naming an original debtor is eective against a new debtor, the suciency of the nancing statement should be tested against the name of the new debtor.

9-507. Eect of Certain Events on Eectiveness of Financing Statement. (a) [Disposition.] A led nancing statement remains eective with respect to collateral that is sold, exchanged, leased, licensed, or otherwise disposed of and in which a security interest or agricultural lien continues, even if the secured party knows of or consents to the disposition. (b) [Information becoming seriously misleading.] Except as otherwise provided in subsection (c) and Section 9-508, a nancing statement is not rendered ineective if, after the nancing statement is led, the information provided in the nancing statement becomes seriously misleading under Section 9-506. (c) [Change in debtor's name.] If a debtor so changes its name that a led nancing statement becomes seriously misleading under Section 9-506: (1) the nancing statement is eective to perfect a security interest in collateral acquired by the debtor before, or within four months after, the change; and (2) the nancing statement is not eective to perfect a security interest in collateral acquired by the debtor more than four months after the change, unless an amendment to the nancing statement which renders the nancing statement not seriously misleading is led within four months after the change. Ocial Comment
1. Source. Former Section 9-402(7). 2. Scope of Section. This section deals with situations in which the information in a proper nancing statement becomes inaccurate after the nancing statement is led. Compare Section 9-338, which deals with situations in which a nancing statement contains a particular kind of information concerning the debtor (i.e., the information described in Section 9-516(b)(5)) that is incorrect at the time it is led. 3. Post-Filing Disposition of Collateral. Under subsection (a), a nancing statement remains eective even if the collateral is sold or otherwise disposed of. This subsection claries the third sentence of former Section 9-402(7) by providing that a nancing statement remains eective following the disposition of collateral only when the security interest or agricultural lien continues in that collateral. This result is consistent with the conclusion of PEB Commentary No. 3. Normally, a security interest does continue after disposition of the collateral. See Section 9-315(a). Law other than this Article determines whether an agricultural lien survives disposition of the collateral. As a consequence of the disposition, the collateral may be owned by a person other than the debtor against whom the nancing statement was led. Under subsection (a), the secured party remains perfected even if it does not correct the public record. For this rea1009

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son, any person seeking to determine whether a debtor owns collateral free of security interests must inquire as to the debtor's source of title and, if circumstances seem to require it, search in the name of a former owner. Subsection (a) addresses only the suciency of the information contained in the nancing statement. A disposition of collateral may result in loss of perfection for other reasons. See Section 9-316. Example: Dee Corp. is an Illinois corporation. It creates a security interest in its equipment in favor of Secured Party. Secured Party les a proper nancing statement in Illinois. Dee Corp. sells an item of equipment to Bee Corp., a Pennsylvania corporation, subject to the security interest. The security interest continues, see Section 9-315(a), and remains perfected, see Section 9-507(a), notwithstanding that the nancing statement is led under D (for Dee Corp.) and not under B. However, because Bee Corp. is located in Pennsylvania and not Illinois, see Section 9-307, unless Secured Party perfects under Pennsylvania law within one year after the transfer, its security interest will become unperfected and will be deemed to have been unperfected against purchasers of the collateral. See Section 9-316. 4. Other Post-Filing Changes. Subsection (b) provides that, as a general matter, postling changes that render a nancing statement inaccurate and seriously misleading have no eect on a nancing statement. The nancing statement remains eective. It is subject to two exceptions: Section 9-508 and Section 9-507(c). Section 9-508 addresses the eectiveness of a nancing statement led against an original debtor when a new debtor becomes bound by the original debtor's security agreement. It is discussed in the Comments to that section. Section 9-507(c) addresses a pure change of the debtor's name, i.e., a change that does not implicate a new debtor. It claries former Section 9-402(7). If a name change renders a led nancing statement seriously misleading, the nancing statement, unless amended to provide the debtor's new correct name, is eective only to perfect a security interest in collateral acquired by the debtor before, or within four months after, the change. If an amendment that provides the new correct name is led within four months after the change, the nancing statement as amended would be eective also with respect to collateral acquired more than four months after the change. If an amendment that provides the new correct name is led more than four months after the change, the nancing statement as amended would be eective also with respect to collateral acquired more than four months after the change, but only from the time of the ling of the amendment.

9-508. Eectiveness of Financing Statement if New Debtor Becomes Bound by Security Agreement. (a) [Financing statement naming original debtor.] Except as otherwise provided in this section, a led nancing statement naming an original debtor is eective to perfect a security interest in collateral in which a new debtor has or acquires rights to the extent that the nancing statement would have been eective had the original debtor acquired rights in the collateral. (b) [Financing statement becoming seriously misleading.] If the dierence between the name of the original debtor and that of the new debtor causes a led nancing statement that is eective under subsection (a) to be seriously misleading under Section 9-506: (1) the nancing statement is eective to perfect a security interest in collateral acquired by the new debtor before, and within four months after, the new debtor becomes bound under Section 9-203(d); and (2) the nancing statement is not eective to perfect a security interest in collateral acquired by the new debtor more than four months after the new debtor becomes bound under Section 9-203(d) unless an initial nancing statement providing the name of the new debtor is led before the expiration of that time. (c) [When section not applicable.] This section does not apply to collateral as to which a led nancing statement remains eective against the new debtor under Section 9-507(a).
1010

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Ocial Comment
1. Source. New. 2. The Problem. Section 9-203(d) and (e) and this section deal with situations where one party (the new debtor) becomes bound as debtor by a security agreement entered into by another person (the original debtor). These situations often arise as a consequence of changes in business structure. For example, the original debtor may be an individual debtor who operates a business as a sole proprietorship and then incorporates it. Or, the original debtor may be a corporation that is merged into another corporation. Under both former Article 9 and this Article, collateral that is transferred in the course of the incorporation or merger normally would remain subject to a perfected security interest. See Sections 9-315(a), 9-507(a). Former Article 9 was less clear with respect to whether an after-acquired property clause in a security agreement signed by the original debtor would be eective to create a security interest in property acquired by the new corporation or the merger survivor and, if so, whether a nancing statement led against the original debtor would be eective to perfect the security interest. This section and Sections 9-203(d) and (e) are a clarication. 3. How New Debtor Becomes Bound. Normally, a security interest is unenforceable unless the debtor has authenticated a security agreement describing the collateral. See Section 9-203(b). New Section 9-203(e) creates an exception, under which a security agreement entered into by one person is eective with respect to the property of another. This exception comes into play if a new debtor becomes bound as debtor by a security agreement entered into by another person (the original debtor). (The quoted terms are dened in Section 9-102.) If a new debtor does become bound, then the security agreement entered into by the original debtor satises the security-agreement requirement of Section 9-203(b) (3) as to existing or after-acquired property of the new debtor to the extent the property is described in the security agreement. In that case, no other agreement is necessary to make a security interest enforceable in that property. See Section 9-203(e). Section 9-203(d) explains when a new debtor becomes bound by an original debtor's security agreement. Under Section 9-203(d)(1), a new debtor becomes bound as debtor if, by contract or operation of other law, the security agreement becomes eective to create a security interest in the new debtor's property. For example, if the applicable corporate law of mergers provides that when A Corp merges into B Corp, B Corp becomes a debtor under A Corp's security agreement, then B Corp would become bound as debtor following such a merger. Similarly, B Corp would become bound as debtor if B Corp contractually assumes A's obligations under the security agreement. Under certain circumstances, a new debtor becomes bound for purposes of this Article even though it would not be bound under other law. Under Section 9-203(d)(2), a new debtor becomes bound when, by contract or operation of other law, it (i) becomes obligated not only for the secured obligation but also generally for the obligations of the original debtor and (ii) acquires or succeeds to substantially all the assets of the original debtor. For example, some corporate laws provide that, when two corporations merge, the surviving corporation succeeds to the assets of its merger partner and has all liabilities of both corporations. In the case where, for example, A Corp merges into B Corp (and A Corp ceases to exist), some people have questioned whether A Corp's grant of a security interest in its existing and after-acquired property becomes a liability of B Corp, such that B Corp's existing and after-acquired property becomes subject to a security interest in favor of A Corp's lender. Even if corporate law were to give a negative answer, under Section 9-203(d)(2), B Corp would become bound for purposes of Section 9-203(e) and this section. The substantially all of the assets requirement of Section 9-203(d)(2) excludes sureties and other secondary obligors as well as persons who become obligated through veil piercing and other non-successorship doctrines. In most cases, it will exclude successors to the assets and liabilities of a division of a debtor. 4. When Financing Statement Eective Against New Debtor. Subsection (a) provides that a ling against the original debtor generally is eective to perfect a security interest in collateral that a new debtor has at the time it becomes bound by the original debtor's security agreement and collateral that it acquires after the new debtor becomes bound. Under subsection (b), however, if the ling against the original debtor is seriously misleading as to the new debtor's name, the ling is eective as to collateral acquired by the new debtor more than four months after the new debtor becomes bound only if a person 1011

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les during the four-month period an initial nancing statement providing the name of the new debtor. Compare Section 9-507(c) (four-month period of eectiveness with respect to collateral acquired by a debtor after the debtor changes its name). Moreover, if the original debtor and the new debtor are located in dierent jurisdictions, a ling against the original debtor would not be eective to perfect a security interest in collateral that the new debtor acquires or has acquired from a person other than the original debtor. See Example 5, Section 9-316, Comment 2. 5. Transferred Collateral. This section does not apply to collateral transferred by the original debtor to a new debtor. See subsection (c). Under those circumstances, the ling against the original debtor continues to be eective until it lapses or perfection is lost for another reason. See sections 9-316, 9-507(a). 6. Priority. Section 9-326 governs the priority contest between a secured creditor of the original debtor and a secured creditor of the new debtor.

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

9-509. Persons Entitled to File a Record. (a) [Person entitled to le record.] A person may le an initial nancing statement, amendment that adds collateral covered by a nancing statement, or amendment that adds a debtor to a nancing statement only if: (1) the debtor authorizes the ling in an authenticated record or pursuant to subsection (b) or (c); or (2) the person holds an agricultural lien that has become eective at the time of ling and the nancing statement covers only collateral in which the person holds an agricultural lien. (b) [Security agreement as authorization.] By authenticating or becoming bound as debtor by a security agreement, a debtor or new debtor authorizes the ling of an initial nancing statement, and an amendment, covering: (1) the collateral described in the security agreement; and (2) property that becomes collateral under Section 9-315(a)(2), whether or not the security agreement expressly covers proceeds. (c) [Acquisition of collateral as authorization.] By acquiring collateral in which a security interest or agricultural lien continues under Section 9-315(a)(1), a debtor authorizes the ling of an initial nancing statement, and an amendment, covering the collateral and property that becomes collateral under Section 9-315(a)(2). (d) [Person entitled to le certain amendments.] A person may le an amendment other than an amendment that adds collateral covered by a nancing statement or an amendment that adds a debtor to a nancing statement only if: (1) the secured party of record authorizes the ling; or (2) the amendment is a termination statement for a nancing statement as to which the secured party of record has failed to le or send a termination statement as required by Section 9-513(a) or (c), the debtor authorizes the ling, and the termination statement indicates that the debtor authorized it to be led. (e) [Multiple secured parties of record.] If there is more than one
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secured party of record for a nancing statement, each secured party of record may authorize the ling of an amendment under subsection (d). As amended in 2000.
See Appendix P for material relating to changes made in text in 2000.

Ocial Comment
1. Source. New. 2. Scope and Approach of This Section. This section collects in one place most of the rules determining whether a record may be led. Section 9-510 explains the extent to which a led record is eective. Under these sections, the identity of the person who eects a ling is immaterial. The ling scheme contemplated by this Part does not contemplate that the identity of a ler will be a part of the searchable records. This is consistent with, and a necessary aspect of, eliminating signatures or other evidence of authorization from the system. (Note that the 1972 amendments to this Article eliminated the requirement that a nancing statement contain the signature of the secured party.) As long as the appropriate person authorizes the ling, or, in the case of a termination statement, the debtor is entitled to the termination, it is insignicant whether the secured party or another person les any given record. The question of authorization is one for the court, not the ling oce. However, a ling oce may choose to employ authentication procedures in connection with electronic communications, e.g., to verify the identity of a ler who seeks to charge the ling fee. 3. Unauthorized Filings. Records led in the ling oce do not require signatures for their eectiveness. Subsection (a)(1) substitutes for the debtor's signature on a nancing statement the requirement that the debtor authorize in an authenticated record the ling of an initial nancing statement or an amendment that adds collateral. Also, under subsection (a)(1), if an amendment adds a debtor, the debtor who is added must authorize the amendment. A person who les an unauthorized record in violation of subsection (a)(1) is liable under Section 9-625(b) and (e) for actual and statutory damages. Of course, a led nancing statement is ineective to perfect a security interest if the ling is not authorized. See Section 9-510(a). Law other than this Article, including the law with respect to ratication of past acts, generally determines whether a person has the requisite authority to le a record under this section. See Sections 1-103, 9-502, Comment 3. This Article applies to other issues, such as the priority of a security interest perfected by the ling of a nancing statement. 4. Ipso Facto Authorization. Under subsection (b), the authentication of a security agreement ipso facto constitutes the debtor's authorization of the ling of a nancing statement covering the collateral described in the security agreement. The secured party need not obtain a separate authorization. Similarly, a new debtor's becoming bound by a security agreement ipso facto constitutes the new debtor's authorization of the ling of a nancing statement covering the collateral described in the security agreement by which the new debtor has become bound. And, under subsection (c), the acquisition of collateral in which a security interest continues after disposition under Section 9-315(a)(1) ipso facto constitutes an authorization to le an initial nancing statement againt the person who acquired the collateral. The authorization to le an initial nancing statement also constitutes an authorization to le a record covering actual proceeds of the original collateral, even if the security agreement is silent as to proceeds. Example 1: Debtor authenticates a security agreement creating a security interest in Debtor's inventory in favor of Secured Party. Secured Party les a nancing statement covering inventory and accounts. The nancing statement is authorized insofar as it covers inventory and unauthorized insofar as it covers accounts. (Note, however, that the nancing statement will be eective to perfect a security interest in accounts constituting proceeds of the inventory to the same extent as a nancing statement covering only inventory.) Example 2: Debtor authenticates a security agreement creating a security interest in Debtor's inventory in favor of Secured Party. Secured Party les a nancing statement covering inventory. Debtor sells some inventory, deposits the buyer's payment into a deposit account, and withdraws the funds to purchase equipment. As long as the equipment can be traced to the inventory, the security interest continues in the equipment. See Section 9-315(a)(2). However, because the equipment was acquired with cash proceeds, 1013

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the nancing statement becomes ineective to perfect the security interest in the equipment on the 21st day after the security interest attaches to the equipment unless Secured Party continues perfection beyond the 20-day period by ling a nancing statement against the equipment or amending the led nancing statement to cover equipment. See Section 9-315(d). Debtor's authentication of the security agreement authorizes the ling of an initial nancing statement or amendment covering the equipment, which is property that becomes collateral under Section 9-315(a)(2). See Section 9-509(b)(2). 5. Agricultural Liens. Under subsection (a)(2), the holder of an agricultural lien may le a nancing statement covering collateral subject to the lien without obtaining the debtor's authorization. Because the lien arises as matter of law, the debtor's consent is not required. A person who les an unauthorized record in violation of this subsection is liable under Section 9-625(e) for a statutory penalty and damages. 6. Amendments; Termination Statements Authorized by Debtor. Most amendments may not be led unless the secured party of record, as determined under Section 9-511, authorizes the ling. See subsection (d)(1). However, under subsection (d)(2), the authorization of the secured party of record is not required for the ling of a termination statement if the secured party of record failed to send or le a termination statement as required by Section 9-513, the debtor authorizes it to be led, and the termination statement so indicates. 7. Multiple Secured Parties of Record. Subsection (e) deals with multiple secured parties of record. It permits each secured party of record to authorize the ling of amendments. However, Section 9-510(b) protects the rights and powers of one secured party of record from the eects of lings made by another secured party of record. See Section 9-510, Comment 3. 8. Successor to Secured Party of Record. A person may succeed to the powers of the secured party of record by operation of other law, e.g., the law of corporate mergers. In that case, the successor has the power to authorize lings within the meaning of this section.

9-510. Eectiveness of Filed Record. (a) [Filed record eective if authorized.] A led record is eective only to the extent that it was led by a person that may le it under Section 9-509. (b) [Authorization by one secured party of record.] A record authorized by one secured party of record does not aect the nancing statement with respect to another secured party of record. (c) [Continuation statement not timely led.] A continuation statement that is not led within the six-month period prescribed by Section 9-515(d) is ineective. Ocial Comment
1. Source. New. 2. Ineectiveness of Unauthorized or Overbroad Filings. Subsection (a) provides that a led nancing statement is eective only to the extent it was led by a person entitled to le it. Example 1: Debtor authorizes the ling of a nancing statement covering inventory. Under Section 9-509, the secured party may le a nancing statement covering only inventory; it may not le a nancing statement covering other collateral. The secured party les a nancing statement covering inventory and equipment. This section provides that the nancing statement is eective only to the extent the secured party may le it. Thus, the nancing statement is eective to perfect a security interest in inventory but ineective to perfect a security interest in equipment. 3. Multiple Secured Parties of Record. Section 9-509(e) permits any secured party of record to authorize the ling of most amendments. Subsection (b) of this section prevents a ling authorized by one secured party of record from aecting the rights and powers of another secured party of record without the latter's consent. Example 2: Debtor creates a security interest in favor of A and B. The led nancing statement names A and B as the secured parties. An amendment deleting some col1014

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lateral covered by the nancing statement is led pursuant to B's authorization. Although B's security interest in the deleted collateral becomes unperfected, A's security interest remains perfected in all the collateral. Example 3: Debtor creates a security interest in favor of A and B. The nancing statement names A and B as the secured parties. A termination statement is led pursuant to B's authorization. Although the eectiveness of the nancing statement terminates with respect to B's security interest, A's rights are unaected. That is, the nancing statement continues to be eective to perfect A's security interest. 4. Continuation Statements. A continuation statement may be led only within the six months immediately before lapse. See Section 9-515(d). The ling oce is obligated to reject a continuation statement that is led outside the six-month period. See Sections 9-520(a), 9-516(b)(7). Subsection (c) provides that if the ling oce fails to reject a continuation statement that is not led in a timely manner, the continuation statement is ineective nevertheless.

9-511. Secured Party of Record. (a) [Secured party of record.] A secured party of record with respect to a nancing statement is a person whose name is provided as the name of the secured party or a representative of the secured party in an initial nancing statement that has been led. If an initial nancing statement is led under Section 9-514(a), the assignee named in the initial nancing statement is the secured party of record with respect to the nancing statement. (b) [Amendment naming secured party of record.] If an amendment of a nancing statement which provides the name of a person as a secured party or a representative of a secured party is led, the person named in the amendment is a secured party of record. If an amendment is led under Section 9-514(b), the assignee named in the amendment is a secured party of record. (c) [Amendment deleting secured party of record.] A person remains a secured party of record until the ling of an amendment of the nancing statement which deletes the person. Ocial Comment
1. Source. New. 2. Secured Party of Record. This new section explains how the secured party of record is to be determined. If SP-1 is named as the secured party in an initial nancing statement, it is the secured party of record. Similarly, if an initial nancing statement reects a total assignment from SP-0 to SP-1, then SP-1 is the secured party of record. See subsection (a). If, subsequently, an amendment is led assigning SP-1's status to SP-2, then SP-2 becomes the secured party of record in place of SP-1. The same result obtains if a subsequent amendment deletes the reference to SP-1 and substitutes therefor a reference to SP-2. If, however, a subsequent amendment adds SP-2 as a secured party but does not purport to remove SP-1 as a secured party, then SP-2 and SP-1 each is a secured party of record. See subsection (b). An amendment purporting to remove the only secured party of record without providing a successor is ineective. See Section 9-512(e). At any point in time, all eective records that comprise a nancing statement must be examined to determine the person or persons that have the status of secured party of record. 3. Successor to Secured Party of Record. Application of other law may result in a person succeeding to the powers of a secured party of record. For example, if the secured party of record (A) merges into another corporation (B) and the other corporation (B) survives, other law may provide that B has all of A's powers. In that case, B is authorized to take all actions under this Part that A would have been authorized to take. Similarly, acts taken by a person who is authorized under generally applicable principles of agency to act on behalf of the secured party of record are eective under this Part. 1015

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9-512. Amendment of Financing Statement.

[Alternative A]

(a) [Amendment of information in nancing statement.] Subject to Section 9-509, a person may add or delete collateral covered by, continue or terminate the eectiveness of, or, subject to subsection (e), otherwise amend the information provided in, a nancing statement by ling an amendment that: (1) identies, by its le number, the initial nancing statement to which the amendment relates; and (2) if the amendment relates to an initial nancing statement led [or recorded] in a ling oce described in Section 9-501(a)(1), provides the information specied in Section 9-502(b).
[Alternative B]

(a) [Amendment of information in nancing statement.] Subject to Section 9-509, a person may add or delete collateral covered by, continue or terminate the eectiveness of, or, subject to subsection (e), otherwise amend the information provided in, a nancing statement by ling an amendment that: (1) identies, by its le number, the initial nancing statement to which the amendment relates; and (2) if the amendment relates to an initial nancing statement led [or recorded] in a ling oce described in Section 9-501(a)(1), provides the date [and time] that the initial nancing statement was led [or recorded] and the information specied in Section 9-502(b).
[End of Alternatives]

(b) [Period of eectiveness not aected.] Except as otherwise provided in Section 9-515, the ling of an amendment does not extend the period of eectiveness of the nancing statement. (c) [Eectiveness of amendment adding collateral.] A nancing statement that is amended by an amendment that adds collateral is eective as to the added collateral only from the date of the ling of the amendment. (d) [Eectiveness of amendment adding debtor.] A nancing statement that is amended by an amendment that adds a debtor is eective as to the added debtor only from the date of the ling of the amendment. (e) [Certain amendments ineective.] An amendment is ineective to the extent it: (1) purports to delete all debtors and fails to provide the name of a debtor to be covered by the nancing statement; or (2) purports to delete all secured parties of record and fails to provide the name of a new secured party of record.
Legislative Note: States whose real-estate ling oces require additional information in amendments and cannot search their records by both the name of the debtor and the le number should enact Alternative B to Sections 9-512(a), 9-518(b), 9-519(f) and 9-522(a).

Ocial Comment
1. Source. Former 9-402(4). 2. Changes to Financing Statements. This section addresses changes to nancing 1016

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statements, including addition and deletion of collateral. Although termination statements, assignments, and continuation statements are types of amendment, this Article follows former Article 9 and contains separate sections containing additional provisions applicable to particular types of amendments. See Section 9-513 (termination statements); 9-514 (assignments); 9-515 (continuation statements). One should not infer from this separate treatment that this Article requires a separate amendment to accomplish each change. Rather, a single amendment would be legally sucient to, e.g., add collateral and continue the effectiveness of the nancing statement. 3. Amendments. An amendment under this Article may identify only the information contained in a nancing statement that is to be changed; alternatively, it may take the form of an amended and restated nancing statement. The latter would state, for example, that the nancing statement is amended and restated to read as follows: . . . References in this Part to an amended nancing statement are to a nancing statement as amended by an amendment using either technique. This section revises former Section 9-402(4) to permit secured parties of record to make changes in the public record without the need to obtain the debtor's signature. However, the ling of an amendment that adds collateral or adds a debtor must be authorized by the debtor or it will not be eective. See Sections 9-509(a), 9-510(a). 4. Amendment Adding Debtor. An amendment that adds a debtor is eective, provided that the added debtor authorizes the ling. See Section 9-509(a). However, ling an amendment adding a debtor to a previously led nancing statement aords no advantage over ling an initial nancing statement against that debtor and may be disadvantageous. With respect to the added debtor, for purposes of determining the priority of the security interest, the time of ling is the time of the ling of the amendment, not the time of the ling of the initial nancing statement. See subsection (d). However, the eectiveness of the nancing statement lapses with respect to added debtor at the time it lapses with respect to the original debtor. See subsection (b). 5. Deletion of All Debtors or Secured Parties of Record. Subsection (e) assures that there will be a debtor and secured party of record for every nancing statement. Example: A led nancing statement names A and B as secured parties of record and covers inventory and equipment. An amendment deletes equipment and purports to delete A and B as secured parties of record without adding a substitute secured party. The amendment is ineective to the extent it purports to delete the secured parties of record but eective with respect to the deletion of collateral. As a consequence, the nancing statement, as amended, covers only inventory, but A and B remain as secured parties of record.

9-513. Termination Statement. (a) [Consumer goods.] A secured party shall cause the secured party of record for a nancing statement to le a termination statement for the nancing statement if the nancing statement covers consumer goods and: (1) there is no obligation secured by the collateral covered by the nancing statement and no commitment to make an advance, incur an obligation, or otherwise give value; or (2) the debtor did not authorize the ling of the initial nancing statement. (b) [Time for compliance with subsection (a).] To comply with subsection (a), a secured party shall cause the secured party of record to le the termination statement: (1) within one month after there is no obligation secured by the collateral covered by the nancing statement and no commitment to make an advance, incur an obligation, or otherwise give value; or (2) if earlier, within 20 days after the secured party receives an authenticated demand from a debtor. (c) [Other collateral.] In cases not governed by subsection (a), within
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20 days after a secured party receives an authenticated demand from a debtor, the secured party shall cause the secured party of record for a nancing statement to send to the debtor a termination statement for the nancing statement or le the termination statement in the ling oce if: (1) except in the case of a nancing statement covering accounts or chattel paper that has been sold or goods that are the subject of a consignment, there is no obligation secured by the collateral covered by the nancing statement and no commitment to make an advance, incur an obligation, or otherwise give value; (2) the nancing statement covers accounts or chattel paper that has been sold but as to which the account debtor or other person obligated has discharged its obligation; (3) the nancing statement covers goods that were the subject of a consignment to the debtor but are not in the debtor's possession; or (4) the debtor did not authorize the ling of the initial nancing statement. (d) [Eect of ling termination statement.] Except as otherwise provided in Section 9-510, upon the ling of a termination statement with the ling oce, the nancing statement to which the termination statement relates ceases to be eective. Except as otherwise provided in Section 9-510, for purposes of Sections 9-519(g), 9-522(a), and 9-523(c), the ling with the ling oce of a termination statement relating to a nancing statement that indicates that the debtor is a transmitting utility also causes the eectiveness of the nancing statement to lapse. As amended in 2000.
See Appendix P for material relating to changes made in text in 2000.

Ocial Comment
1. Source. Former Section 9-404. 2. Duty to File or Send. This section species when a secured party must cause the secured party of record to le or send to the debtor a termination statement for a nancing statement. Because most nancing statements expire in ve years unless a continuation statement is led (Section 9-515), no compulsion is placed on the secured party to le a termination statement unless demanded by the debtor, except in the case of consumer goods. Because many consumers will not realize the importance to them of clearing the public record, an armative duty is put on the secured party in that case. But many purchase-money security interests in consumer goods will not be led, except for motor vehicles. See Section 9-309(1). Under Section 9-311(b), compliance with a certicate-of-title statute is equivalent to the ling of a nancing statement under this article. Thus, this section applies to a certicate of title unless the section is superseded by a certicate-oftitle statute that contains a specic rule addressing a secured party's duty to cause a notation of a security interest to be removed from a certicate of title. In the context of a certificate of title, however, the secured party could comply with this section by causing the removal itself or providing the debtor with documentation sucient to enable the debtor to eect the removal. Subsections (a) and (b) apply to a nancing statement covering consumer goods. Subsection (c) applies to other nancing statements. Subsection (a) and (c) each makes explicit what was implicit under former Article 9: If the debtor did not authorize the ling of a nancing statement in the rst place, the secured party of record should le or send a termination statement. The liability imposed upon a secured party that fails to comply with subsection (a) or (c) is identical to that imposed for the ling of an unauthorized nancing statement or amendment. See Section 9-625(e). 3. Bogus Filings. A secured party's duty to send a termination statement arises when 1018

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the secured party receives an authenticated demand from the debtor. In the case of an unauthorized nancing statement, the person named as debtor in the nancing statement may have no relationship with the named secured party and no reason to know the secured party's address. Inasmuch as the address in the nancing statement is held out by [the person named as secured party in the nancing statement] as the place for receipt of such communications [i.e., communications relating to security interests], the putative secured party is deemed to have received a notication delivered to that address. See Section 1-201(26). If a termination statement is not forthcoming, the person named as debtor itself may authorize the ling of a termination statement, which will be eective if it indicates that the person authorized it to be led. See Sections 9-509(d)(2), 9-510(c). 4. Buyers of Receivables. Applied literally, former Section 9-404(1) would have required many buyers of receivables to le a termination statement immediately upon ling a nancing statement because there is no outstanding secured obligation and no commitment to make advances, incur obligations, or otherwise give value. Subsections (c)(1) and (2) remedy this problem. While the security interest of a buyer of accounts or chattel paper (B-1) is perfected, the debtor is not deemed to retain an interest in the sold receivables and thus could transfer no interest in them to another buyer (B-2) or to a lien creditor (LC). However, for purposes of determining the rights of the debtor's creditors and certain purchasers of accounts or chattel paper from the debtor, while B-1's security interest is unperfected, the debtor-seller is deemed to have rights in the sold receivables, and a competing security interest or judicial lien may attach to those rights. See Sections 9-318, 9-109, Comment 5. Suppose that B-1's security interest in certain accounts and chattel paper is perfected by ling, but the eectiveness of the nancing statement lapses. Both before and after lapse, B-1 collects some of the receivables. After lapse, LC acquires a lien on the accounts and chattel paper. B-1's unperfected security interest in the accounts and chattel paper is subordinate to LC's rights. See Section 9-317(a)(2). But collections on accounts and chattel paper are not accounts or chattel paper. Even if B-1's security interest in the accounts and chattel paper is or becomes unperfected, neither the debtor nor LC acquires rights to the collections that B-1 collects (and owns) before LC acquires a lien. 5. Eect of Filing. Subsection (d) states the eect of ling a termination statement: the related nancing statement ceases to be eective. If one of several secured parties of record les a termination statement, subsection (d) applies only with respect to the rights of the person who authorized the ling of the termination statement. See Section 9-510(b). The nancing statement remains eective with respect to the rights of the others. However, even if a nancing statement is terminated (and thus no longer is eective) with respect to all secured parties of record, the nancing statement, including the termination statement, will remain of record until at least one year after it lapses with respect to all secured parties of record. See Section 9-519(g).

9-514. Assignment of Powers of Secured Party of Record. (a) [Assignment reected on initial nancing statement.] Except as otherwise provided in subsection (c), an initial nancing statement may reect an assignment of all of the secured party's power to authorize an amendment to the nancing statement by providing the name and mailing address of the assignee as the name and address of the secured party. (b) [Assignment of led nancing statement.] Except as otherwise provided in subsection (c), a secured party of record may assign of record all or part of its power to authorize an amendment to a nancing statement by ling in the ling oce an amendment of the nancing statement which: (1) identies, by its le number, the initial nancing statement to which it relates; (2) provides the name of the assignor; and (3) provides the name and mailing address of the assignee. (c) [Assignment of record of mortgage.] An assignment of record of a security interest in a xture covered by a record of a mortgage which is ef1019

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fective as a nancing statement led as a xture ling under Section 9-502(c) may be made only by an assignment of record of the mortgage in the manner provided by law of this State other than [the Uniform Commercial Code]. Ocial Comment
1. Source. Former Section 9-405. 2. Assignments. This section provides a permissive device whereby a secured party of record may eectuate an assignment of its power to aect a nancing statement. It may also be useful for a secured party who has assigned all or part of its security interest or agricultural lien and wishes to have the fact noted of record, so that inquiries concerning the transaction would be addressed to the assignee. See Section 9-502, Comment 2. Upon the ling of an assignment, the assignee becomes the secured party of record and may authorize the ling of a continuation statement, termination statement, or other amendment. Note that under Section 9-310(c) no ling of an assignment is required as a condition of continuing the perfected status of the security interest against creditors and transferees of the original debtor. However, if an assignment is not led, the assignor remains the secured party of record, with the power (even if not the right) to authorize the ling of eective amendments. See Sections 9-511(c), 9-509(d). Where a record of a mortgage is eective as a nancing statement led as a xture ling (Section 9-502(c)), then an assignment of record of the security interest may be made only in the manner in which an assignment of record of the mortgage may be made under local real-property law. 3. Comparison to Prior Law. Most of the changes reected in this section are for clarication or to embrace medium-neutral drafting. As a general matter, this section preserves the opportunity given by former Section 9-405 to assign a security interest of record in one of two dierent ways. Under subsection (a), a secured party may assign all of its power to aect a nancing statement by naming an assignee in the initial nancing statement. The secured party of record may accomplish the same result under subsection (b) by making a subsequent ling. Subsection (b) also may be used for an assignment of only some of the secured party of record's power to aect a nancing statement, e.g., the power to aect the nancing statement as it relates to particular items of collateral or as it relates to an undivided interest in a security interest in all the collateral. An initial nancing statement may not be used to change the secured party of record under these circumstances. However, an amendment adding the assignee as a secured party of record may be used.

9-515. Duration and Eectiveness of Financing Statement; Eect of Lapsed Financing Statement. (a) [Five-year eectiveness.] Except as otherwise provided in subsections (b), (e), (f), and (g), a led nancing statement is eective for a period of ve years after the date of ling. (b) [Public-nance or manufactured-home transaction.] Except as otherwise provided in subsections (e), (f), and (g), an initial nancing statement led in connection with a public-nance transaction or manufacturedhome transaction is eective for a period of 30 years after the date of ling if it indicates that it is led in connection with a public-nance transaction or manufactured-home transaction. (c) [Lapse and continuation of nancing statement.] The eectiveness of a led nancing statement lapses on the expiration of the period of its eectiveness unless before the lapse a continuation statement is led pursuant to subsection (d). Upon lapse, a nancing statement ceases to be eective and any security interest or agricultural lien that was perfected by the nancing statement becomes unperfected, unless the security interest is perfected otherwise. If the security interest or agricultural lien
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becomes unperfected upon lapse, it is deemed never to have been perfected as against a purchaser of the collateral for value. (d) [When continuation statement may be led.] A continuation statement may be led only within six months before the expiration of the ve-year period specied in subsection (a) or the 30-year period specied in subsection (b), whichever is applicable. (e) [Eect of ling continuation statement.] Except as otherwise provided in Section 9-510, upon timely ling of a continuation statement, the eectiveness of the initial nancing statement continues for a period of ve years commencing on the day on which the nancing statement would have become ineective in the absence of the ling. Upon the expiration of the ve-year period, the nancing statement lapses in the same manner as provided in subsection (c), unless, before the lapse, another continuation statement is led pursuant to subsection (d). Succeeding continuation statements may be led in the same manner to continue the eectiveness of the initial nancing statement. (f) [Transmitting utility nancing statement.] If a debtor is a transmitting utility and a led nancing statement so indicates, the nancing statement is eective until a termination statement is led. (g) [Record of mortgage as nancing statement.] A record of a mortgage that is eective as a nancing statement led as a xture ling under Section 9-502(c) remains eective as a nancing statement led as a xture ling until the mortgage is released or satised of record or its effectiveness otherwise terminates as to the real property. Ocial Comment
1. Source. Former Section 9-403(2), (3), (6). 2. Period of Financing Statement's Eectiveness. Subsection (a) states the general rule: a nancing statement is eective for a ve-year period unless its eectiveness is continued under this section or terminated under Section 9-513. Subsection (b) provides that if the nancing statement relates to a public-nance transaction or a manufacturedhome transaction and so indicates, the nancing statement is eective for 30 years. These nancings typically extend well beyond the standard, ve-year period. Under subsection (f), a nancing statement led against a transmitting utility remains eective indenitely, until a termination statement is led. Likewise, under subsection (g), a mortgage eective as a xture ling remains eective until its eectiveness terminates under real-property law. 3. Lapse. When the period of eectiveness under subsection (a) or (b) expires, the effectiveness of the nancing statement lapses. The last sentence of subsection (c) addresses the eect of lapse. The deemed retroactive unperfection applies only with respect to purchasers for value; unlike former Section 9-403(2), it does not apply with respect to lien creditors. Example 1: SP-1 and SP-2 both hold security interests in the same collateral. Both security interests are perfected by ling. SP-1 led rst and has priority under Section 9-322(a)(1). The eectiveness of SP-1's ling lapses. As long as SP-2's security interest remains perfected thereafter, SP-2 is entitled to priority over SP-1's security interest, which is deemed never to have been perfected as against a purchaser for value (SP-2). See Section 9-322(a)(2). Example 2: SP holds a security interest perfected by ling. On July 1, LC acquires a judicial lien on the collateral. Two weeks later, the eectiveness of the nancing statement lapses. Although the security interest becomes unperfected upon lapse, it was perfected when LC acquired its lien. Accordingly, notwithstanding the lapse, the perfected security interest has priority over the rights of LC, who is not a purchaser. See Section 9-317(a)(2). 4. Eect of Debtor's Bankruptcy. Under former Section 9-403(2), lapse was tolled if 1021

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the debtor entered bankruptcy or another insolvency proceeding. Nevertheless, being unaware that insolvency proceedings had been commenced, ling oces routinely removed records from the les as if lapse had not been tolled. Subsection (c) deletes the former tolling provision and thereby imposes a new burden on the secured party: to be sure that a nancing statement does not lapse during the debtor's bankruptcy. The secured party can prevent lapse by ling a continuation statement, even without rst obtaining relief from the automatic stay. See Bankruptcy Code Section 362(b)(3). Of course, if the debtor enters bankruptcy before lapse, the provisions of this Article with respect to lapse would be of no eect to the extent that federal bankruptcy law dictates a contrary result (e.g., to the extent that the Bankruptcy Code determines rights as of the date of the ling of the bankruptcy petition). 5. Continuation Statements. Subsection (d) explains when a continuation statement may be led. A continuation statement led at a time other than that prescribed by subsection (d) is ineective, see Section 9-510(c), and the ling oce may not accept it. See Sections 9-520(a), 9-516(b). Subsection (e) species the eect of a continuation statement and provides for successive continuation statements.

9-516. What Constitutes Filing; Eectiveness of Filing. (a) [What constitutes ling.] Except as otherwise provided in subsection (b), communication of a record to a ling oce and tender of the ling fee or acceptance of the record by the ling oce constitutes ling. (b) [Refusal to accept record; ling does not occur.] Filing does not occur with respect to a record that a ling oce refuses to accept because: (1) the record is not communicated by a method or medium of communication authorized by the ling oce; (2) an amount equal to or greater than the applicable ling fee is not tendered; (3) the ling oce is unable to index the record because: (A) in the case of an initial nancing statement, the record does not provide a name for the debtor; (B) in the case of an amendment or correction statement, the record: (i) does not identify the initial nancing statement as required by Section 9-512 or 9-518, as applicable; or (ii) identies an initial nancing statement whose eectiveness has lapsed under Section 9-515; (C) in the case of an initial nancing statement that provides the name of a debtor identied as an individual or an amendment that provides a name of a debtor identied as an individual which was not previously provided in the nancing statement to which the record relates, the record does not identify the debtor's last name; or (D) in the case of a record led [or recorded] in the ling oce described in Section 9-501(a)(1), the record does not provide a sufcient description of the real property to which it relates; (4) in the case of an initial nancing statement or an amendment that adds a secured party of record, the record does not provide a name and mailing address for the secured party of record; (5) in the case of an initial nancing statement or an amendment that provides a name of a debtor which was not previously provided in the nancing statement to which the amendment relates, the record does not: (A) provide a mailing address for the debtor;
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(B) indicate whether the debtor is an individual or an organization; or (C) if the nancing statement indicates that the debtor is an organization, provide: (i) a type of organization for the debtor; (ii) a jurisdiction of organization for the debtor; or (iii) an organizational identication number for the debtor or indicate that the debtor has none; (6) in the case of an assignment reected in an initial nancing statement under Section 9-514(a) or an amendment led under Section 9-514(b), the record does not provide a name and mailing address for the assignee; or (7) in the case of a continuation statement, the record is not led within the six-month period prescribed by Section 9-515(d). (c) [Rules applicable to subsection (b).] For purposes of subsection (b): (1) a record does not provide information if the ling oce is unable to read or decipher the information; and (2) a record that does not indicate that it is an amendment or identify an initial nancing statement to which it relates, as required by Section 9-512, 9-514, or 9-518, is an initial nancing statement. (d) [Refusal to accept record; record eective as led record.] A record that is communicated to the ling oce with tender of the ling fee, but which the ling oce refuses to accept for a reason other than one set forth in subsection (b), is eective as a led record except as against a purchaser of the collateral which gives value in reasonable reliance upon the absence of the record from the les. Ocial Comment
1. Source. Subsection (a): former Section 9-403(1); the remainder is new. 2. What Constitutes Filing. Subsection (a) deals generically with what constitutes ling of a record, including an initial nancing statement and amendments of all kinds (e.g., assignments, termination statements, and continuation statements). It follows former Section 9-403(1), under which either acceptance of a record by the ling oce or presentation of the record and tender of the ling fee constitutes ling. 3. Eectiveness of Rejected Record. Subsection (b) provides an exclusive list of grounds upon which the ling oce may reject a record. See Section 9-520(a). Although some of these grounds would also be grounds for rendering a led record ineective (e.g., an initial nancing statement does not provide a name for the debtor), many others would not be (e.g., an initial nancing statement does not provide a mailing address for the debtor or secured party of record). Neither this section nor Section 9-520 requires or authorizes the ling oce to determine, or even consider, the accuracy of information provided in a record. For example, the State A ling oce may not reject under subsection (b)(5)(C) an initial nancing statement indicating that the debtor is a State A corporation and providing a three-digit organizational identication number, even if all State A organizational identication numbers contain at least ve digits and two letters. Some organizations that are not registered organizations (such as foreign corporations) have a readily determinable jurisdiction of organization. When that is not the case, with respect to an organization that is not a registered organization, for purposes of this section, the debtor's jurisdiction of organization is any jurisdiction that bears a reasonable relation to the debtor, such as the jurisdiction stated in any organizational document or agreement for the debtor as the jurisdiction under whose law the organization is formed or as the jurisdiction whose law is the governing law, or the jurisdiction in which the debtor is located under Section 9-307(b) (i.e., 1023

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its place of business or its chief executive oce). Thus, for purposes of this section, more than one jurisdiction may qualify as the debtor's jurisdiction of organization. See Comment 9. A nancing statement or other record that is communicated to the ling oce but which the ling oce refuses to accept provides no public notice, regardless of the reason for the rejection. However, this section distinguishes between records that the ling oce rightfully rejects and those that it wrongfully rejects. A ler is able to prevent a rightful rejection by complying with the requirements of subsection (b). No purpose is served by giving eect to records that justiably never nd their way into the system, and subsection (b) so provides. Subsection (d) deals with the ling oce's unjustied refusal to accept a record. Here, the ler is in no position to prevent the rejection and as a general matter should not be prejudiced by it. Although wrongfully rejected records generally are eective, subsection (d) contains a special rule to protect a third-party purchaser of the collateral (e.g., a buyer or competing secured party) who gives value in reliance upon the apparent absence of the record from the les. As against a person who searches the public record and reasonably relies on what the public record shows, subsection (d) imposes upon the ler the risk that a record failed to make its way into the ling system because of the ling oce's wrongful rejection of it. (Compare Section 9-517, under which a mis-indexed nancing statement is fully eective.) This risk is likely to be small, particularly when a record is presented electronically, and the ler can guard against this risk by conducting a post-ling search of the records. Moreover, Section 9-520(b) requires the ling oce to give prompt notice of its refusal to accept a record for ling. 4. Method or Medium of Communication. Rejection pursuant to subsection (b)(1) for failure to communicate a record properly should be understood to mean noncompliance with procedures relating to security, authentication, or other communication-related requirements that the ling oce may impose. Subsection (b)(1) does not authorize a ling oce to impose additional substantive requirements. See Section 9-520, Comment 2. 5. Address for Secured Party of Record. Under subsection (b)(4) and Section 9-520(a), the lack of a mailing address for the secured party of record requires the ling oce to reject an initial nancing statement. The failure to include an address for the secured party of record no longer renders a nancing statement ineective. See Section 9-502(a). The function of the address is not to identify the secured party of record but rather to provide an address to which others can send required notications, e.g., of a purchase-money security interest in inventory or of the disposition of collateral. Inasmuch as the address shown on a led nancing statement is an address that is reasonable under the circumstances, a person required to send a notication to the secured party may satisfy the requirement by sending a notication to that address, even if the address is or becomes incorrect. See Section 9-102 (denition of send). Similarly, because the address is held out by [the secured party] as the place for receipt of such communications [i.e., communications relating to security interests], the secured party is deemed to have received a notication delivered to that address. See Section 1-201(26). 6. Uncertainty Concerning Individual Debtor's Last Name. Subsection (b)(3)(C) requires the ling oce to reject an initial nancing statement or amendment adding an individual debtor if the oce cannot index the record because it does not identify the debtor's last name (e.g., it is unclear whether the debtor's name is Elton John or John Elton). 7. Inability of Filing Oce to Read or Decipher Information. Under subsection (c)(1), if the ling oce cannot read or decipher information, the information is not provided by a record for purposes of subsection (b). 8. Classication of Records. For purposes of subsection (b), a record that does not indicate it is an amendment or identify an initial nancing statement to which it relates is deemed to be an initial nancing statement. See subsection (c)(2). 9. Eectiveness of Rejectable But Unrejected Record. Section 9-520(a) requires the ling oce to refuse to accept an initial nancing statement for a reason set forth in subsection (b). However, if the ling oce accepts such a nancing statement nevertheless, the nancing statement generally is eective if it complies with the requirements of Section 9-502(a) and (b). See Section 9-520(c). Similarly, an otherwise eective nancing statement generally remains so even though the information in the nancing statement becomes 1024

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incorrect. See Section 9-507(b). (Note that if the information required by subsection (b)(5) is incorrect when the nancing statement is led, Section 9-338 applies.)

9-517. Eect of Indexing Errors. The failure of the ling oce to index a record correctly does not aect the eectiveness of the led record. Ocial Comment
1. Source. New. 2. Eectiveness of Mis-Indexed Records. This section provides that the ling oce's error in mis-indexing a record does not render ineective an otherwise eective record. As did former Section 9-401, this section imposes the risk of ling-oce error on those who search the les rather than on those who le.

9-518. Claim Concerning Inaccurate or Wrongfully Filed Record. (a) [Correction statement.] A person may le in the ling oce a correction statement with respect to a record indexed there under the person's name if the person believes that the record is inaccurate or was wrongfully led.
[Alternative A]

(b) [Suciency of correction statement.] A correction statement must: (1) identify the record to which it relates by the le number assigned to the initial nancing statement to which the record relates; (2) indicate that it is a correction statement; and (3) provide the basis for the person's belief that the record is inaccurate and indicate the manner in which the person believes the record should be amended to cure any inaccuracy or provide the basis for the person's belief that the record was wrongfully led.
[Alternative B]

(b) [Suciency of correction statement.] A correction statement must: (1) identify the record to which it relates by: (A) the le number assigned to the initial nancing statement to which the record relates; and (B) if the correction statement relates to a record led [or recorded] in a ling oce described in Section 9-501(a)(1), the date [and time] that the initial nancing statement was led [or recorded] and the information specied in Section 9-502(b); (2) indicate that it is a correction statement; and (3) provide the basis for the person's belief that the record is inaccurate and indicate the manner in which the person believes the record should be amended to cure any inaccuracy or provide the basis for the person's belief that the record was wrongfully led.
[End of Alternatives]

(c) [Record not aected by correction statement.] The ling of a correction statement does not aect the eectiveness of an initial nancing statement or other led record.
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Legislative Note: States whose real-estate ling oces require additional information in amendments and cannot search their records by both the name of the debtor and the le number should enact Alternative B to Sections 9-512(a), 9-518(b), 9-519(f) and 9-522(a).

Ocial Comment
1. Source. New. 2. Correction Statements. Former Article 9 did not aord a nonjudicial means for a debtor to correct a nancing statement or other record that was inaccurate or wrongfully led. Subsection (a) aords the debtor the right to le a correction statement. Among other requirements, the correction statement must provide the basis for the debtor's belief that the public record should be corrected. See subsection (b). These provisions, which resemble the analogous remedy in the Fair Credit Reporting Act, 15 U.S.C. 1681i, aord an aggrieved person the opportunity to state its position on the public record. They do not permit an aggrieved person to change the legal eect of the public record. Thus, although a led correction statement becomes part of the nancing statement, as dened in Section 9-102, the ling does not aect the eectiveness of the initial nancing statement or any other led record. See subsection (c). This section does not displace other provisions of this Article that impose liability for making unauthorized lings or failing to le or send a termination statement (see Section 9-625(e)), nor does it displace any available judicial remedies. 3. Resort to Other Law. This Article cannot provide a satisfactory or complete solution to problems caused by misuse of the public records. The problem of bogus lings is not limited to the UCC ling system but extends to the real-property records, as well. A summary judicial procedure for correcting the public record and criminal penalties for those who misuse the ling and recording systems are likely to be more eective and put less strain on the ling system than provisions authorizing or requiring action by ling and recording oces.

[SUBPART 2. DUTIES AND OPERATION OF FILING OFFICE] 9-519. Numbering, Maintaining, and Indexing Records; Communicating Information Provided in Records. (a) [Filing oce duties.] For each record led in a ling oce, the ling oce shall: (1) assign a unique number to the led record; (2) create a record that bears the number assigned to the led record and the date and time of ling; (3) maintain the led record for public inspection; and (4) index the led record in accordance with subsections (c), (d), and (e). (b) [File number.] A le number [assigned after January 1, 2002,] must include a digit that: (1) is mathematically derived from or related to the other digits of the le number; and (2) aids the ling oce in determining whether a number communicated as the le number includes a single-digit or transpositional error. (c) [Indexing: general.] Except as otherwise provided in subsections (d) and (e), the ling oce shall: (1) index an initial nancing statement according to the name of the debtor and index all led records relating to the initial nancing statement in a manner that associates with one another an initial nancing statement and all led records relating to the initial nancing statement; and
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(2) index a record that provides a name of a debtor which was not previously provided in the nancing statement to which the record relates also according to the name that was not previously provided. (d) [Indexing: real-property-related nancing statement.] If a nancing statement is led as a xture ling or covers as-extracted collateral or timber to be cut, [it must be led for record and] the ling oce shall index it: (1) under the names of the debtor and of each owner of record shown on the nancing statement as if they were the mortgagors under a mortgage of the real property described; and (2) to the extent that the law of this State provides for indexing of records of mortgages under the name of the mortgagee, under the name of the secured party as if the secured party were the mortgagee thereunder, or, if indexing is by description, as if the nancing statement were a record of a mortgage of the real property described. (e) [Indexing: real-property-related assignment.] If a nancing statement is led as a xture ling or covers as-extracted collateral or timber to be cut, the ling oce shall index an assignment led under Section 9-514(a) or an amendment led under Section 9-514(b): (1) under the name of the assignor as grantor; and (2) to the extent that the law of this State provides for indexing a record of the assignment of a mortgage under the name of the assignee, under the name of the assignee.
[Alternative A]

(f) [Retrieval and association capability.] The ling oce shall maintain a capability: (1) to retrieve a record by the name of the debtor and by the le number assigned to the initial nancing statement to which the record relates; and (2) to associate and retrieve with one another an initial nancing statement and each led record relating to the initial nancing statement.
[Alternative B]

(f) [Retrieval and association capability.] The ling oce shall maintain a capability: (1) to retrieve a record by the name of the debtor and: (A) if the ling oce is described in Section 9-501(a)(1), by the le number assigned to the initial nancing statement to which the record relates and the date [and time] that the record was led [or recorded]; or (B) if the ling oce is described in Section 9-501(a)(2), by the le number assigned to the initial nancing statement to which the record relates; and (2) to associate and retrieve with one another an initial nancing statement and each led record relating to the initial nancing statement.
[End of Alternatives]

(g) [Removal of debtor's name.] The ling oce may not remove a
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debtor's name from the index until one year after the eectiveness of a nancing statement naming the debtor lapses under Section 9-515 with respect to all secured parties of record. (h) [Timeliness of ling oce performance.] The ling oce shall perform the acts required by subsections (a) through (e) at the time and in the manner prescribed by ling-oce rule, but not later than two business days after the ling oce receives the record in question. [(i) [Inapplicability to real-property-related ling oce.] Subsection[s] [(b)] [and] [(h)] do[es] not apply to a ling oce described in Section 9-501(a)(1).]
Legislative Notes: 1. States whose ling oces currently assign le numbers that include a verication number, commonly known as a check digit, or can implement this requirement before the eective date of this Article should omit the bracketed language in subsection (b). 2. In States in which writings will not appear in the real property records and indices unless actually recorded the bracketed language in subsection (d) should be used. 3. States whose real-estate ling oces require additional information in amendments and cannot search their records by both the name of the debtor and the le number should enact Alternative B to Sections 9-512(a), 9-518(b), 9-519(f) and 9-522(a). 4. A State that elects not to require real-estate ling oces to comply with either or both of subsections (b) and (h) may adopt an applicable variation of subsection (i) and add Except as otherwise provided in subsection (i), to the appropriate subsection or subsections.

Ocial Comment
1. Source. Former Sections 9-403(4), (7), 9-405(2). 2. Filing Oce's Duties. Subsections (a) through (e) set forth the duties of the ling ofce with respect to led records. Subsection (h), which is new, imposes a minimum standard of performance for those duties. Prompt indexing is crucial to the eectiveness of any ling system. An accepted but un-indexed record aords no public notice. Subsection (f) requires the ling oce to maintain appropriate storage and retrieval facilities, and subsection (g) contains minimum requirements for the retention of records. 3. File Number. Subsection (a)(1) requires the ling oce to assign a unique number to each led record. That number is the le number only if the record is an initial nancing statement. See Section 9-102. 4. Time of Filing. Subsection (a)(2) and Section 9-523 refer to the date and time of ling. The statutory text does not contain any instructions to a ling oce as to how the time of ling is to be determined. The method of determining or assigning a time of ling is an appropriate matter for ling-oce rules to address. 5. Related Records. Subsections (c) and (f) are designed to ensure that an initial nancing statement and all led records relating to it are associated with one another, indexed under the name of the debtor, and retrieved together. To comply with subsection (f), a ling oce (other than a real-property recording oce in a State that enacts subsection (f), Alternative B) must be capable of retrieving records in each of two ways: by the name of the debtor and by the le number of the initial nancing statement to which the record relates. 6. Prohibition on Deleting Names from Index. This Article contemplates that the ling oce will not delete the name of a debtor from the index until at least one year passes after the eectiveness of the nancing statement lapses as to all secured parties of record. See subsection (g). This rule applies even if the ling oce accepts an amendment purporting to delete or modify the name of a debtor or terminate the eectiveness of the nancing statement. If an amendment provides a modied name for a debtor, the amended name should be added to the index, see subsection (c)(2), but the pre-amendment name should remain in the index. Compared to former Article 9, the rule in subsection (g) increases the amount of information available to those who search the public records. The rule also contemplates that 1028

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searchersnot the ling ocewill determine the signicance and eectiveness of led records.

9-520. Acceptance and Refusal to Accept Record. (a) [Mandatory refusal to accept record.] A ling oce shall refuse to accept a record for ling for a reason set forth in Section 9-516(b) and may refuse to accept a record for ling only for a reason set forth in Section 9-516(b). (b) [Communication concerning refusal.] If a ling oce refuses to accept a record for ling, it shall communicate to the person that presented the record the fact of and reason for the refusal and the date and time the record would have been led had the ling oce accepted it. The communication must be made at the time and in the manner prescribed by ling-oce rule but [, in the case of a ling oce described in Section 9-501(a)(2),] in no event more than two business days after the ling oce receives the record. (c) [When led nancing statement eective.] A led nancing statement satisfying Section 9-502(a) and (b) is eective, even if the ling oce is required to refuse to accept it for ling under subsection (a). However, Section 9-338 applies to a led nancing statement providing information described in Section 9-516(b)(5) which is incorrect at the time the nancing statement is led. (d) [Separate application to multiple debtors.] If a record communicated to a ling oce provides information that relates to more than one debtor, this part applies as to each debtor separately.
Legislative Note: A State that elects not to require real-property ling oces to comply with subsection (b) should include the bracketed language.

Ocial Comment
1. Source. New. 2. Refusal to Accept Record for Filing. In some States, ling oces considered themselves obligated by former Article 9 to review the form and content of a nancing statement and to refuse to accept those that they determine are legally insucient. Some ling oces imposed requirements for or conditions to ling that do not appear in the statute. Under this section, the ling oce is not expected to make legal judgments and is not permitted to impose additional conditions or requirements. Subsection (a) both prescribes and limits the bases upon which the ling oce must and may reject records by reference to the reasons set forth in Section 9-516(b). For the most part, the bases for rejection are limited to those that prevent the ling oce from dealing with a record that it receivesbecause some of the requisite information (e.g., the debtor's name) is missing or cannot be deciphered, because the record is not communicated by a method (e.g., it is MIME-rather than UU-encoded) or medium (e.g., it is written rather than electronic) that the ling oce accepts, or because the ler fails to tender an amount equal to or greater than the ling fee. 3. Consequences of Accepting Rejectable Record. Section 9-516(b) includes among the reasons for rejecting an initial nancing statement the failure to give certain information that is not required as a condition of eectiveness. In conjunction with Section 9-516(b) (5), this section requires the ling oce to refuse to accept a nancing statement that is legally sucient to perfect a security interest under Section 9-502 but does not contain a mailing address for the debtor, does not disclose whether the debtor is an individual or an organization (e.g., a partnership or corporation) or, if the debtor is an organization, does not give certain specied information concerning the organization. The information required by Section 9-516(b)(5) assists searchers in weeding out false positives, i.e., records that a search reveals but which do not pertain to the debtor in question. It assists lers by helping to ensure that the debtor's name is correct and that the nancing statement is led in 1029

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the proper jurisdiction. If the ling oce accepts a nancing statement that does not give this information at all, the ling is fully eective. Section 9-520(c). The nancing statement also generally is eective if the information is given but is incorrect; however, Section 9-338 aords protection to buyers and holders of perfected security interests who gives value in reasonable reliance upon the incorrect information. 4. Filing Oce's Duties with Respect to Rejected Record. Subsection (b) requires the ling oce to communicate the fact of rejection and the reason therefor within a xed period of time. Inasmuch as a rightfully rejected record is ineective and a wrongfully rejected record is not fully eective, prompt communication concerning any rejection is important. 5. Partial Eectiveness of Record. Under subsection (d), the provisions of this Part apply to each debtor separately. Thus, a ling oce may reject an initial nancing statement or other record as to one named debtor but accept it as to the other. Example: An initial nancing statement is communicated to the ling oce. The nancing statement names two debtors, John Smith and Jane Smith. It contains all of the information described in Section 9-516(b)(5) with respect to John but lacks some of the information with respect to Jane. The ling oce must accept the nancing statement with respect to John, reject it with respect to Jane, and notify the ler of the rejection.

9-521. Uniform Form of Written Financing Statement and Amendment. (a) [Initial nancing statement form.] A ling oce that accepts written records may not refuse to accept a written initial nancing statement in the following form and format except for a reason set forth in Section 9-516(b):

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1031

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1032

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(b) [Amendment form.] A ling oce that accepts written records may not refuse to accept a written record in the following form and format except for a reason set forth in Section 9-516(b):

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Ocial Comment
1. Source. New. 2. Safe Harbor Written Forms. Although Section 9-520 limits the bases upon which the ling oce can refuse to accept records, this section provides sample written forms that must be accepted in every ling oce in the country, as long as the ling oce's rules permit it to accept written communications. By completing one of the forms in this section, a secured party can be certain that the ling oce is obligated to accept it. The forms in this section are based upon national nancing statement forms that were in use under former Article 9. Those forms were developed over an extended period and reect the comments and suggestions of ling ocers, secured parties and their counsel, and service companies. The formatting of those forms and of the ones in this section has been designed to reduce error by both lers and ling oces. A ling oce that accepts written communications may not reject, on grounds of form or format, a ling using these forms. Although lers are not required to use the forms, they are encouraged and can be expected to do so, inasmuch as the forms are well designed and avoid the risk of rejection on the basis of form or format. As their use expands, the forms will rapidly become familiar to both lers and ling-oce personnel. Filing oces may and should encourage the use of these forms by declaring them to be the standard (but not exclusive) forms for each jurisdiction, albeit without in any way suggesting that alternative forms are unacceptable. The multi-purpose form in subsection (b) covers changes with respect to the debtor, the secured party, the collateral, and the status of the nancing statement (termination and continuation). A single form may be used for several dierent types of amendments at once (e.g., both to change a debtor's name and continue the eectiveness of the nancing statement).

9-522. Maintenance and Destruction of Records.

[Alternative A]

(a) [Post-lapse maintenance and retrieval of information.] The ling oce shall maintain a record of the information provided in a led nancing statement for at least one year after the eectiveness of the nancing statement has lapsed under Section 9-515 with respect to all secured parties of record. The record must be retrievable by using the name of the debtor and by using the le number assigned to the initial nancing statement to which the record relates.
[Alternative B]

(a) [Post-lapse maintenance and retrieval of information.] The ling oce shall maintain a record of the information provided in a led nancing statement for at least one year after the eectiveness of the nancing statement has lapsed under Section 9-515 with respect to all secured parties of record. The record must be retrievable by using the name of the debtor and: (1) if the record was led [or recorded] in the ling oce described in Section 9-501(a)(1), by using the le number assigned to the initial nancing statement to which the record relates and the date [and time] that the record was led [or recorded]; or (2) if the record was led in the ling oce described in Section 9-501(a)(2), by using the le number assigned to the initial nancing statement to which the record relates.
[End of Alternatives]

(b) [Destruction of written records.] Except to the extent that a statute governing disposition of public records provides otherwise, the ling of1035

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ce immediately may destroy any written record evidencing a nancing statement. However, if the ling oce destroys a written record, it shall maintain another record of the nancing statement which complies with subsection (a).
Legislative Note: States whose real-estate ling oces require additional information in amendments and cannot search their records by both the name of the debtor and the le number should enact Alternative B to Sections 9-512(a), 9-518(b), 9-519(f) and 9-522(a).

Ocial Comment
1. Source. Former Section 9-403(3), revised substantially. 2. Maintenance of Records. Section 9-523 requires the ling oce to provide information concerning certain lapsed nancing statements. Accordingly, subsection (a) requires the ling oce to maintain a record of the information in a nancing statement for at least one year after lapse. During that time, the ling oce may not delete any information with respect to a led nancing statement; it may only add information. This approach relieves the ling oce from any duty to determine whether to substitute or delete information upon receipt of an amendment. It also assures searchers that they will receive all information with respect to nancing statements led against a debtor and thereby be able themselves to determine the state of the public record. The ling oce may maintain this information in any medium. Subsection (b) permits the ling oce immediately to destroy written records evidencing a nancing statement, provided that the ling oce maintains another record of the information contained in the nancing statement as required by subsection (a).

9-523. Information From Filing Oce; Sale or License of Records. (a) [Acknowledgment of ling written record.] If a person that les a written record requests an acknowledgment of the ling, the ling oce shall send to the person an image of the record showing the number assigned to the record pursuant to Section 9-519(a)(1) and the date and time of the ling of the record. However, if the person furnishes a copy of the record to the ling oce, the ling oce may instead: (1) note upon the copy the number assigned to the record pursuant to Section 9-519(a)(1) and the date and time of the ling of the record; and (2) send the copy to the person. (b) [Acknowledgment of ling other record.] If a person les a record other than a written record, the ling oce shall communicate to the person an acknowledgment that provides: (1) the information in the record; (2) the number assigned to the record pursuant to Section 9-519(a)(1); and (3) the date and time of the ling of the record. (c) [Communication of requested information.] The ling oce shall communicate or otherwise make available in a record the following information to any person that requests it: (1) whether there is on le on a date and time specied by the ling ofce, but not a date earlier than three business days before the ling ofce receives the request, any nancing statement that: (A) designates a particular debtor [or, if the request so states, designates a particular debtor at the address specied in the request]; (B) has not lapsed under Section 9-515 with respect to all secured parties of record; and
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(C) if the request so states, has lapsed under Section 9-515 and a record of which is maintained by the ling oce under Section 9-522(a); (2) the date and time of ling of each nancing statement; and (3) the information provided in each nancing statement. (d) [Medium for communicating information.] In complying with its duty under subsection (c), the ling oce may communicate information in any medium. However, if requested, the ling oce shall communicate information by issuing [its written certicate] [a record that can be admitted into evidence in the courts of this State without extrinsic evidence of its authenticity]. (e) [Timeliness of ling oce performance.] The ling oce shall perform the acts required by subsections (a) through (d) at the time and in the manner prescribed by ling-oce rule, but not later than two business days after the ling oce receives the request. (f) [Public availability of records.] At least weekly, the [insert appropriate ocial or governmental agency] [ling oce] shall oer to sell or license to the public on a nonexclusive basis, in bulk, copies of all records led in it under this part, in every medium from time to time available to the ling oce.
Legislative Notes: 1. States whose ling oce does not oer the additional service of responding to search requests limited to a particular address should omit the bracketed language in subsection (c)(1)(A). 2. A State that elects not to require real-estate ling oces to comply with either or both of subsections (e) and (f) should specify in the appropriate subsection(s) only the ling oce described in Section 9-501(a)(2).

Ocial Comment
1. Source. Former Section 9-407; subsections (d) and (e) are new. 2. Filing Oce's Duty to Provide Information. Former Section 9-407, dealing with obtaining information from the ling oce, was bracketed to suggest to legislatures that its enactment was optional. Experience has shown that the method by which interested persons can obtain information concerning the public records should be uniform. Accordingly, the analogous provisions of this Article are not in brackets. Most of the other changes from former Section 9-407 are for clarication, to embrace medium-neutral drafting, or to impose standards of performance on the ling oce. 3. Acknowledgments of Filing. Subsections (a) and (b) require the ling oce to acknowledge the ling of a record. Under subsection (a), the ling oce is required to acknowledge the ling of a written record only upon request of the ler. Subsection (b) requires the ling oce to acknowledge the ling of a non-written record even in the absence of a request from the ler. 4. Response to Search Request. Subsection (c)(3) requires the ling oce to provide the information contained in each nancing statement to a person who requests it. This requirement can be satised by providing copies, images, or reports. The requirement does not in any manner inhibit the ling oce from also oering to provide less than all of the information (presumably for a lower fee) to a person who asks for less. Thus, subsection (c) accommodates the practice of providing only the type of record (e.g., initial nancing statement, continuation statement), number assigned to the record, date and time of ling, and names and addresses of the debtor and secured party when a requesting person asks for no more (i.e., when the person does not ask for copies of nancing statements). In contrast, the ling oce's obligation under subsection (b) to provide an acknowledgment containing the information contained in the record is not dened by a customer's request. Thus unless the ler stipulates otherwise, to comply with subsection (b) the ling oce's acknowledgment must contain all of the information in a record. Subsection (c) assures that a minimum amount of information about led records will be 1037

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available to the public. It does not preclude a ling oce from oering additional services. 5. Lapsed and Terminated Financing Statements. This section reects the policy that terminated nancing statements will remain part of the ling oce's data base. The ling oce may remove from the data base only lapsed nancing statements, and then only when at least a year has passed after lapse. See Section 9-519(g). Subsection (c)(1)(C) requires a ling oce to conduct a search and report as to lapsed nancing statements that have not been removed from the data base, when requested. 6. Search by Debtor's Address. Subsection (c)(1)(A) contemplates that, by making a single request, a searcher will receive the results of a search of the entire public record maintained by any given ling oce. Addition of the bracketed language in subsection (c)(1)(A) would permit a search report limited to nancing statements showing a particular address for the debtor, but only if the search request is so limited. With or without the bracketed language, this subsection does not permit the ling oce to compel a searcher to limit a request by address. 7. Medium of Communication; Certicates. Former Article 9 provided that the ling oce respond to a request for information by providing a certicate. The principle of medium-neutrality would suggest that the statute not require a written certicate. Subsection (d) follows this principle by permitting the ling oce to respond by communicating in any medium. By permitting communication in any medium, subsection (d) is not inconsistent with a system in which persons other than ling oce sta conduct searches of the ling oce's (computer) records. Some searchers nd it necessary to introduce the results of their search into evidence. Because ocial written certicates might be introduced into evidence more easily than ofcial communications in another medium, subsection (d) aords States the option of requiring the ling oce to issue written certicates upon request. The alternative bracketed language in subsection (d) recognizes that some States may prefer to permit the ling oce to respond in another medium, as long as the response can be admitted into evidence in the courts of that State without extrinsic evidence of its authenticity. 8. Performance Standard. The utility of the ling system depends on the ability of searchers to get current information quickly. Accordingly, subsection (e) requires that the ling oce respond to a request for information no later than two business days after it receives the request. The information contained in the response must be current as of a date no earlier than three business days before the ling oce receives the request. See subsection (c)(1). The failure of the ling oce to comply with performance standards, such as subsection (e), has no eect on the private rights of persons aected by the ling of records. 9. Sales of Records in Bulk. Subsection (f), which is new, mandates that the appropriate ocial or the ling oce sell or license the ling records to the public in bulk, on a nonexclusive basis, in every medium available to the ling oce. The details of implementation are left to ling-oce rules.

9-524. Delay by Filing Oce. Delay by the ling oce beyond a time limit prescribed by this part is excused if: (1) the delay is caused by interruption of communication or computer facilities, war, emergency conditions, failure of equipment, or other circumstances beyond control of the ling oce; and (2) the ling oce exercises reasonable diligence under the circumstances. Ocial Comment
Source. New; derived from Section 4-109.

9-525. Fees. (a) [Initial nancing statement or other record: general rule.] Except as otherwise provided in subsection (e), the fee for ling and indexing a record under this part, other than an initial nancing statement of
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the kind described in subsection (b), is [the amount specied in subsection (c), if applicable, plus]: (1) $[X] if the record is communicated in writing and consists of one or two pages; (2) $[2X] if the record is communicated in writing and consists of more than two pages; and (3) $[X] if the record is communicated by another medium authorized by ling-oce rule. (b) [Initial nancing statement: public-nance and manufacturedhousing transactions.] Except as otherwise provided in subsection (e), the fee for ling and indexing an initial nancing statement of the following kind is [the amount specied in subsection (c), if applicable, plus]: (1) $ if the nancing statement indicates that it is led in connection with a public-nance transaction; (2) $ if the nancing statement indicates that it is led in connection with a manufactured-home transaction.
[Alternative A]

(c) [Number of names.] The number of names required to be indexed does not aect the amount of the fee in subsections (a) and (b).
[Alternative B]

(c) [Number of names.] Except as otherwise provided in subsection (e), if a record is communicated in writing, the fee for each name more than two required to be indexed is $ .
[End of Alternatives]

(d) [Response to information request.] The fee for responding to a request for information from the ling oce, including for [issuing a certificate showing] [communicating] whether there is on le any nancing statement naming a particular debtor, is: (1) $ if the request is communicated in writing; and (2) $ if the request is communicated by another medium authorized by ling-oce rule. (e) [Record of mortgage.] This section does not require a fee with respect to a record of a mortgage which is eective as a nancing statement led as a xture ling or as a nancing statement covering as-extracted collateral or timber to be cut under Section 9-502(c). However, the recording and satisfaction fees that otherwise would be applicable to the record of the mortgage apply.
Legislative Notes: 1. To preserve uniformity, a State that places the provisions of this section together with statutes setting fees for other services should do so without modication. 2. A State should enact subsection (c), Alternative A, and omit the bracketed language in subsections (a) and (b) unless its indexing system entails a substantial additional cost when indexing additional names.

As amended in 2000.
See Appendix P for material relating to changes made in text in 2000.

Ocial Comment
1. Source. Various sections of former Part 4. 2. Fees. This section contains all fee requirements for ling, indexing, and responding to 1039

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requests for information. Uniformity in the fee structure (but not necessarily in the amount of fees) makes this Article easier for secured parties to use and reduces the likelihood that a led record will be rejected for failure to pay at least the correct amount of the fee. See Section 9-516(b)(2). The costs of processing electronic records are less than those with respect to written records. Accordingly, this section mandates a lower fee as an incentive to le electronically and imposes the additional charge (if any) for multiple debtors only with respect to written records. When written records are used, this Article encourages the use of the uniform forms in Section 9-521. The fee for ling these forms should be no greater than the fee for other written records. To make the relevant information included in a led record more accessible once the record is found, this section mandates a higher fee for longer written records than for shorter ones. Finally, recognizing that nancing statements naming more than one debtor are most often led against a husband and wife, any additional charge for multiple debtors applies to records led with respect to more than two debtors, rather than with respect to more than one.

9-526. Filng-Oce Rules. (a) [Adoption of ling-oce rules.] The [insert appropriate governmental ocial or agency] shall adopt and publish rules to implement this article. The ling-oce rules must be[: (1)] consistent with this article[; and (2) adopted and published in accordance with the [insert any applicable state administrative procedure act]]. (b) [Harmonization of rules.] To keep the ling-oce rules and practices of the ling oce in harmony with the rules and practices of ling ofces in other jurisdictions that enact substantially this part, and to keep the technology used by the ling oce compatible with the technology used by ling oces in other jurisdictions that enact substantially this part, the [insert appropriate governmental ocial or agency], so far as is consistent with the purposes, policies, and provisions of this article, in adopting, amending, and repealing ling-oce rules, shall: (1) consult with ling oces in other jurisdictions that enact substantially this part; and (2) consult the most recent version of the Model Rules promulgated by the International Association of Corporate Administrators or any successor organization; and (3) take into consideration the rules and practices of, and the technology used by, ling oces in other jurisdictions that enact substantially this part. Ocial Comment
1. Source. New; subsection (b) derives in part from the Uniform Consumer Credit Code (1974). 2. Rules Required. Operating a ling oce is a complicated business, requiring many more rules and procedures than this Article can usefully provide. Subsection (a) requires the adoption of rules to carry out the provisions of Article 9. The ling-oce rules must be consistent with the provisions of the statute and adopted in accordance with local procedures. The publication requirement informs secured parties about ling-oce practices, aids secured parties in evaluating ling-related risks and costs, and promotes regularity of application within the ling oce. 3. Importance of Uniformity. In today's national economy, uniformity of the policies and practices of the ling oces will reduce the costs of secured transactions substantially. The International Association of Corporate Administrators (IACA), referred to in subsec1040

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tion (b), is an organization whose membership includes ling ocers from every State. These individuals are responsible for the proper functioning of the Article 9 ling system and have worked diligently to develop model ling-oce rules, with a view toward eciency and uniformity. Although uniformity is an important desideratum, subsection (a) aords considerable exibility in the adoption of ling-oce rules. Each State may adopt a version of subsection (a) that reects the desired relationship between the statewide ling oce described in Section 9-501(a)(2) and the local ling oces described in Section 9-501(a)(1) and that takes into account the practices of its ling oces. Subsection (a) need not designate a single ocial or agency to adopt rules applicable to all ling oces, and the rules applicable to the statewide ling oce need not be identical to those applicable to the local ling oce. For example, subsection (a) might provide for the statewide ling oce to adopt ling-oce rules, and, if not prohibited by other law, the ling oce might adopt one set of rules for itself and another for local oces. Or, subsection (a) might designate one ocial or agency to adopt rules for the statewide ling oce and another to adopt rules for local ling oces.

9-527. Duty to Report. The [insert appropriate governmental ocial or agency] shall report [annually on or before ] to the [Governor and Legislature] on the operation of the ling oce. The report must contain a statement of the extent to which: (1) the ling-oce rules are not in harmony with the rules of ling ofces in other jurisdictions that enact substantially this part and the reasons for these variations; and (2) the ling-oce rules are not in harmony with the most recent version of the Model Rules promulgated by the International Association of Corporate Administrators, or any successor organization, and the reasons for these variations. Ocial Comment
1. Source. New; derived in part from the Uniform Consumer Credit Code (1974). 2. Duty to Report. This section is designed to promote compliance with the standards of performance imposed upon the ling oce and with the requirement that the ling oce's policies, practices, and technology be consistent and compatible with the policies, practices, and technology of other ling oces.

PART 6. DEFAULT
[SUBPART 1. DEFAULT AND ENFORCEMENT OF SECURITY INTEREST] 9-601. Rights After Default; Judicial Enforcement; Consignor or Buyer of Accounts, Chattel Paper, Payment Intangibles, or Promissory Notes. (a) [Rights of secured party after default.] After default, a secured party has the rights provided in this part and, except as otherwise provided in Section 9-602, those provided by agreement of the parties. A secured party: (1) may reduce a claim to judgment, foreclose, or otherwise enforce the claim, security interest, or agricultural lien by any available judicial procedure; and (2) if the collateral is documents, may proceed either as to the documents or as to the goods they cover.
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(b) [Rights and duties of secured party in possession or control.] A secured party in possession of collateral or control of collateral under Section 7-106, 9-104, 9-105, 9-106, or 9-107 has the rights and duties provided in Section 9-207. (c) [Rights cumulative; simultaneous exercise.] The rights under subsections (a) and (b) are cumulative and may be exercised simultaneously. (d) [Rights of debtor and obligor.] Except as otherwise provided in subsection (g) and Section 9-605, after default, a debtor and an obligor have the rights provided in this part and by agreement of the parties. (e) [Lien of levy after judgment.] If a secured party has reduced its claim to judgment, the lien of any levy that may be made upon the collateral by virtue of an execution based upon the judgment relates back to the earliest of: (1) the date of perfection of the security interest or agricultural lien in the collateral; (2) the date of ling a nancing statement covering the collateral; or (3) any date specied in a statute under which the agricultural lien was created. (f) [Execution sale.] A sale pursuant to an execution is a foreclosure of the security interest or agricultural lien by judicial procedure within the meaning of this section. A secured party may purchase at the sale and thereafter hold the collateral free of any other requirements of this article. (g) [Consignor or buyer of certain rights to payment.] Except as otherwise provided in Section 9-607(c), this part imposes no duties upon a secured party that is a consignor or is a buyer of accounts, chattel paper, payment intangibles, or promissory notes. As amended in 2003.
See Appendix I contained within revised Article 7 for material relating to changes made in text in 2003.

Ocial Comment
1. Source. Former Section 9-501(1), (2), (5). 2. Enforcement: In General. The rights of a secured party to enforce its security interest in collateral after the debtor's default are an important feature of a secured transaction. (Note that the term rights, as dened in Section 1-201, includes remedies.) This Part provides those rights as well as certain limitations on their exercise for the protection of the defaulting debtor, other creditors, and other aected persons. However, subsections (a) and (d) make clear that the rights provided in this Part do not exclude other rights provided by agreement. 3. When Remedies Arise. Under subsection (a) the secured party's rights arise [a]fter default. As did former Section 9-501, this Article leaves to the agreement of the parties the circumstances giving rise to a default. This Article does not determine whether a secured party's post-default conduct can constitute a waiver of default in the face of an agreement stating that such conduct shall not constitute a waiver. Rather, it continues to leave to the parties' agreement, as supplemented by law other than this Article, the determination whether a default has occurred or has been waived. See Section 1-103. 4. Possession of Collateral; Section 9-207. After a secured party takes possession of collateral following a default, there is no longer any distinction between a security interest that before default was nonpossessory and a security interest that was possessory before default, as under a common-law pledge. This Part generally does not distinguish between the rights of a secured party with a nonpossessory security interest and those of a secured 1042

Art. 9

Secured Transactions

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party with a possessory security interest. However, Section 9-207 addresses rights and duties with respect to collateral in a secured party's possession. Under subsection (b) of this section, Section 9-207 applies not only to possession before default but also to possession after default. Subsection (b) also has been conformed to Section 9-207, which, unlike former Section 9-207, applies to secured parties having control of collateral. 5. Cumulative Remedies. Former Section 9-501(1) provided that the secured party's remedies were cumulative, but it did not explicitly provide whether the remedies could be exercised simultaneously. Subsection (c) permits the simultaneous exercise of remedies if the secured party acts in good faith. The liability scheme of Subpart 2 aords redress to an aggrieved debtor or obligor. Moreover, permitting the simultaneous exercise of remedies under subsection (c) does not override any non-UCC law, including the law of tort and statutes regulating collection of debts, under which the simultaneous exercise of remedies in a particular case constitutes abusive behavior or harassment giving rise to liability. 6. Judicial Enforcement. Under subsection (a) a secured party may reduce its claim to judgment or foreclose its interest by any available procedure outside this Article under applicable law. Subsection (e) generally follows former Section 9-501(5). It makes clear that any judicial lien that the secured party may acquire against the collateral eectively is a continuation of the original security interest (if perfected) and not the acquisition of a new interest or a transfer of property on account of a preexisting obligation. Under former Section 9-501(5), the judicial lien was stated to relate back to the date of perfection of the security interest. Subsection (e), however, provides that the lien relates back to the earlier of the date of ling or the date of perfection. This provides a secured party who enforces a security interest by judicial process with the benet of the rst-to-le-or-perfect priority rule of Section 9-322(a)(1). 7. Agricultural Liens. Part 6 provides parallel treatment for the enforcement of agricultural liens and security interests. Because agricultural liens are statutory rather than consensual, this Article does draw a few distinctions between these liens and security interests. Under subsection (e), the statute creating an agricultural lien would govern whether and the date to which an execution lien relates back. Section 9-606 explains when a default occurs in the agricultural lien context. 8. Execution Sales. Subsection (f) also follows former Section 9-501(5). It makes clear that an execution sale is an appropriate method of foreclosure contemplated by this Part. However, the sale is governed by other law and not by this Article, and the limitations under Section 9-610 on the right of a secured party to purchase collateral do not apply. 9. Sales of Receivables; Consignments. Subsection (g) provides that, except as provided in Section 9-607(c), the duties imposed on secured parties do not apply to buyers of accounts, chattel paper, payment intangibles, or promissory notes. Although denominated secured parties, these buyers own the entire interest in the property sold and so may enforce their rights without regard to the seller (debtor) or the seller's creditors. Likewise, a true consignor may enforce its ownership interest under other law without regard to the duties that this Part imposes on secured parties. Note, however, that Section 9-615 governs cases in which a consignee's secured party (other than a consignor) is enforcing a security interest that is senior to the security interest (i.e., ownership interest) of a true consignor.

9-602. Waiver and Variance of Rights and Duties. Except as otherwise provided in Section 9-624, to the extent that they give rights to a debtor or obligor and impose duties on a secured party, the debtor or obligor may not waive or vary the rules stated in the following listed sections: (1) Section 9-207(b)(4)(C), which deals with use and operation of the collateral by the secured party; (2) Section 9-210, which deals with requests for an accounting and requests concerning a list of collateral and statement of account; (3) Section 9-607(c), which deals with collection and enforcement of collateral; (4) Sections 9-608(a) and 9-615(c) to the extent that they deal with ap1043

 9-602

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plication or payment of noncash proceeds of collection, enforcement, or disposition; (5) Sections 9-608(a) and 9-615(d) to the extent that they require accounting for or payment of surplus proceeds of collateral; (6) Section 9-609 to the extent that it imposes upon a secured party that takes possession of collateral without judicial process the duty to do so without breach of the peace; (7) Sections 9-610(b), 9-611, 9-613, and 9-614, which deal with disposition of collateral; (8) Section 9-615(f), which deals with calculation of a deciency or surplus when a disposition is made to the secured party, a person related to the secured party, or a secondary obligor; (9) Section 9-616, which deals with explanation of the calculation of a surplus or deciency; (10) Sections 9-620, 9-621, and 9-622, which deal with acceptance of collateral in satisfaction of obligation; (11) Section 9-623, which deals with redemption of collateral; (12) Section 9-624, which deals with permissible waivers; and (13) Sections 9-625 and 9-626, which deal with the secured party's liability for failure to comply with this article. Ocial Comment
1. Source. Former Section 9-501(3). 2. Waiver: In General. Section 1-102(3) addresses which provisions of the UCC are mandatory and which may be varied by agreement. With exceptions relating to good faith, diligence, reasonableness, and care, immediate parties, as between themselves, may vary its provisions by agreement. However, in the context of rights and duties after default, our legal system traditionally has looked with suspicion on agreements that limit the debtor's rights and free the secured party of its duties. As stated in former Section 9-501, Comment 4, no mortgage clause has ever been allowed to clog the equity of redemption. The context of default oers great opportunity for overreaching. The suspicious attitudes of the courts have been grounded in common sense. This section, like former Section 9-501(3), codies this long-standing and deeply rooted attitude. The specied rights of the debtor and duties of the secured party may not be waived or varied except as stated. Provisions that are not specied in this section are subject to the general rules in Section 1-102(3). 3. Nonwaivable Rights and Duties. This section revises former Section 9-501(3) by restricting the ability to waive or modify additional specied rights and duties: (i) duties under Section 9-207(b)(4)(C), which deals with the use and operation of consumer goods, (ii) the right to a response to a request for an accounting, concerning a list of collateral, or concerning a statement of account (Section 9-210), (iii) the duty to collect collateral in a commercially reasonable manner (Section 9-607), (iv) the implicit duty to refrain from a breach of the peace in taking possession of collateral under Section 9-609, (v) the duty to apply noncash proceeds of collection or disposition in a commercially reasonable manner (Sections 9-608 and 9-615), (vi) the right to a special method of calculating a surplus or deciency in certain dispositions to a secured party, a person related to secured party, or a secondary obligor (Section 9-615), (vii) the duty to give an explanation of the calculation of a surplus or deciency (Section 9-616), (viii) the right to limitations on the eectiveness of certain waivers (Section 9-624), and (ix) the right to hold a secured party liable for failure to comply with this Article (Sections 9-625 and 9-626). For clarity and consistency, this Article uses the term waive or vary instead of renounc[e] or modify[], which appeared in former Section 9-504(3). This section provides generally that the specied rights and duties may not be waived or varied. However, it does not restrict the ability of parties to agree to settle, compromise, or renounce claims for past conduct that may have constituted a violation or breach of those 1044

Art. 9

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rights and duties, even if the settlement involves an express waiver. 4. Waiver by Debtors and Obligors. The restrictions on waiver contained in this section apply to obligors as well as debtors. This resolves a question under former Article 9 as to whether secondary obligors, assuming that they were debtors for purposes of former Part 5, were permitted to waive, under the law of suretyship, rights and duties under that Part. 5. Certain Post-Default Waivers. Section 9-624 permits post-default waivers in limited circumstances. These waivers must be made in agreements that are authenticated. Under Section 1-201, an agreement means the bargain of the parties in fact. In considering waivers under Section 9-624 and analogous agreements in other contexts, courts should carefully scrutinize putative agreements that appear in records that also address many additional or unrelated matters.

9-603. Agreement on Standards Concerning Rights and Duties. (a) [Agreed standards.] The parties may determine by agreement the standards measuring the fulllment of the rights of a debtor or obligor and the duties of a secured party under a rule stated in Section 9-602 if the standards are not manifestly unreasonable. (b) [Agreed standards inapplicable to breach of peace.] Subsection (a) does not apply to the duty under Section 9-609 to refrain from breaching the peace. Ocial Comment
1. Source. Former Section 9-501(3). 2. Limitation on Ability to Set Standards. Subsection (a), like former Section 9-501(3), permits the parties to set standards for compliance with the rights and duties under this Part if the standards are not manifestly unreasonable. Under subsection (b), the parties are not permitted to set standards measuring fulllment of the secured party's duty to take collateral without breaching the peace.

9-604. Procedure if Security Agreement Covers Real Property or Fixtures. (a) [Enforcement: personal and real property.] If a security agreement covers both personal and real property, a secured party may proceed: (1) under this part as to the personal property without prejudicing any rights with respect to the real property; or (2) as to both the personal property and the real property in accordance with the rights with respect to the real property, in which case the other provisions of this part do not apply. (b) [Enforcement: xtures.] Subject to subsection (c), if a security agreement covers goods that are or become xtures, a secured party may proceed: (1) under this part; or (2) in accordance with the rights with respect to real property, in which case the other provisions of this part do not apply. (c) [Removal of xtures.] Subject to the other provisions of this part, if a secured party holding a security interest in xtures has priority over all owners and encumbrancers of the real property, the secured party, after default, may remove the collateral from the real property. (d) [Injury caused by removal.] A secured party that removes collateral shall promptly reimburse any encumbrancer or owner of the real property, other than the debtor, for the cost of repair of any physical injury
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caused by the removal. The secured party need not reimburse the encumbrancer or owner for any diminution in value of the real property caused by the absence of the goods removed or by any necessity of replacing them. A person entitled to reimbursement may refuse permission to remove until the secured party gives adequate assurance for the performance of the obligation to reimburse. Ocial Comment
1. Source. Former Sections 9-501(4), 9-313(8). 2. Real-Property-Related Collateral. The collateral in many transactions consists of both real and personal property. In the interest of simplicity, speed, and economy, subsection (a), like former Section 9-501(4), permits (but does not require) the secured party to proceed as to both real and personal property in accordance with its rights and remedies with respect to the real property. Subsection (a) also makes clear that a secured party who exercises rights under Part 6 with respect to personal property does not prejudice any rights under real-property law. This Article does not address certain other real-property-related problems. In a number of States, the exercise of remedies by a creditor who is secured by both real property and non-real property collateral is governed by special legal rules. For example, under some anti-deciency laws, creditors risk loss of rights against personal property collateral if they err in enforcing their rights against the real property. Under a one-form-of-action rule (or rule against splitting a cause of action), a creditor who judicially enforces a real property mortgage and does not proceed in the same action to enforce a security interest in personalty may (among other consequences) lose the right to proceed against the personalty. Although statutes of this kind create impediments to enforcement of security interests, this Article does not override these limitations under other law. 3. Fixtures. Subsection (b) is new. It makes clear that a security interest in xtures may be enforced either under real-property law or under any of the applicable provisions of Part 6, including sale or other disposition either before or after removal of the xtures (see subsection (c)). Subsection (b) also serves to overrule cases holding that a secured party's only remedy after default is the removal of the xtures from the real property. See, e.g., Maplewood Bank & Trust v. Sears, Roebuck & Co., 625 A.2d 537 (N.J. Super. Ct. App. Div. 1993). Subsection (c) generally follows former Section 9-313(8). It gives the secured party the right to remove xtures under certain circumstances. A secured party whose security interest in xtures has priority over owners and encumbrancers of the real property may remove the collateral from the real property. However, subsection (d) requires the secured party to reimburse any owner (other than the debtor) or encumbrancer for the cost of repairing any physical injury caused by the removal. This right to reimbursement is implemented by the last sentence of subsection (d), which gives the owner or encumbrancer a right to security or indemnity as a condition for giving permission to remove.

9-605. Unknown Debtor or Secondary Obligor. A secured party does not owe a duty based on its status as secured party: (1) to a person that is a debtor or obligor, unless the secured party knows: (A) that the person is a debtor or obligor; (B) the identity of the person; and (C) how to communicate with the person; or (2) to a secured party or lienholder that has led a nancing statement against a person, unless the secured party knows: (A) that the person is a debtor; and (B) the identity of the person.
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Secured Transactions

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Ocial Comment
1. Source. New. 2. Duties to Unknown Persons. This section relieves a secured party from duties owed to a debtor or obligor, if the secured party does not know about the debtor or obligor. Similarly, it relieves a secured party from duties owed to a secured party or lienholder who has led a nancing statement against the debtor, if the secured party does not know about the debtor. For example, a secured party may be unaware that the original debtor has sold the collateral subject to the security interest and that the new owner has become the debtor. If so, the secured party owes no duty to the new owner (debtor) or to a secured party who has led a nancing statement against the new owner. This section should be read in conjunction with the exculpatory provisions in Section 9-628. Note that it relieves a secured party not only from duties arising under this Article but also from duties arising under other law by virtue of the secured party's status as such under this Article, unless the other law otherwise provides.

9-606. Time of Default for Agricultural Lien. For purposes of this part, a default occurs in connection with an agricultural lien at the time the secured party becomes entitled to enforce the lien in accordance with the statute under which it was created. Ocial Comment
1. Source. New. 2. Time of Default. Remedies under this Part become available upon the debtor's default. See Section 9-601. This section explains when default occurs in the agriculturallien context. It requires one to consult the enabling statute to determine when the lienholder is entitled to enforce the lien.

9-607. Collection and Enforcement by Secured Party. (a) [Collection and enforcement generally.] If so agreed, and in any event after default, a secured party: (1) may notify an account debtor or other person obligated on collateral to make payment or otherwise render performance to or for the benet of the secured party; (2) may take any proceeds to which the secured party is entitled under Section 9-315; (3) may enforce the obligations of an account debtor or other person obligated on collateral and exercise the rights of the debtor with respect to the obligation of the account debtor or other person obligated on collateral to make payment or otherwise render performance to the debtor, and with respect to any property that secures the obligations of the account debtor or other person obligated on the collateral; (4) if it holds a security interest in a deposit account perfected by control under Section 9-104(a)(1), may apply the balance of the deposit account to the obligation secured by the deposit account; and (5) if it holds a security interest in a deposit account perfected by control under Section 9-104(a)(2) or (3), may instruct the bank to pay the balance of the deposit account to or for the benet of the secured party. (b) [Nonjudicial enforcement of mortgage.] If necessary to enable a secured party to exercise under subsection (a)(3) the right of a debtor to enforce a mortgage nonjudicially, the secured party may record in the ofce in which a record of the mortgage is recorded: (1) a copy of the security agreement that creates or provides for a security interest in the obligation secured by the mortgage; and
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(2) the secured party's sworn adavit in recordable form stating that: (A) a default has occurred; and (B) the secured party is entitled to enforce the mortgage nonjudicially. (c) [Commercially reasonable collection and enforcement.] A secured party shall proceed in a commercially reasonable manner if the secured party: (1) undertakes to collect from or enforce an obligation of an account debtor or other person obligated on collateral; and (2) is entitled to charge back uncollected collateral or otherwise to full or limited recourse against the debtor or a secondary obligor. (d) [Expenses of collection and enforcement.] A secured party may deduct from the collections made pursuant to subsection (c) reasonable expenses of collection and enforcement, including reasonable attorney's fees and legal expenses incurred by the secured party. (e) [Duties to secured party not aected.] This section does not determine whether an account debtor, bank, or other person obligated on collateral owes a duty to a secured party. Ocial Comment
1. Source. Former Section 9-502; subsections (b), (d), and (e) are new. 2. Collections: In General. Collateral consisting of rights to payment is not only the most liquid asset of a typical debtor's business but also is property that may be collected without any interruption of the debtor's business This situation is far dierent from that in which collateral is inventory or equipment, whose removal may bring the business to a halt. Furthermore, problems of valuation and identication, present with collateral that is tangible personal property, frequently are not as serious in the case of rights to payment and other intangible collateral. Consequently, this section, like former Section 9-502, recognizes that nancing through assignments of intangibles lacks many of the complexities that arise after default in other types of nancing. This section allows the assignee to liquidate collateral by collecting whatever may become due on the collateral, whether or not the method of collection contemplated by the security arrangement before default was direct (i.e., payment by the account debtor to the assignee, notication nancing) or indirect (i.e., payment by the account debtor to the assignor, nonnotication nancing). 3. Scope. The scope of this section is broader than that of former Section 9-502. It applies not only to collections from account debtors and obligors on instruments but also to enforcement more generally against all persons obligated on collateral. It explicitly provides for the secured party's enforcement of the debtor's rights in respect of the account debtor's (and other third parties') obligations and for the secured party's enforcement of supporting obligations with respect to those obligations. (Supporting obligations are components of the collateral under Section 9-203(f).) The rights of a secured party under subsection (a) include the right to enforce claims that the debtor may enjoy against others. For example, the claims might include a breach-of-warranty claim arising out of a defect in equipment that is collateral or a secured party's action for an injunction against infringement of a patent that is collateral. Those claims typically would be proceeds of original collateral under Section 9-315. 4. Collection and Enforcement Before Default. Like Part 6 generally, this section deals with the rights and duties of secured parties following default. However, as did former Section 9-502 with respect to collection rights, this section also applies to the collection and enforcement rights of secured parties even if a default has not occurred, as long as the debtor has so agreed. It is not unusual for debtors to agree that secured parties are entitled to collect and enforce rights against account debtors prior to default. 5. Collections by Junior Secured Party. A secured party who holds a security interest in a right to payment may exercise the right to collect and enforce under this section, even if the security interest is subordinate to a conicting security interest in the same 1048

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right to payment. Whether the junior secured party has priority in the collected proceeds depends on whether the junior secured party qualies for priority as a purchaser of an instrument (e.g., the account debtor's check) under Section 9-330(d), as a holder in due course of an instrument under Sections 3-305 and 9-331(a), or as a transferee of money under Section 9-332(a). See Sections 9-330, Comment 7; 9-331, Comment 5; and 9-332. 6. Relationship to Rights and Duties of Persons Obligated on Collateral. This section permits a secured party to collect and enforce obligations included in collateral in its capacity as a secured party. It is not necessary for a secured party rst to become the owner of the collateral pursuant to a disposition or acceptance. However, the secured party's rights, as between it and the debtor, to collect from and enforce collateral against account debtors and others obligated on collateral under subsection (a) are subject to Section 9-341, Part 4, and other applicable law. Neither this section nor former Section 9-502 should be understood to regulate the duties of an account debtor or other person obligated on collateral. Subsection (e) makes this explicit. For example, the secured party may be unable to exercise the debtor's rights under an instrument if the debtor is in possession of the instrument, or under a non-transferable letter of credit if the debtor is the beneciary. Unless a secured party has control over a letter-of-credit right and is entitled to receive payment or performance from the issuer or a nominated person under Article 5, its remedies with respect to the letter-of-credit right may be limited to the recovery of any identiable proceeds from the debtor. This section establishes only the baseline rights of the secured party vis-a-vis the debtorthe secured party is entitled to enforce and collect after default or earlier if so agreed. 7. Deposit Account Collateral. Subsections (a)(4) and (5) set forth the self-help remedy for a secured party whose collateral is a deposit account. Subsection (a)(4) addresses the rights of a secured party that is the bank with which the deposit account is maintained. That secured party automatically has control of the deposit account under Section 9-104(a) (1). After default, and otherwise if so agreed, the bank/secured party may apply the funds on deposit to the secured obligation. If a security interest of a third party is perfected by control (Section 9-104(a)(2) or (a)(3)), then after default, and otherwise if so agreed, the secured party may instruct the bank to pay out the funds in the account. If the third party has control under Section 9-104(a)(3), the depositary institution is obliged to obey the instruction because the secured party is its customer. See Section 4-401. If the third party has control under Section 9-104(a)(2), the control agreement determines the depositary institution's obligation to obey. If a security interest in a deposit account is unperfected, or is perfected by ling by virtue of the proceeds rules of Section 9-315, the depositary institution ordinarily owes no obligation to obey the secured party's instructions. See Section 9-341. To reach the funds without the debtor's cooperation, the secured party must use an available judicial procedure. 8. Rights Against Mortgagor of Real Property. Subsection (b) addresses the situation in which the collateral consists of a mortgage note (or other obligation secured by a mortgage on real property). After the debtor's (mortgagee's) default, the secured party (assignee) may wish to proceed with a nonjudicial foreclosure of the mortgage securing the note but may be unable to do so because it has not become the assignee of record. The assignee/secured party may not have taken a recordable assignment at the commencement of the transaction (perhaps the mortgage note in question was one of hundreds assigned to the secured party as collateral). Having defaulted, the mortgagee may be unwilling to sign a recordable assignment. This section enables the secured party (assignee) to become the assignee of record by recording in the applicable real-property records the security agreement and an adavit certifying default. Of course, the secured party's rights derive from those of its debtor. Subsection (b) would not entitle the secured party to proceed with a foreclosure unless the mortgagor also were in default or the debtor (mortgagee) otherwise enjoyed the right to foreclose. 9. Commercial Reasonableness. Subsection (c) provides that the secured party's collection and enforcement rights under subsection (a) must be exercised in a commercially reasonable manner. These rights include the right to settle and compromise claims against the account debtor. The secured party's failure to observe the standard of commercial reasonableness could render it liable to an aggrieved person under Section 9-625, and the secured party's recovery of a deciency would be subject to Section 9-626. Subsection (c) does not apply if, as is characteristic of most sales of accounts, chattel paper, payment intangibles, and promissory notes, the secured party (buyer) has no right of recourse 1049

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against the debtor (seller) or a secondary obligor. However, if the secured party does have a right of recourse, the commercial-reasonableness standard applies to collection and enforcement even though the assignment to the secured party was a true sale. The obligation to proceed in a commercially reasonable manner arises because the collection process aects the extent of the seller's recourse liability, not because the seller retains an interest in the sold collateral (the seller does not). Concerning classication of a transaction, see Section 9-109, Comment 4. 10. Attorney's Fees and Legal Expenses. The phrase reasonable attorney's fees and legal expenses, which appears in subsection (d), includes only those fees and expenses incurred in proceeding against account debtors or other third parties. The secured party's right to recover these expenses from the collections arises automatically under this section. The secured party also may incur other attorney's fees and legal expenses in proceeding against the debtor or obligor. Whether the secured party has a right to recover those fees and expenses depends on whether the debtor or obligor has agreed to pay them, as is the case with respect to attorney's fees and legal expenses under Sections 9-608(a)(1)(A) and 9-615(a)(1). The parties also may agree to allocate a portion of the secured party's overhead to collection and enforcement under subsection (d) or Section 9-608(a).

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

9-608. Application of Proceeds of Collection or Enforcement; Liability for Deciency and Right to Surplus. (a) [Application of proceeds, surplus, and deciency if obligation secured.] If a security interest or agricultural lien secures payment or performance of an obligation, the following rules apply: (1) A secured party shall apply or pay over for application the cash proceeds of collection or enforcement under Section 9-607 in the following order to: (A) the reasonable expenses of collection and enforcement and, to the extent provided for by agreement and not prohibited by law, reasonable attorney's fees and legal expenses incurred by the secured party; (B) the satisfaction of obligations secured by the security interest or agricultural lien under which the collection or enforcement is made; and (C) the satisfaction of obligations secured by any subordinate security interest in or other lien on the collateral subject to the security interest or agricultural lien under which the collection or enforcement is made if the secured party receives an authenticated demand for proceeds before distribution of the proceeds is completed. (2) If requested by a secured party, a holder of a subordinate security interest or other lien shall furnish reasonable proof of the interest or lien within a reasonable time. Unless the holder complies, the secured party need not comply with the holder's demand under paragraph (1)(C). (3) A secured party need not apply or pay over for application noncash proceeds of collection and enforcement under Section 9-607 unless the failure to do so would be commercially unreasonable. A secured party that applies or pays over for application noncash proceeds shall do so in a commercially reasonable manner. (4) A secured party shall account to and pay a debtor for any surplus, and the obligor is liable for any deciency.
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(b) [No surplus or deciency in sales of certain rights to payment.] If the underlying transaction is a sale of accounts, chattel paper, payment intangibles, or promissory notes, the debtor is not entitled to any surplus, and the obligor is not liable for any deciency. As amended in 2000.
See Appendix P for material relating to changes made in text in 2000.

Ocial Comment
1. Source. Subsection (a) is new; subsection (b) derives from former Section 9-502(2). 2. Modications of Prior Law. Subsections (a) and (b) modify former Section 9-502(2) by explicitly providing for the application of proceeds recovered by the secured party in substantially the same manner as provided in Section 9-615(a) and (e) for dispositions of collateral. 3. Surplus and Deciency. Subsections (a)(4) and (b) omit, as unnecessary, the references contained in former Section 9-502(2) to agreements varying the baseline rules on surplus and deciency. The parties are always free to agree that an obligor will not be liable for a deciency, even if the collateral secures an obligation, and that an obligor is liable for a deciency, even if the transaction is a sale of receivables. For parallel provisions, see Section 9-615(d) and (e). 4. Noncash Proceeds. Subsection (a)(3) addresses the situation in which an enforcing secured party receives noncash proceeds. Example: An enforcing secured party receives a promissory note from an account debtor who is unable to pay an account when it is due. The secured party accepts the note in exchange for extending the date on which the account debtor's obligation is due. The secured party may wish to credit its debtor (the assignor) with the principal amount of the note upon receipt of the note, but probably will prefer to credit the debtor only as and when the note is paid. Under subsection (a)(3), the secured party is under no duty to apply the note or its value to the outstanding obligation unless its failure to do so would be commercially unreasonable. If the secured party does apply the note to the outstanding obligation, however, it must do so in a commercially reasonable manner. The parties may provide for the method of application of noncash proceeds by agreement, if the method is not manifestly unreasonable. See Section 9-603. This section does not explain when the failure to apply noncash proceeds would be commercially unreasonable; it leaves that determination to case-by-case adjudication. In the example, the secured party appears to have accepted the account debtor's note in order to increase the likelihood of payment and decrease the likelihood that the account debtor would dispute its obligation. Under these circumstances, it may well be commercially reasonable for the secured party to credit its debtor's obligations only as and when cash proceeds are collected from the account debtor, especially given the uncertainty that attends the account debtor's eventual payment. For an example of a secured party's receipt of noncash proceeds in which it may well be commercially unreasonable for the secured party to delay crediting its debtor's obligations with the value of noncash proceeds, see Section 9-615, Comment 3. When the secured party is not required to apply or pay over for application noncash proceeds, the proceeds nonetheless remain collateral subject to this Article. If the secured party were to dispose of them, for example, appropriate notication would be required (see Section 9-611), and the disposition would be subject to the standards provided in this Part (see Section 9-610). Moreover, a secured party in possession of the noncash proceeds would have the duties specied in Section 9-207. 5. No Eect on Priority of Senior Security Interest. The application of proceeds required by subsection (a) does not aect the priority of a security interest in collateral which is senior to the interest of the secured party who is collecting or enforcing collateral under Section 9-607. Although subsection (a) imposes a duty to apply proceeds to the enforcing secured party's expenses and to the satisfaction of the secured obligations owed to it and to subordinate secured parties, that duty applies only among the enforcing secured party and those persons. Concerning the priority of a junior secured party who collects and enforces collateral, see Section 9-607, Comment 5. 1051

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Uniform Commercial Code

Art. 9

9-609. Secured Party's Right to Take Possession After Default. (a) [Possession; rendering equipment unusable; disposition on debtor's premises.] After default, a secured party: (1) may take possession of the collateral; and (2) without removal, may render equipment unusable and dispose of collateral on a debtor's premises under Section 9-610. (b) [Judicial and nonjudicial process.] A secured party may proceed under subsection (a): (1) pursuant to judicial process; or (2) without judicial process, if it proceeds without breach of the peace. (c) [Assembly of collateral.] If so agreed, and in any event after default, a secured party may require the debtor to assemble the collateral and make it available to the secured party at a place to be designated by the secured party which is reasonably convenient to both parties. Ocial Comment
1. Source. Former Section 9-503. 2. Secured Party's Right to Possession. This section follows former Section 9-503 and earlier uniform legislation. It provides that the secured party is entitled to take possession of collateral after default. 3. Judicial Process; Breach of Peace. Subsection (b) permits a secured party to proceed under this section without judicial process if it does so without breach of the peace. Although former Section 9-503 placed the same condition on a secured party's right to take possession of collateral, subsection (b) extends the condition to the right provided in subsection (a)(2) as well. Like former Section 9-503, this section does not dene or explain the conduct that will constitute a breach of the peace, leaving that matter for continuing development by the courts. In considering whether a secured party has engaged in a breach of the peace, however, courts should hold the secured party responsible for the actions of others taken on the secured party's behalf, including independent contractors engaged by the secured party to take possession of collateral. This section does not authorize a secured party who repossesses without judicial process to utilize the assistance of a law-enforcement ocer. A number of cases have held that a repossessing secured party's use of a law-enforcement ocer without benet of judicial process constituted a failure to comply with former Section 9-503. 4. Damages for Breach of Peace. Concerning damages that may be recovered based on a secured party's breach of the peace in connection with taking possession of collateral, see Section 9-625, Comment 3. 5. Multiple Secured Parties. More than one secured party may be entitled to take possession of collateral under this section. Conicting rights to possession among secured parties are resolved by the priority rules of this Article. Thus, a senior secured party is entitled to possession as against a junior claimant. Non-UCC law governs whether a junior secured party in possession of collateral is liable to the senior in conversion. Normally, a junior who refuses to relinquish possession of collateral upon the demand of a secured party having a superior possessory right to the collateral would be liable in conversion. 6. Secured Party's Right to Disable and Dispose of Equipment on Debtor's Premises. In the case of some collateral, such as heavy equipment, the physical removal from the debtor's plant and the storage of the collateral pending disposition may be impractical or unduly expensive. This section follows former Section 9-503 by providing that, in lieu of removal, the secured party may render equipment unusable or may dispose of collateral on the debtor's premises. Unlike former Section 9-503, however, this section explicitly conditions these rights on the debtor's default. Of course, this section does not validate unreasonable action by a secured party. Under Section 9-610, all aspects of a disposition must be commercially reasonable. 7. Debtor's Agreement to Assemble Collateral. This section follows former Section 9-503 also by validating a debtor's agreement to assemble collateral and make it available to a secured party at a place that the secured party designates. Similar to the treatment of 1052

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agreements to permit collection prior to default under Section 9-607 and former 9-502, however, this section validates these agreements whether or not they are conditioned on the debtor's default. For example, a debtor might agree to make available to a secured party, from time to time, any instruments or negotiable documents that the debtor receives on account of collateral. A court should not infer from this section's validation that a debtor's agreement to assemble and make available collateral would not be enforceable under other applicable law. 8. Agreed Standards. Subject to the limitation imposed by Section 9-603(b), this section's provisions concerning agreements to assemble and make available collateral and a secured party's right to disable equipment and dispose of collateral on a debtor's premises are likely topics for agreement on standards as contemplated by Section 9-603.

9-610. Disposition of Collateral After Default. (a) [Disposition after default.] After default, a secured party may sell, lease, license, or otherwise dispose of any or all of the collateral in its present condition or following any commercially reasonable preparation or processing. (b) [Commercially reasonable disposition.] Every aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable. If commercially reasonable, a secured party may dispose of collateral by public or private proceedings, by one or more contracts, as a unit or in parcels, and at any time and place and on any terms. (c) [Purchase by secured party.] A secured party may purchase collateral: (1) at a public disposition; or (2) at a private disposition only if the collateral is of a kind that is customarily sold on a recognized market or the subject of widely distributed standard price quotations. (d) [Warranties on disposition.] A contract for sale, lease, license, or other disposition includes the warranties relating to title, possession, quiet enjoyment, and the like which by operation of law accompany a voluntary disposition of property of the kind subject to the contract. (e) [Disclaimer of warranties.] A secured party may disclaim or modify warranties under subsection (d): (1) in a manner that would be eective to disclaim or modify the warranties in a voluntary disposition of property of the kind subject to the contract of disposition; or (2) by communicating to the purchaser a record evidencing the contract for disposition and including an express disclaimer or modication of the warranties. (f) [Record sucient to disclaim warranties.] A record is sucient to disclaim warranties under subsection (e) if it indicates There is no warranty relating to title, possession, quiet enjoyment, or the like in this disposition or uses words of similar import. Ocial Comment
1. Source. Former Section 9-504(1), (3) 2. Commercially Reasonable Dispositions. Subsection (a) follows former Section 9-504 by permitting a secured party to dispose of collateral in a commercially reasonable manner following a default. Although subsection (b) permits both public and private dispositions, every aspect of a disposition . . . must be commercially reasonable. This section en1053

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courages private dispositions on the assumption that they frequently will result in higher realization on collateral for the benet of all concerned. Subsection (a) does not restrict dispositions to sales; collateral may be sold, leased, licensed, or otherwise disposed. Section 9-627 provides guidance for determining the circumstances under which a disposition is commercially reasonable. 3. Time of Disposition. This Article does not specify a period within which a secured party must dispose of collateral. This is consistent with this Article's policy to encourage private dispositions through regular commercial channels. It may, for example, be prudent not to dispose of goods when the market has collapsed. Or, it might be more appropriate to sell a large inventory in parcels over a period of time instead of in bulk. Of course, under subsection (b) every aspect of a disposition of collateral must be commercially reasonable. This requirement explicitly includes the method, manner, time, place and other terms. For example, if a secured party does not proceed under Section 9-620 and holds collateral for a long period of time without disposing of it, and if there is no good reason for not making a prompt disposition, the secured party may be determined not to have acted in a commercially reasonable manner. See also Section 1-203 (general obligation of good faith). 4. Pre-Disposition Preparation and Processing. Former Section 9-504(1) appeared to give the secured party the choice of disposing of collateral either in its then condition or following any commercially reasonable preparation or processing. Some courts held that the commercially reasonable standard of former Section 9-504(3) nevertheless could impose an armative duty on the secured party to process or prepare the collateral prior to disposition. Subsection (a) retains the substance of the quoted language. Although courts should not be quick to impose a duty of preparation or processing on the secured party, subsection (a) does not grant the secured party the right to dispose of the collateral in its then condition under all circumstances. A secured party may not dispose of collateral in its then condition when, taking into account the costs and probable benets of preparation or processing and the fact that the secured party would be advancing the costs at its risk, it would be commercially unreasonable to dispose of the collateral in that condition. 5. Disposition by Junior Secured Party. Disposition rights under subsection (a) are not limited to rst-priority security interests. Rather, any secured party as to whom there has been a default enjoys the right to dispose of collateral under this subsection. The exercise of this right by a secured party whose security interest is subordinate to that of another secured party does not of itself constitute a conversion or otherwise give rise to liability in favor of the holder of the senior security interest. Section 9-615 addresses application of the proceeds of a disposition by a junior secured party. Under Section 9-615(a), a junior secured party owes no obligation to apply the proceeds of disposition to the satisfaction of obligations secured by a senior security interest. Section 9-615(g) builds on this general rule by protecting certain juniors from claims of a senior concerning cash proceeds of the disposition. Even if a senior were to have a non-Article 9 claim to proceeds of a junior's disposition, Section 9-615(g) would protect a junior that acts in good faith and without knowledge that its actions violate the rights of a senior party. Because the disposition by a junior would not cut o a senior's security interest or other lien (see Section 9-617), in many (probably most) cases the junior's receipt of the cash proceeds would not violate the rights of the senior. The holder of a senior security interest is entitled, by virtue of its priority, to take possession of collateral from the junior secured party and conduct its own disposition, provided that the senior enjoys the right to take possession of the collateral from the debtor. See Section 9-609. The holder of a junior security interest normally must notify the senior secured party of an impending disposition. See Section 9-611. Regardless of whether the senior receives a notication from the junior, the junior's disposition does not of itself discharge the senior's security interest. See Section 9-617. Unless the senior secured party has authorized the disposition free and clear of its security interest, the senior's security interest ordinarily will survive the disposition by the junior and continue under Section 9-315(a). If the senior enjoys the right to repossess the collateral from the debtor, the senior likewise may recover the collateral from the transferee. When a secured party's collateral is encumbered by another security interest or other lien, one of the claimants may seek to invoke the equitable doctrine of marshaling. As explained by the Supreme Court, that doctrine rests upon the principle that a creditor having two funds to satisfy his debt, may not by his application of them to his demand, defeat another creditor, who may resort to only one of the funds. Meyer v. United States, 1054

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375 U.S. 233, 236 (1963), quoting Sowell v. Federal Reserve Bank, 268 U.S. 449, 45657 (1925). The purpose of the doctrine is to prevent the arbitrary action of a senior lienor from destroying the rights of a junior lienor or a creditor having less security. Id. at 237. Because it is an equitable doctrine, marshaling is applied only when it can be equitably fashioned as to all of the parties having an interest in the property. Id. This Article leaves courts free to determine whether marshaling is appropriate in any given case. See Section 1-103. 6. Security Interests of Equal Rank. Sometimes two security interests enjoy the same priority. This situation may arise by contract, e.g., pursuant to equal and ratable provisions in indentures, or by operation of law. See Section 9-328(6). This Article treats a security interest having equal priority like a senior security interest in many respects. Assume, for example, that SP-X and SP-Y enjoy equal priority, SP-W is senior to them, and SP-Z is junior. If SP-X disposes of the collateral under this section, then (i) SP-W's and SP-Y's security interests survive the disposition but SP-Z's does not, see Section 9-617, and (ii) neither SP-W nor SP-Y is entitled to receive a distribution of proceeds, but SP-Z is. See Section 9-615(a)(3). When one considers the ability to obtain possession of the collateral, a secured party with equal priority is unlike a senior secured party. As the senior secured party, SP-W should enjoy the right to possession as against SP-X. See Section 9-609, Comment 5. If SP-W takes possession and disposes of the collateral under this section, it is entitled to apply the proceeds to satisfy its secured claim. SP-Y, however, should not have such a right to take possession from SP-X; otherwise, once SP-Y took possession from SP-X, SP-X would have the right to get possession from SP-Y, which would be obligated to redeliver possession to SP-X, and so on. Resolution of this problem is left to the parties and, if necessary, the courts. 7. Public vs. Private Dispositions. This Part maintains two distinctions between public and other dispositions: (i) the secured party may buy at the former, but normally not at the latter (Section 9-610(c)), and (ii) the debtor is entitled to notication of the time and place of a public disposition and notication of the time after which a private disposition or other intended disposition is to be made (Section 9-613(1)(E)). It does not retain the distinction under former Section 9-504(4), under which transferees in a noncomplying public disposition could lose protection more easily than transferees in other noncomplying dispositions. Instead, Section 9-617(b) adopts a unitary standard. Although the term is not dened, as used in this Article, a public disposition is one at which the price is determined after the public has had a meaningful opportunity for competitive bidding. Meaningful opportunity is meant to imply that some form of advertisement or public notice must precede the sale (or other disposition) and that the public must have access to the sale (disposition). 8. Investment Property. Dispositions of investment property may be regulated by the federal securities laws. Although a public disposition of securities under this Article may implicate the registration requirements of the Securities Act of 1933, it need not do so. A disposition that qualies for a private placement exemption under the Securities Act of 1933 nevertheless may constitute a public disposition within the meaning of this section. Moreover, the commercially reasonable requirements of subsection (b) need not prevent a secured party from conducting a foreclosure sale without the issuer's compliance with federal registration requirements. 9. Recognized Market. A recognized market, as used in subsection (c) and Section 9-611(d), is one in which the items sold are fungible and prices are not subject to individual negotiation. For example, the New York Stock Exchange is a recognized market. A market in which prices are individually negotiated or the items are not fungible is not a recognized market, even if the items are the subject of widely disseminated price guides or are disposed of through dealer auctions. 10. Relevance of Price. While not itself sucient to establish a violation of this Part, a low price suggests that a court should scrutinize carefully all aspects of a disposition to ensure that each aspect was commercially reasonable. Note also that even if the disposition is commercially reasonable, Section 9-615(f) provides a special method for calculating a deciency or surplus if (i) the transferee in the disposition is the secured party, a person related to the secured party, or a secondary obligor, and (ii) the amount of proceeds of the disposition is signicantly below the range of proceeds that a complying disposition to a person other than the secured party, a person related to the secured party, or a secondary obligor would have brought. 1055

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11. Warranties. Subsection (d) aords the transferee in a disposition under this section the benet of any title, possession, quiet enjoyment, and similar warranties that would have accompanied the disposition by operation of non-Article 9 law had the disposition been conducted under other circumstances. For example, the Article 2 warranty of title would apply to a sale of goods, the analogous warranties of Article 2A would apply to a lease of goods, and any common-law warranties of title would apply to dispositions of other types of collateral. See, e.g., Restatement (2d), Contracts 333 (warranties of assignor). Subsection (e) explicitly provides that these warranties can be disclaimed either under other applicable law or by communicating a record containing an express disclaimer. The record need not be written, but an oral communication would not be sucient. See Section 9-102 (denition of record). Subsection (f) provides a sample of wording that will effectively exclude the warranties in a disposition under this section, whether or not the exclusion would be eective under non-Article 9 law. The warranties incorporated by subsection (d) are those relating to title, possession, quiet enjoyment, and the like. Depending on the circumstances, a disposition under this section also may give rise to other statutory or implied warranties, e.g., warranties of quality or tness for purpose. Law other than this Article determines whether such other warranties apply to a disposition under this section. Other law also determines issues relating to disclaimer of such warranties. For example, a foreclosure sale of a car by a car dealer could give rise to an implied warranty of merchantability (Section 2-314) unless eectively disclaimed or modied (Section 2-316). This section's approach to these warranties conicts with the former Comment to Section 2-312. This Article rejects the baseline assumption that commercially reasonable dispositions under this section are out of the ordinary commercial course or peculiar. The Comment to Section 2-312 has been revised accordingly.

9-611. Notication Before Disposition of Collateral. (a) [Notication date.] In this section, notication date means the earlier of the date on which: (1) a secured party sends to the debtor and any secondary obligor an authenticated notication of disposition; or (2) the debtor and any secondary obligor waive the right to notication. (b) [Notication of disposition required.] Except as otherwise provided in subsection (d), a secured party that disposes of collateral under Section 9-610 shall send to the persons specied in subsection (c) a reasonable authenticated notication of disposition. (c) [Persons to be notied.] To comply with subsection (b), the secured party shall send an authenticated notication of disposition to: (1) the debtor; (2) any secondary obligor; and (3) if the collateral is other than consumer goods: (A) any other person from which the secured party has received, before the notication date, an authenticated notication of a claim of an interest in the collateral; (B) any other secured party or lienholder that, 10 days before the notication date, held a security interest in or other lien on the collateral perfected by the ling of a nancing statement that: (i) identied the collateral; (ii) was indexed under the debtor's name as of that date; and (iii) was led in the oce in which to le a nancing statement against the debtor covering the collateral as of that date; and (C) any other secured party that, 10 days before the notication
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date, held a security interest in the collateral perfected by compliance with a statute, regulation, or treaty described in Section 9-311(a). (d) [Subsection (b) inapplicable: perishable collateral; recognized market.] Subsection (b) does not apply if the collateral is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market. (e) [Compliance with subsection (c)(3)(B).] A secured party complies with the requirement for notication prescribed by subsection (c)(3)(B) if: (1) not later than 20 days or earlier than 30 days before the notication date, the secured party requests, in a commercially reasonable manner, information concerning nancing statements indexed under the debtor's name in the oce indicated in subsection (c)(3)(B); and (2) before the notication date, the secured party: (A) did not receive a response to the request for information; or (B) received a response to the request for information and sent an authenticated notication of disposition to each secured party or other lienholder named in that response whose nancing statement covered the collateral. Ocial Comment
1. Source. Former Section 9-504(3). 2. Reasonable Notication. This section requires a secured party who wishes to dispose of collateral under Section 9-610 to send a reasonable authenticated notication of disposition to specied interested persons, subject to certain exceptions. The notication must be reasonable as to the manner in which it is sent, its timeliness (i.e., a reasonable time before the disposition is to take place), and its content. See Sections 9-612 (timeliness of notication), 9-613 (contents of notication generally), 9-614 (contents of notication in consumergoods transactions). 3. Notication to Debtors and Secondary Obligors. This section imposes a duty to send notication of a disposition not only to the debtor but also to any secondary obligor. Subsections (b) and (c) resolve an uncertainty under former Article 9 by providing that secondary obligors (sureties) are entitled to receive notication of an intended disposition of collateral, regardless of who created the security interest in the collateral. If the surety created the security interest, it would be the debtor. If it did not, it would be a secondary obligor. (This Article also resolves the question of the secondary obligor's ability to waive, pre-default, the right to noticationwaiver generally is not permitted. See Section 9-602.) Section 9-605 relieves a secured party from any duty to send notication to a debtor or secondary obligor unknown to the secured party. Under subsection (b), the principal obligor (borrower) is not always entitled to notication of disposition. Example: Behnfeldt borrows on an unsecured basis, and Bruno grants a security interest in her car to secure the debt. Behnfeldt is a primary obligor, not a secondary obligor. As such, she is not entitled to notication of disposition under this section. 4. Notication to Other Secured Parties. Prior to the 1972 amendments to Article 9, former Section 9-504(3) required the enforcing secured party to send reasonable notication of the disposition:
except in the case of consumer goods to any other person who has a security interest in the collateral and who has duly led a nancing statement indexed in the name of the debtor in this State or who is known by the secured party to have a security interest in the collateral.

The 1972 amendments eliminated the duty to give notice to secured parties other than those from whom the foreclosing secured party had received written notice of a claim of an interest in the collateral. Many of the problems arising from dispositions of collateral encumbered by multiple security interests can be ameliorated or solved by informing all secured parties of an intended disposition and aording them the opportunity to work with one another. To this end, 1057

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subsection (c)(3)(B) expands the duties of the foreclosing secured party to include the duty to notify (and the corresponding burden of searching the les to discover) certain competing secured parties. The subsection imposes a search burden that in some cases may be greater than the pre-1972 burden on foreclosing secured parties but certainly is more modest than that faced by a new secured lender. To determine who is entitled to notication, the foreclosing secured party must determine the proper oce for ling a nancing statement as of a particular date, measured by reference to the notication date, as dened in subsection (a). This determination requires reference to the choice-of-law provisions of Part 3. The secured party must ascertain whether any nancing statements covering the collateral and indexed under the debtor's name, as the name existed as of that date, in fact were led in that oce. The foreclosing secured party generally need not notify secured parties whose eective nancing statements have become more dicult to locate because of changes in the location of the debtor, proceeds rules, or changes in the debtor's name. Under subsection (c)(3)(C), the secured party also must notify a secured party who has perfected a security interest by complying with a statute or treaty described in Section 9-311(a), such as a certicate-of-title statute. Subsection (e) provides a safe harbor that takes into account the delays that may be attendant to receiving information from the public ling oces. It provides, generally, that the secured party will be deemed to have satised its notication duty under subsection (c)(3)(B) if it requests a search from the proper oce at least 20 but not more than 30 days before sending notication to the debtor and if it also sends a notication to all secured parties (and other lienholders) reected on the search report. The secured party's duty under subsection (c)(3)(B) also will be satised if the secured party requests but does not receive a search report before the notication is sent to the debtor. Thus, if subsection (e) applies, a secured party who is entitled to notication under subsection (c)(3)(B) has no remedy against a foreclosing secured party who does not send the notication. The foreclosing secured party has complied with the notication requirement. Subsection (e) has no eect on the requirements of the other paragraphs of subsection (c). For example, if the foreclosing secured party received a notication from the holder of a conicting security interest in accordance with subsection (c)(3)(A) but failed to send to the holder a notication of the disposition, the holder of the conicting security interest would have the right to recover any loss under Section 9-625(b). 5. Authentication Requirement. Subsections (b) and (c) explicitly provide that a notication of disposition must be authenticated. Some cases read former Section 9-504(3) as validating oral notication. 6. Second Try. This Article leaves to judicial resolution, based upon the facts of each case, the question whether the requirement of reasonable notication requires a second try, i.e., whether a secured party who sends notication and learns that the debtor did not receive it must attempt to locate the debtor and send another notication. 7. Recognized Market; Perishable Collateral. New subsection (d) makes it clear that there is no obligation to give notication of a disposition in the case of perishable collateral or collateral customarily sold on a recognized market (e.g., marketable securities). Former Section 9-504(3) might be read (incorrectly) to relieve the secured party from its duty to notify a debtor but not from its duty to notify other secured parties in connection with dispositions of such collateral. 8. Failure to Conduct Notied Disposition. Nothing in this Article prevents a secured party from electing not to conduct a disposition after sending a notication. Nor does this Article prevent a secured party from electing to send a revised notication if its plans for disposition change. This assumes, however, that the secured party acts in good faith, the revised notication is reasonable, and the revised plan for disposition and any attendant delay are commercially reasonable. 9. Waiver. A debtor or secondary obligor may waive the right to notication under this section only by a post-default authenticated agreement. See Section 9-624(a).

9-612. Timeliness of Notication Before Disposition of Collateral. (a) [Reasonable time is question of fact.] Except as otherwise provided in subsection (b), whether a notication is sent within a reasonable time is a question of fact.
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(b) [10-day period sucient in non-consumer transaction.] In a transaction other than a consumer transaction, a notication of disposition sent after default and 10 days or more before the earliest time of disposition set forth in the notication is sent within a reasonable time before the disposition. Ocial Comment
1. Source. New. 2. Reasonable Notication. Section 9-611(b) requires the secured party to send a reasonable authenticated notication. Under that section, as under former Section 9-504(3), one aspect of a reasonable notication is its timeliness. This generally means that the notication must be sent at a reasonable time in advance of the date of a public disposition or the date after which a private disposition is to be made. A notication that is sent so near to the disposition date that a notied person could not be expected to act on or take account of the notication would be unreasonable. 3. Timeliness of Notication: Safe Harbor. The 10-day notice period in subsection (b) is intended to be a safe harbor and not a minimum requirement. To qualify for the safe harbor the notication must be sent after default. A notication also must be sent in a commercially reasonable manner. See Section 9-611(b) (reasonable authenticated notication). These requirements prevent a secured party from taking advantage of the safe harbor by, for example, giving the debtor a notication at the time of the original extension of credit or sending the notice by surface mail to a debtor overseas.

9-613. Contents and Form of Notication Before Disposition of Collateral: General. Except in a consumer-goods transaction, the following rules apply: (1) The contents of a notication of disposition are sucient if the notication: (A) describes the debtor and the secured party; (B) describes the collateral that is the subject of the intended disposition; (C) states the method of intended disposition; (D) states that the debtor is entitled to an accounting of the unpaid indebtedness and states the charge, if any, for an accounting; and (E) states the time and place of a public disposition or the time after which any other disposition is to be made. (2) Whether the contents of a notication that lacks any of the information specied in paragraph (1) are nevertheless sucient is a question of fact. (3) The contents of a notication providing substantially the information specied in paragraph (1) are sucient, even if the notication includes: (A) information not specied by that paragraph; or (B) minor errors that are not seriously misleading. (4) A particular phrasing of the notication is not required. (5) The following form of notication and the form appearing in Section 9-614(3), when completed, each provides sucient information: NOTIFICATION OF DISPOSITION OF COLLATERAL To: [Name of debtor, obligor, or other person to which the notication is sent]
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From: [Name, address, and telephone number of secured party] Name of Debtor(s): [Include only if debtor(s) are not an addressee] [For a public disposition:] We will sell [or lease or license, as applicable] the [describe collateral] [to the highest qualied bidder] in public as follows: Day and Date: Time: Place: [For a private disposition:] We will sell [or lease or license, as applicable] the [describe collateral] privately sometime after [day and date]. You are entitled to an accounting of the unpaid indebtedness secured by the property that we intend to sell [or lease or license, as applicable] [for a charge of $ ]. You may request an accounting by calling us at [telephone number] [End of Form] As amended in 2000.
See Appendix P for material relating to changes made in text in 2000.

Ocial Comment
1. Source. New. 2. Contents of Notication. To comply with the reasonable authenticated notication requirement of Section 9-611(b), the contents of a notication must be reasonable. Except in a consumer-goods transaction, the contents of a notication that includes the information set forth in paragraph (1) are sucient as a matter of law, unless the parties agree otherwise. (The reference to time of disposition means here, as it did in former Section 9-504(3), not only the hour of the day but also the date.) Although a secured party may choose to include additional information concerning the transaction or the debtor's rights and obligations, no additional information is required unless the parties agree otherwise. A notication that lacks some of the information set forth in paragraph (1) nevertheless may be sucient if found to be reasonable by the trier of fact, under paragraph (2). A properly completed sample form of notication in paragraph (5) or in Section 9-614(a)(3) is an example of a notication that would contain the information set forth in paragraph (1). Under paragraph (4), however, no particular phrasing of the notication is required.

9-614. Contents and Form of Notication Before Disposition of Collateral: Consumer-Goods Transaction. In a consumer-goods transaction, the following rules apply: (1) A notication of disposition must provide the following information: (A) the information specied in Section 9-613(1); (B) a description of any liability for a deciency of the person to which the notication is sent; (C) a telephone number from which the amount that must be paid to the secured party to redeem the collateral under Section 9-623 is available; and (D) a telephone number or mailing address from which additional information concerning the disposition and the obligation secured is available. (2) A particular phrasing of the notication is not required.
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(3) The following form of notication, when completed, provides sufcient information: [Name and address of secured party] [Date] NOTICE OF OUR PLAN TO SELL PROPERTY [Name and address of any obligor who is also a debtor] Subject: [Identication of Transaction] We have your [describe collateral], because you broke promises in our agreement. [For a public disposition:] We will sell [describe collateral] at public sale. A sale could include a lease or license. The sale will be held as follows: Date: Time: Place: You may attend the sale and bring bidders if you want. [For a private disposition:] We will sell [describe collateral] at private sale sometime after [date]. A sale could include a lease or license. The money that we get from the sale (after paying our costs) will reduce the amount you owe. If we get less money than you owe, you [will or will not, as applicable] still owe us the dierence. If we get more money than you owe, you will get the extra money, unless we must pay it to someone else. You can get the property back at any time before we sell it by paying us the full amount you owe (not just the past due payments), including our expenses. To learn the exact amount you must pay, call us at [telephone number]. If you want us to explain to you in writing how we have gured the amount that you owe us, you may call us at [telephone number] [or write us at [secured party's address]] and request a written explanation. [We will charge you $for the explanation if we sent you another written explanation of the amount you owe us within the last six months.] If you need more information about the sale call us at [telephone number] [or write us at [secured party's address]]. We are sending this notice to the following other people who have an interest in [describe collateral] or who owe money under your agreement: [Names of all other debtors and obligors, if any] [End of Form] (4) A notication in the form of paragraph (3) is sucient, even if additional information appears at the end of the form. (5) A notication in the form of paragraph (3) is sucient, even if it includes errors in information not required by paragraph (1), unless the error is misleading with respect to rights arising under this article.
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(6) If a notication under this section is not in the form of paragraph (3), law other than this article determines the eect of including information not required by paragraph (1). Ocial Comment
1. Source. New. 2. Notication in Consumer-Goods Transactions. Paragraph (1) sets forth the information required for a reasonable notication in a consumer-goods transaction. A notication that lacks any of the information set forth in paragraph (1) is insucient as a matter of law. Compare Section 9-613(2), under which the trier of fact may nd a notication to be sucient even if it lacks some information listed in paragraph (1) of that section. 3. Safe-Harbor Form of Notication; Errors in Information. Although paragraph (2) provides that a particular phrasing of a notication is not required, paragraph (3) species a safe-harbor form that, when properly completed, satises paragraph (1). Paragraphs (4), (5), and (6) contain special rules applicable to erroneous and additional information. Under paragraph (4), a notication in the safe-harbor form specied in paragraph (3) is not rendered insucient if it contains additional information at the end of the form. Paragraph (5) provides that non-misleading errors in information contained in a notication are permitted if the safe-harbor form is used and if the errors are in information not required by paragraph (1). Finally, if a notication is in a form other than the paragraph (3) safeharbor form, other law determines the eect of including in the notication information other than that required by paragraph (1).

9-615. Application of Proceeds of Disposition; Liability for Deciency and Right to Surplus. (a) [Application of proceeds.] A secured party shall apply or pay over for application the cash proceeds of disposition under Section 9-610 in the following order to: (1) the reasonable expenses of retaking, holding, preparing for disposition, processing, and disposing, and, to the extent provided for by agreement and not prohibited by law, reasonable attorney's fees and legal expenses incurred by the secured party; (2) the satisfaction of obligations secured by the security interest or agricultural lien under which the disposition is made; (3) the satisfaction of obligations secured by any subordinate security interest in or other subordinate lien on the collateral if: (A) the secured party receives from the holder of the subordinate security interest or other lien an authenticated demand for proceeds before distribution of the proceeds is completed; and (B) in a case in which a consignor has an interest in the collateral, the subordinate security interest or other lien is senior to the interest of the consignor; and (4) a secured party that is a consignor of the collateral if the secured party receives from the consignor an authenticated demand for proceeds before distribution of the proceeds is completed. (b) [Proof of subordinate interest.] If requested by a secured party, a holder of a subordinate security interest or other lien shall furnish reasonable proof of the interest or lien within a reasonable time. Unless the holder does so, the secured party need not comply with the holder's demand under subsection (a)(3). (c) [Application of noncash proceeds.] A secured party need not apply or pay over for application noncash proceeds of disposition under Section
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9-610 unless the failure to do so would be commercially unreasonable. A secured party that applies or pays over for application noncash proceeds shall do so in a commercially reasonable manner. (d) [Surplus or deciency if obligation secured.] If the security interest under which a disposition is made secures payment or performance of an obligation, after making the payments and applications required by subsection (a) and permitted by subsection (c): (1) unless subsection (a)(4) requires the secured party to apply or pay over cash proceeds to a consignor, the secured party shall account to and pay a debtor for any surplus; and (2) the obligor is liable for any deciency. (e) [No surplus or deciency in sales of certain rights to payment.] If the underlying transaction is a sale of accounts, chattel paper, payment intangibles, or promissory notes: (1) the debtor is not entitled to any surplus; and (2) the obligor is not liable for any deciency. (f) [Calculation of surplus or deciency in disposition to person related to secured party.] The surplus or deciency following a disposition is calculated based on the amount of proceeds that would have been realized in a disposition complying with this part to a transferee other than the secured party, a person related to the secured party, or a secondary obligor if: (1) the transferee in the disposition is the secured party, a person related to the secured party, or a secondary obligor; and (2) the amount of proceeds of the disposition is signicantly below the range of proceeds that a complying disposition to a person other than the secured party, a person related to the secured party, or a secondary obligor would have brought. (g) [Cash proceeds received by junior secured party.] A secured party that receives cash proceeds of a disposition in good faith and without knowledge that the receipt violates the rights of the holder of a security interest or other lien that is not subordinate to the security interest or agricultural lien under which the disposition is made: (1) takes the cash proceeds free of the security interest or other lien; (2) is not obligated to apply the proceeds of the disposition to the satisfaction of obligations secured by the security interest or other lien; and (3) is not obligated to account to or pay the holder of the security interest or other lien for any surplus. As amended in 2000.
See Appendix P for material relating to changes made in text in 2000.

Ocial Comment
1. Source. Former Section 9-504(1), (2). 2. Application of Proceeds. This section contains the rules governing application of proceeds and the debtor's liability for a deciency following a disposition of collateral. Subsection (a) sets forth the basic order of application. The proceeds are applied rst to the expenses of disposition, second to the obligation secured by the security interest that is being enforced, and third, in the specied circumstances, to interests that are subordinate to that security interest. 1063

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Subsections (a) and (d) also address the right of a consignor to receive proceeds of a disposition by a secured party whose interest is senior to that of the consignor. Subsection (a) requires the enforcing secured party to pay excess proceeds rst to subordinate secured parties or lienholders whose interests are senior to that of a consignor and, nally, to a consignor. Inasmuch as a consignor is the owner of the collateral, secured parties and lienholders whose interests are junior to the consignor's interest will not be entitled to any proceeds. In like fashion, under subsection (d)(1) the debtor is not entitled to a surplus when the enforcing secured party is required to pay over proceeds to a consignor. 3. Noncash Proceeds. Subsection (c) addresses the application of noncash proceeds of a disposition, such as a note or lease. The explanation in Section 9-608, Comment 4, generally applies to this subsection. Example: A secured party in the business of selling or nancing automobiles takes possession of collateral (an automobile) following its debtor's default. The secured party decides to sell the automobile in a private disposition under Section 9-610 and sends appropriate notication under Section 9-611. After undertaking its normal credit investigation and in accordance with its normal credit policies, the secured party sells the automobile on credit, on terms typical of the credit terms normally extended by the secured party in the ordinary course of its business. The automobile stands as collateral for the remaining balance of the price. The noncash proceeds received by the secured party are chattel paper. The secured party may wish to credit its debtor (the assignor) with the principal amount of the chattel paper or may wish to credit the debtor only as and when the payments are made on the chattel paper by the buyer. Under subsection (c), the secured party is under no duty to apply the noncash proceeds (here, the chattel paper) or their value to the secured obligation unless its failure to do so would be commercially unreasonable. If a secured party elects to apply the chattel paper to the outstanding obligation, however, it must do so in a commercially reasonable manner. The facts in the example indicate that it would be commercially unreasonable for the secured party to fail to apply the value of the chattel paper to the original debtor's secured obligation. Unlike the example in Comment 4 to Section 9-608, the noncash proceeds received in this example are of the type that the secured party regularly generates in the ordinary course of its nancing business in nonforeclosure transactions. The original debtor should not be exposed to delay or uncertainty in this situation. Of course, there will be many situations that fall between the examples presented in the Comment to Section 9-608 and in this Comment. This Article leaves their resolution to the court based on the facts of each case. One would expect that where noncash proceeds are or may be material, the secured party and debtor would agree to more specic standards in an agreement entered into before or after default. The parties may agree to the method of application of noncash proceeds if the method is not manifestly unreasonable. See Section 9-603. When the secured party is not required to apply or pay over for application noncash proceeds, the proceeds nonetheless remain collateral subject to this Article. See Section 9-608, Comment 4. 4. Surplus and Deciency. Subsection (d) deals with surplus and deciency. It revises former Section 9-504(2) by imposing an explicit requirement that the secured party pay the debtor for any surplus, while retaining the secured party's duty to account. Inasmuch as the debtor may not be an obligor, subsection (d) provides that the obligor (not the debtor) is liable for the deciency. The special rule governing surplus and deciency when receivables have been sold likewise takes into account the distinction between a debtor and an obligor. Subsection (d) also addresses the situation in which a consignor has an interest that is subordinate to the security interest being enforced. 5. Collateral Under New Ownership. When the debtor sells collateral subject to a security interest, the original debtor (creator of the security interest) is no longer a debtor inasmuch as it no longer has a property interest in the collateral; the buyer is the debtor. See Section 9-102. As between the debtor (buyer of the collateral) and the original debtor (seller of the collateral), the debtor (buyer) normally would be entitled to the surplus following a disposition. Subsection (d) therefore requires the secured party to pay the surplus to the debtor (buyer), not to the original debtor (seller) with which it has dealt. But, because this situation typically arises as a result of the debtor's wrongful act, this Article does not expose the secured party to the risk of determining ownership of the collateral. If the secured party does not know about the buyer and accordingly pays the surplus to the origi1064

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nal debtor, the exculpatory provisions of this Article exonerate the secured party from liability to the buyer. See Sections 9-605, 9-628(a), (b). If a debtor sells collateral free of a security interest, as in a sale to a buyer in ordinary course of business (see Section 9-320(a)), the property is no longer collateral and the buyer is not a debtor. 6. Certain Low-Price Dispositions. Subsection (f) provides a special method for calculating a deciency or surplus when the secured party, a person related to the secured party (dened in Section 9-102), or a secondary obligor acquires the collateral at a foreclosure disposition. It recognizes that when the foreclosing secured party or a related party is the transferee of the collateral, the secured party sometimes lacks the incentive to maximize the proceeds of disposition. As a consequence, the disposition may comply with the procedural requirements of this Article (e.g., it is conducted in a commercially reasonable manner following reasonable notice) but nevertheless fetch a low price. Subsection (f) adjusts for this lack of incentive. If the proceeds of a disposition of collateral to a secured party, a person related to the secured party, or a secondary obligor are signicantly below the range of proceeds that a complying disposition to a person other than the secured party, a person related to the secured party, or a secondary obligor would have brought, then instead of calculating a deciency (or surplus) based on the actual net proceeds, the calculation is based upon the amount that would have been received in a commercially reasonable disposition to a person other than the secured party, a person related to the secured party, or a secondary obligor. Subsection (f) thus rejects the view that the secured party's receipt of such a price necessarily constitutes noncompliance with Part 6. However, such a price may suggest the need for greater judicial scrutiny. See Section 9-610, Comment 10. 7. Person Related To. Section 9-102 denes person related to. That term is a key element of the system provided in subsection (f) for low-price dispositions. One part of the denition applies when the secured party is an individual, and the other applies when the secured party is an organization. The denition is patterned closely on the corresponding denition in Section 1.301(32) of the Uniform Consumer Credit Code.

9-616. Explanation of Calculation of Surplus or Deciency. (a) [Denitions.] In this section: (1) Explanation means a writing that: (A) states the amount of the surplus or deciency; (B) provides an explanation in accordance with subsection (c) of how the secured party calculated the surplus or deciency; (C) states, if applicable, that future debits, credits, charges, including additional credit service charges or interest, rebates, and expenses may aect the amount of the surplus or deciency; and (D) provides a telephone number or mailing address from which additional information concerning the transaction is available. (2) Request means a record: (A) authenticated by a debtor or consumer obligor; (B) requesting that the recipient provide an explanation; and (C) sent after disposition of the collateral under Section 9-610. (b) [Explanation of calculation.] In a consumer-goods transaction in which the debtor is entitled to a surplus or a consumer obligor is liable for a deciency under Section 9-615, the secured party shall: (1) send an explanation to the debtor or consumer obligor, as applicable, after the disposition and: (A) before or when the secured party accounts to the debtor and pays any surplus or rst makes written demand on the consumer obligor after the disposition for payment of the deciency; and (B) within 14 days after receipt of a request; or
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(2) in the case of a consumer obligor who is liable for a deciency, within 14 days after receipt of a request, send to the consumer obligor a record waiving the secured party's right to a deciency. (c) [Required information.] To comply with subsection (a)(1)(B), a writing must provide the following information in the following order: (1) the aggregate amount of obligations secured by the security interest under which the disposition was made, and, if the amount reects a rebate of unearned interest or credit service charge, an indication of that fact, calculated as of a specied date: (A) if the secured party takes or receives possession of the collateral after default, not more than 35 days before the secured party takes or receives possession; or (B) if the secured party takes or receives possession of the collateral before default or does not take possession of the collateral, not more than 35 days before the disposition; (2) the amount of proceeds of the disposition; (3) the aggregate amount of the obligations after deducting the amount of proceeds; (4) the amount, in the aggregate or by type, and types of expenses, including expenses of retaking, holding, preparing for disposition, processing, and disposing of the collateral, and attorney's fees secured by the collateral which are known to the secured party and relate to the current disposition; (5) the amount, in the aggregate or by type, and types of credits, including rebates of interest or credit service charges, to which the obligor is known to be entitled and which are not reected in the amount in paragraph (1); and (6) the amount of the surplus or deciency. (d) [Substantial compliance.] A particular phrasing of the explanation is not required. An explanation complying substantially with the requirements of subsection (a) is sucient, even if it includes minor errors that are not seriously misleading. (e) [Charges for responses.] A debtor or consumer obligor is entitled without charge to one response to a request under this section during any six-month period in which the secured party did not send to the debtor or consumer obligor an explanation pursuant to subsection (b)(1). The secured party may require payment of a charge not exceeding $25 for each additional response. Ocial Comment
1. Source. New. 2. Duty to Send Information Concerning Surplus or Deciency. This section reects the view that, in every consumer-goods transaction, the debtor or obligor is entitled to know the amount of a surplus or deciency and the basis upon which the surplus or deciency was calculated. Under subsection (b)(1), a secured party is obligated to provide this information (an explanation, dened in subsection (a)(1)) no later than the time that it accounts for and pays a surplus or the time of its rst written attempt to collect the deciency. The obligor need not make a request for an accounting in order to receive an explanation. A secured party who does not attempt to collect a deciency in writing or account for and pay a surplus has no obligation to send an explanation under subsection (b)(1) and, consequently, cannot be liable for noncompliance. 1066

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A debtor or secondary obligor need not wait until the secured party commences written collection eorts in order to receive an explanation of how a deciency or surplus was calculated. Subsection (b)(2) obliges the secured party to send an explanation within 14 days after it receives a request (dened in subsection (a)(2)). 3. Explanation of Calculation of Surplus or Deciency. Subsection (c) contains the requirements for how a calculation of a surplus or deciency must be explained in order to satisfy subsection (a)(1)(B). It gives a secured party some discretion concerning rebates of interest or credit service charges. The secured party may include these rebates in the aggregate amount of obligations secured, under subsection (c)(1), or may include them with other types of rebates and credits under subsection (c)(5). Rebates of interest or credit service charges are the only types of rebates for which this discretion is provided. If the secured party provides an explanation that includes rebates of pre-computed interest, its explanation must so indicate. The expenses and attorney's fees to be described pursuant to subsection (c)(4) are those relating to the most recent disposition, not those that may have been incurred in connection with earlier enforcement eorts and which have been resolved by the parties. 4. Liability for Noncompliance. A secured party who fails to comply with subsection (b)(2) is liable for any loss caused plus $500. See Section 9-625(b), (c), (e)(6). A secured party who fails to send an explanation under subsection (b)(1) is liable for any loss caused plus, if the noncompliance was part of a pattern, or consistent with a practice of noncompliance, $500. See Section 9-625(b), (c), (e)(5). However, a secured party who fails to comply with this section is not liable for statutory minimum damages under Section 9-625(c)(2). See Section 9-628(d).

9-617. Rights of Transferee of Collateral. (a) [Eects of disposition.] A secured party's disposition of collateral after default: (1) transfers to a transferee for value all of the debtor's rights in the collateral; (2) discharges the security interest under which the disposition is made; and (3) discharges any subordinate security interest or other subordinate lien [other than liens created under [cite acts or statutes providing for liens, if any, that are not to be discharged]]. (b) [Rights of good-faith transferee.] A transferee that acts in good faith takes free of the rights and interests described in subsection (a), even if the secured party fails to comply with this article or the requirements of any judicial proceeding. (c) [Rights of other transferee.] If a transferee does not take free of the rights and interests described in subsection (a), the transferee takes the collateral subject to: (1) the debtor's rights in the collateral; (2) the security interest or agricultural lien under which the disposition is made; and (3) any other security interest or other lien. Ocial Comment
1. Source. Former Section 9-504(4). 2. Title Taken by Good-Faith Transferee. Subsection (a) sets forth the rights acquired by persons who qualify under subsection (b)transferees who act in good faith. Such a person is a transferee, inasmuch as a buyer at a foreclosure sale does not meet the denition of purchaser in Section 1-201 (the transfer is not, vis-a-vis the debtor, voluntary). By virtue of the expanded denition of the term debtor in Section 9-102, subsection (a) makes clear that the ownership interest of a person who bought the collateral subject to the 1067

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security interest is terminated by a subsequent disposition under this Part. Such a person is a debtor under this Article. Under former Article 9, the result arguably was the same, but the statute was less clear. Under subsection (a), a disposition normally discharges the security interest being foreclosed and any subordinate security interests and other liens. A disposition has the eect specied in subsection (a), even if the secured party fails to comply with this Article. An aggrieved person (e.g., the holder of a subordinate security interest to whom a notication required by Section 9-611 was not sent) has a right to recover any loss under Section 9-625(b). 3. Unitary Standard in Public and Private Dispositions. Subsection (b) now contains a unitary standard that applies to transferees in both private and public dispositionsacting in good faith. However, this change from former Section 9-504(4) should not be interpreted to mean that a transferee acts in good faith even though it has knowledge of defects or buys in collusion, standards applicable to public dispositions under the former section. Properly understood, those standards were specic examples of the absence of good faith. 4. Title Taken by Nonqualifying Transferee. Subsection (c) species the consequences for a transferee who does not qualify for protection under subsections (a) and (b) (i.e., a transferee who does not act in good faith). The transferee takes subject to the rights of the debtor, the enforcing secured party, and other security interests or other liens.

9-618. Rights and Duties of Certain Secondary Obligors. (a) [Rights and duties of secondary obligor.] A secondary obligor acquires the rights and becomes obligated to perform the duties of the secured party after the secondary obligor: (1) receives an assignment of a secured obligation from the secured party; (2) receives a transfer of collateral from the secured party and agrees to accept the rights and assume the duties of the secured party; or (3) is subrogated to the rights of a secured party with respect to collateral. (b) [Eect of assignment, transfer, or subrogation.] An assignment, transfer, or subrogation described in subsection (a): (1) is not a disposition of collateral under Section 9-610; and (2) relieves the secured party of further duties under this article. Ocial Comment
1. Source. Former Section 9-504(5). 2. Scope of This Section. Under this section, assignments of secured obligations and other transactions (regardless of form) that function like assignments of secured obligations are not dispositions to which Part 6 applies. Rather, they constitute assignments of rights and (occasionally) delegations of duties. Application of this section may require an investigation into the agreement of the parties, which may not be reected in the words of the repurchase agreement (e.g., when the agreement requires a recourse party to purchase the collateral but contemplates that the purchaser will then conduct an Article 9 foreclosure disposition). This section, like former Section 9-504(5), does not constitute a general and comprehensive rule for allocating rights and duties upon assignment of a secured obligation. Rather, it applies only in situations involving a secondary obligor described in subsection (a). In other contexts, the agreement of the parties and applicable law other than Article 9 determine whether the assignment imposes upon the assignee any duty to the debtor and whether the assignor retains its duties to the debtor after the assignment. Subsection (a)(1) applies when there has been an assignment of an obligation that is secured at the time it is assigned. Thus, if a secondary obligor acquires the collateral at a disposition under Section 9-610 and simultaneously or subsequently discharges the unsecured deciency claim, subsection (a)(1) is not implicated. Similarly, subsection (a)(3) applies only when the secondary obligor is subrogated to the secured party's rights with re1068

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spect to collateral. Thus, this subsection will not be implicated if a secondary obligor discharges the debtor's unsecured obligation for a post-disposition deciency. Similarly, if the secured party disposes of some of the collateral and the secondary obligor thereafter discharges the remaining obligation, subsection (a) applies only with respect to rights and duties concerning the remaining collateral, and, under subsection (b), the subrogation is not a disposition of the remaining collateral. As discussed more fully in Comment 3, a secondary obligor may receive a transfer of collateral in a disposition under Section 9-610 in exchange for a payment that is applied against the secured obligation. However, a secondary obligor who pays and receives a transfer of collateral does not necessarily become subrogated to the rights of the secured party as contemplated by subsection (a)(3). Only to the extent the secondary obligor makes a payment in satisfaction of its secondary obligation would it become subrogated. To the extent its payment constitutes the price of the collateral in a Section 9-610 disposition by the secured party, the secondary obligor would not be subrogated. Thus, if the amount paid by the secondary obligor for the collateral in a Section 9-610 disposition is itself insucient to discharge the secured obligation, but the secondary obligor makes an additional payment that satises the remaining balance, the secondary obligor would be subrogated to the secured party's deciency claim. However, the duties of the secured party as such would have come to an end with respect to that collateral. In some situations the capacity in which the payment is made may be unclear. Accordingly, the parties should in their relationship provide clear evidence of the nature and circumstances of the payment by the secondary obligor. 3. Transfer of Collateral to Secondary Obligor. It is possible for a secured party to transfer collateral to a secondary obligor in a transaction that is a disposition under Section 9-610 and that establishes a surplus or deciency under Section 9-615. Indeed, this Article includes a special rule, in Section 9-615(f), for establishing a deciency in the case of some dispositions to, inter alia, secondary obligors. This Article rejects the view, which some may have ascribed to former Section 9-504(5), that a transfer of collateral to a recourse party can never constitute a disposition of collateral which discharges a security interest. Inasmuch as a secured party could itself buy collateral at its own public sale, it makes no sense to prohibit a recourse party ever from buying at the sale. 4. Timing and Scope of Obligations. Under subsection (a), a recourse party acquires rights and incurs obligations only after one of the specied circumstances occurs. This makes clear that when a successor assignee, transferee, or subrogee becomes obligated it does not assume any liability for earlier actions or inactions of the secured party whom it has succeeded unless it agrees to do so. Once the successor becomes obligated, however, it is responsible for complying with the secured party's duties thereafter. For example, if the successor is in possession of collateral, then it has the duties specied in Section 9-207. Under subsection (b), the same event (assignment, transfer, or subrogation) that gives rise to rights to, and imposes obligations on, a successor relieves its predecessor of any further duties under this Article. For example, if the security interest is enforced after the secured obligation is assigned, the assigneebut not the assignorhas the duty to comply with this Part. Similarly, the assignment does not excuse the assignor from liability for failure to comply with duties that arose before the event or impose liability on the assignee for the assignor's failure to comply.

9-619. Transfer of Record or Legal Title. (a) [Transfer statement.] In this section, transfer statement means a record authenticated by a secured party stating: (1) that the debtor has defaulted in connection with an obligation secured by specied collateral; (2) that the secured party has exercised its post-default remedies with respect to the collateral; (3) that, by reason of the exercise, a transferee has acquired the rights of the debtor in the collateral; and (4) the name and mailing address of the secured party, debtor, and transferee.
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(b) [Eect of transfer statement.] A transfer statement entitles the transferee to the transfer of record of all rights of the debtor in the collateral specied in the statement in any ocial ling, recording, registration, or certicate-of-title system covering the collateral. If a transfer statement is presented with the applicable fee and request form to the ocial or oce responsible for maintaining the system, the ocial or oce shall: (1) accept the transfer statement; (2) promptly amend its records to reect the transfer; and (3) if applicable, issue a new appropriate certicate of title in the name of the transferee. (c) [Transfer not a disposition; no relief of secured party's duties.] A transfer of the record or legal title to collateral to a secured party under subsection (b) or otherwise is not of itself a disposition of collateral under this article and does not of itself relieve the secured party of its duties under this article. Ocial Comment
1. Source. New. 2. Transfer of Record or Legal Title. Potential buyers of collateral that is covered by a certicate of title (e.g., an automobile) or is subject to a registration system (e.g., a copyright) typically require as a condition of their purchase that the certicate or registry reect their ownership. In many cases, this condition can be met only with the consent of the record owner. If the record owner is the debtor and, as may be the case after the default, the debtor refuses to cooperate, the secured party may have great diculty disposing of the collateral. Subsection (b) provides a simple mechanism for obtaining record or legal title, for use primarily when other law does not provide one. Of course, use of this mechanism will not be eective to clear title to the extent that subsection (b) is preempted by federal law. Subsection (b) contemplates a transfer of record or legal title to a third party, following a secured party's exercise of its disposition or acceptance remedies under this Part, as well as a transfer by a debtor to a secured party prior to the secured party's exercise of those remedies. Under subsection (c), a transfer of record or legal title (under subsection (b) or under other law) to a secured party prior to the exercise of those remedies merely puts the secured party in a position to pass legal or record title to a transferee at foreclosure. A secured party who has obtained record or legal title retains its duties with respect to enforcement of its security interest, and the debtor retains its rights as well. 3. Title-Clearing Systems Under Other Law. Applicable non-UCC law (e.g., a certicate-of-title statute, federal registry rules, or the like) may provide a means by which the secured party may obtain or transfer record or legal title for the purpose of a disposition of the property under this Article. The mechanism provided by this section is in addition to any title-clearing provision under law other than this Article.

9-620. Acceptance of Collateral in Full or Partial Satisfaction of Obligation; Compulsory Disposition of Collateral. (a) [Conditions to acceptance in satisfaction.] Except as otherwise provided in subsection (g), a secured party may accept collateral in full or partial satisfaction of the obligation it secures only if: (1) the debtor consents to the acceptance under subsection (c); (2) the secured party does not receive, within the time set forth in subsection (d), a notication of objection to the proposal authenticated by: (A) a person to which the secured party was required to send a proposal under Section 9-621; or
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(B) any other person, other than the debtor, holding an interest in the collateral subordinate to the security interest that is the subject of the proposal; (3) if the collateral is consumer goods, the collateral is not in the possession of the debtor when the debtor consents to the acceptance; and (4) subsection (e) does not require the secured party to dispose of the collateral or the debtor waives the requirement pursuant to Section 9-624. (b) [Purported acceptance ineective.] A purported or apparent acceptance of collateral under this section is ineective unless: (1) the secured party consents to the acceptance in an authenticated record or sends a proposal to the debtor; and (2) the conditions of subsection (a) are met. (c) [Debtor's consent.] For purposes of this section: (1) a debtor consents to an acceptance of collateral in partial satisfaction of the obligation it secures only if the debtor agrees to the terms of the acceptance in a record authenticated after default; and (2) a debtor consents to an acceptance of collateral in full satisfaction of the obligation it secures only if the debtor agrees to the terms of the acceptance in a record authenticated after default or the secured party: (A) sends to the debtor after default a proposal that is unconditional or subject only to a condition that collateral not in the possession of the secured party be preserved or maintained; (B) in the proposal, proposes to accept collateral in full satisfaction of the obligation it secures; and (C) does not receive a notication of objection authenticated by the debtor within 20 days after the proposal is sent. (d) [Eectiveness of notication.] To be eective under subsection (a)(2), a notication of objection must be received by the secured party: (1) in the case of a person to which the proposal was sent pursuant to Section 9-621, within 20 days after notication was sent to that person; and (2) in other cases: (A) within 20 days after the last notication was sent pursuant to Section 9-621; or (B) if a notication was not sent, before the debtor consents to the acceptance under subsection (c). (e) [Mandatory disposition of consumer goods.] A secured party that has taken possession of collateral shall dispose of the collateral pursuant to Section 9-610 within the time specied in subsection (f) if: (1) 60 percent of the cash price has been paid in the case of a purchasemoney security interest in consumer goods; or (2) 60 percent of the principal amount of the obligation secured has been paid in the case of a non-purchase-money security interest in consumer goods. (f) [Compliance with mandatory disposition requirement.] To comply with subsection (e), the secured party shall dispose of the collateral:
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(1) within 90 days after taking possession; or (2) within any longer period to which the debtor and all secondary obligors have agreed in an agreement to that eect entered into and authenticated after default. (g) [No partial satisfaction in consumer transaction.] In a consumer transaction, a secured party may not accept collateral in partial satisfaction of the obligation it secures. Ocial Comment
1. Source. Former Section 9-505. 2. Overview. This section and the two sections following deal with strict foreclosure, a procedure by which the secured party acquires the debtor's interest in the collateral without the need for a sale or other disposition under Section 9-610. Although these provisions derive from former Section 9-505, they have been entirely reorganized and substantially rewritten. The more straightforward approach taken in this Article eliminates the ction that the secured party always will present a proposal for the retention of collateral and the debtor will have a xed period to respond. By eliminating the need (but preserving the possibility) for proceeding in that fashion, this section eliminates much of the awkwardness of former Section 9-505. It reects the belief that strict foreclosures should be encouraged and often will produce better results than a disposition for all concerned. Subsection (a) sets forth the conditions necessary to an eective acceptance (formerly, retention) of collateral in full or partial satisfaction of the secured obligation. Section 9-621 requires in addition that a secured party who wishes to proceed under this section notify certain other persons who have or claim to have an interest in the collateral. Unlike the failure to meet the conditions in subsection (a), under Section 9-622(b) the failure to comply with the notication requirement of Section 9-621 does not render the acceptance of collateral ineective. Rather, the acceptance can take eect notwithstanding the secured party's noncompliance. A person to whom the required notice was not sent has the right to recover damages under Section 9-625(b). Section 9-622(a) sets forth the eect of an acceptance of collateral. 3. Conditions to Eective Acceptance. Subsection (a) contains the conditions necessary to the eectiveness of an acceptance of collateral. Subsection (a)(1) requires the debtor's consent. Under subsections (c)(1) and (c)(2), the debtor may consent by agreeing to the acceptance in writing after default. Subsection (c)(2) contains an alternative method by which to satisfy the debtor's-consent condition in subsection (a)(1). It follows the proposaland-objection model found in former Section 9-505: The debtor consents if the secured party sends a proposal to the debtor and does not receive an objection within 20 days. Under subsection (c)(1), however, that silence is not deemed to be consent with respect to acceptances in partial satisfaction. Thus, a secured party who wishes to conduct a partial strict foreclosure must obtain the debtor's agreement in a record authenticated after default. In all other respects, the conditions necessary to an eective partial strict foreclosure are the same as those governing acceptance of collateral in full satisfaction. (But see subsection (g), prohibiting partial strict foreclosure of a security interest in consumer transactions.) The time when a debtor consents to a strict foreclosure is signicant in several circumstances under this section and the following one. See Sections 9-620(a)(1), (d)(2), 9-621(a) (1), (a)(2), (a)(3). For purposes of determining the time of consent, a debtor's conditional consent constitutes consent. Subsection (a)(2) contains the second condition to the eectiveness of an acceptance under this sectionthe absence of a timely objection from a person holding a junior interest in the collateral or from a secondary obligor. Any junior partysecured party or lienholder-is entitled to lodge an objection to a proposal, even if that person was not entitled to notication under Section 9-621. Subsection (d), discussed below, indicates when an objection is timely. Subsections (a)(3) and (a)(4) contain special rules for transactions in which consumers are involved. See Comment 12. 4. Proposals. Section 9-102 denes the term proposal. It is necessary to send a proposal to the debtor only if the debtor does not agree to an acceptance in an authenticated 1072

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record as described in subsection (c)(1) or (c)(2). Section 9-621(a) determines whether it is necessary to send a proposal to third parties. A proposal need not take any particular form as long as it sets forth the terms under which the secured party is willing to accept collateral in satisfaction. A proposal to accept collateral should specify the amount (or a means of calculating the amount, such as by including a per diem accrual gure) of the secured obligations to be satised, state the conditions (if any) under which the proposal may be revoked, and describe any other applicable conditions. Note, however, that a conditional proposal generally requires the debtor's agreement in order to take eect. See subsection (c). 5. Secured Party's Agreement; No Constructive Strict Foreclosure. The conditions of subsection (a) relate to actual or implied consent by the debtor and any secondary obligor or holder of a junior security interest or lien. To ensure that the debtor cannot unilaterally cause an acceptance of collateral, subsection (b) provides that compliance with these conditions is necessary but not sucient to cause an acceptance of collateral. Rather, under subsection (b), acceptance does not occur unless, in addition, the secured party consents to the acceptance in an authenticated record or sends to the debtor a proposal. For this reason, a mere delay in collection or disposition of collateral does not constitute a constructive strict foreclosure. Instead, delay is a factor relating to whether the secured party acted in a commercially reasonable manner for purposes of Section 9-607 or 9-610. A debtor's voluntary surrender of collateral to a secured party and the secured party's acceptance of possession of the collateral does not, of itself, necessarily raise an implication that the secured party intends or is proposing to accept the collateral in satisfaction of the secured obligation under this section. 6. When Acceptance Occurs. This section does not impose any formalities or identify any steps that a secured party must take in order to accept collateral once the conditions of subsections (a) and (b) have been met. Absent facts or circumstances indicating a contrary intention, the fact that the conditions have been met provides a sucient indication that the secured party has accepted the collateral on the terms to which the secured party has consented or proposed and the debtor has consented or failed to object. Following a proposal, acceptance of the collateral normally is automatic upon the secured party's becoming bound and the time for objection passing. As a matter of good business practice, an enforcing secured party may wish to memorialize its acceptance following a proposal, such as by notifying the debtor that the strict foreclosure is eective or by placing a written record to that eect in its les. The secured party's agreement to accept collateral is self-executing and cannot be breached. The secured party is bound by its agreement to accept collateral and by any proposal to which the debtor consents. 7. No Possession Requirement. This section eliminates the requirement in former Section 9-505 that the secured party be in possession of collateral. It claries that intangible collateral, which cannot be possessed, may be subject to a strict foreclosure under this section. However, under subsection (a)(3), if the collateral is consumer goods, acceptance does not occur unless the debtor is not in possession. 8. When Objection Timely. Subsection (d) explains when an objection is timely and thus prevents an acceptance of collateral from taking eect. An objection by a person to which notication was sent under Section 9-621 is eective if it is received by the secured party within 20 days from the date the notication was sent to that person. Other objecting parties (i.e., third parties who are not entitled to notication) may object at any time within 20 days after the last notication is sent under Section 9-621. If no such notication is sent, third parties must object before the debtor agrees to the acceptance in writing or is deemed to have consented by silence. The former may occur any time after default, and the latter requires a 20-day waiting period. See subsection (c). 9. Applicability of Other Law. This section does not purport to regulate all aspects of the transaction by which a secured party may become the owner of collateral previously owned by the debtor. For example, a secured party's acceptance of a motor vehicle in satisfaction of secured obligations may require compliance with the applicable motor vehicle certicate-of-title law. State legislatures should conform those laws so that they mesh well with this section and Section 9-610, and courts should construe those laws and this section harmoniously. A secured party's acceptance of collateral in the possession of the debtor also may implicate statutes dealing with a seller's retention of possession of goods sold. 10. Accounts, Chattel Paper, Payment Intangibles, and Promissory Notes. If the collateral is accounts, chattel paper, payment intangibles, or promissory notes, then a 1073

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secured party's acceptance of the collateral in satisfaction of secured obligations would constitute a sale to the secured party. That sale normally would give rise to a new security interest (the ownership interest) under Sections 1-201(37) and 9-109. In the case of accounts and chattel paper, the new security interest would remain perfected by a ling that was eective to perfect the secured party's original security interest. In the case of payment intangibles or promissory notes, the security interest would be perfected when it attaches. See Section 9-309. However, the procedures for acceptance of collateral under this section satisfy all necessary formalities and a new security agreement authenticated by the debtor would not be necessary. 11. Role of Good Faith. Section 1-203 imposes an obligation of good faith on a secured party's enforcement under this Article. This obligation may not be disclaimed by agreement. See Section 1-102. Thus, a proposal and acceptance made under this section in bad faith would not be eective. For example, a secured party's proposal to accept marketable securities worth $1,000 in full satisfaction of indebtedness in the amount of $100, made in the hopes that the debtor might inadvertently fail to object, would be made in bad faith. On the other hand, in the normal case proposals and acceptances should be not second-guessed on the basis of the value of the collateral involved. Disputes about valuation or even a clear excess of collateral value over the amount of obligations satised do not necessarily demonstrate the absence of good faith. 12. Special Rules in Consumer Cases. Subsection (e) imposes an obligation on the secured party to dispose of consumer goods under certain circumstances. Subsection (f) explains when a disposition that is required under subsection (e) is timely. An eective acceptance of collateral cannot occur if subsection (e) requires a disposition unless the debtor waives this requirement pursuant to Section 9-624(b). Moreover, a secured party who takes possession of collateral and unreasonably delays disposition violates subsection (e), if applicable, and may also violate Section 9-610 or other provisions of this Part. Subsection (e) eliminates as superuous the express statutory reference to conversion found in former Section 9-505. Remedies available under other law, including conversion, remain available under this Article in appropriate cases. See Sections 1-103, 1-106. Subsection (g) prohibits the secured party in consumer transactions from accepting collateral in partial satisfaction of the obligation it secures. If a secured party attempts an acceptance in partial satisfaction in a consumer transaction, the attempted acceptance is void.

9-621. Notication of Proposal to Accept Collateral. (a) [Persons to which proposal to be sent.] A secured party that desires to accept collateral in full or partial satisfaction of the obligation it secures shall send its proposal to: (1) any person from which the secured party has received, before the debtor consented to the acceptance, an authenticated notication of a claim of an interest in the collateral; (2) any other secured party or lienholder that, 10 days before the debtor consented to the acceptance, held a security interest in or other lien on the collateral perfected by the ling of a nancing statement that: (A) identied the collateral; (B) was indexed under the debtor's name as of that date; and (C) was led in the oce or oces in which to le a nancing statement against the debtor covering the collateral as of that date; and (3) any other secured party that, 10 days before the debtor consented to the acceptance, held a security interest in the collateral perfected by compliance with a statute, regulation, or treaty described in Section 9-311(a). (b) [Proposal to be sent to secondary obligor in partial
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satisfaction.] A secured party that desires to accept collateral in partial satisfaction of the obligation it secures shall send its proposal to any secondary obligor in addition to the persons described in subsection (a). Ocial Comment
1. Source. Former Section 9-505. 2. Notication Requirement. Subsection (a) species three classes of competing claimants to whom the secured party must send notication of its proposal: (i) those who notify the secured party that they claim an interest in the collateral, (ii) holders of certain security interests and liens who have led against the debtor, and (iii) holders of certain security interests who have perfected by compliance with a statute (including a certicate-oftitle statute), regulation, or treaty described in Section 9-311(a). With regard to (ii), see Section 9-611, Comment 4. Subsection (b) also requires notication to any secondary obligor if the proposal is for acceptance in partial satisfaction. Unlike Section 9-611, this section contains no safe harbor, which excuses an enforcing secured party from notifying certain secured parties and other lienholders. This is because, unlike Section 9-610, which requires that a disposition of collateral be commercially reasonable, Section 9-620 permits the debtor and secured party to set the amount of credit the debtor will receive for the collateral subject only to the requirement of good faith. An eective acceptance discharges subordinate security interests and other subordinate liens. See Section 9-622. If collateral is subject to several liens securing debts much larger than the value of the collateral, the debtor may be disinclined to refrain from consenting to an acceptance by the holder of the senior security interest, even though, had the debtor objected and the senior disposed of the collateral under Section 9-610, the collateral may have yielded more than enough to satisfy the senior security interest (but not enough to satisfy all the liens). Accordingly, this section imposes upon the enforcing secured party the risk of the ling oce's errors and delay. The holder of a security interest who is entitled to notication under this section but does not receive it has the right to recover under Section 9-625(b) any loss resulting from the enforcing secured party's noncompliance with this section.

9-622. Eect of Acceptance of Collateral. (a) [Eect of acceptance.] A secured party's acceptance of collateral in full or partial satisfaction of the obligation it secures: (1) discharges the obligation to the extent consented to by the debtor; (2) transfers to the secured party all of a debtor's rights in the collateral; (3) discharges the security interest or agricultural lien that is the subject of the debtor's consent and any subordinate security interest or other subordinate lien; and (4) terminates any other subordinate interest. (b) [Discharge of subordinate interest notwithstanding noncompliance.] A subordinate interest is discharged or terminated under subsection (a), even if the secured party fails to comply with this article. Ocial Comment
1. Source. New. 2. Eect of Acceptance. Subsection (a) species the eect of an acceptance of collateral in full or partial satisfaction of the secured obligation. The acceptance to which it refers is an eective acceptance. If a purported acceptance is ineective under Section 9-620, e.g., because the secured party receives a timely objection from a person entitled to notication, then neither this subsection nor subsection (b) applies. Paragraph (1) expresses the fundamental consequence of accepting collateral in full or partial satisfaction of the secured obligationthe obligation is discharged to the extent consented to by the debtor. Unless otherwise agreed, the obligor remains liable for any deciency. Paragraphs (2) through (4) 1075

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indicate the eects of an acceptance on various property rights and interests. Paragraph (2) follows Section 9-617(a) in providing that the secured party acquires all of a debtor's rights in the collateral. Under paragraph (3), the eect of strict foreclosure on holders of junior security interests and other liens is the same regardless of whether the collateral is accepted in full or partial satisfaction of the secured obligation: all junior encumbrances are discharged. Paragraph (4) provides for the termination of other subordinate interests. Subsection (b) makes clear that subordinate interests are discharged under subsection (a) regardless of whether the secured party complies with this Article. Thus, subordinate interests are discharged regardless of whether a proposal was required to be sent or, if required, was sent. However, a secured party's failure to send a proposal or otherwise to comply with this Article may subject the secured party to liability under Section 9-625.

9-623. Right to Redeem Collateral. (a) [Persons that may redeem.] A debtor, any secondary obligor, or any other secured party or lienholder may redeem collateral. (b) [Requirements for redemption.] To redeem collateral, a person shall tender: (1) fulllment of all obligations secured by the collateral; and (2) the reasonable expenses and attorney's fees described in Section 9-615(a)(1). (c) [When redemption may occur.] A redemption may occur at any time before a secured party: (1) has collected collateral under Section 9-607; (2) has disposed of collateral or entered into a contract for its disposition under Section 9-610; or (3) has accepted collateral in full or partial satisfaction of the obligation it secures under Section 9-622. Ocial Comment
1. Source. Former Section 9-506. 2. Redemption Right. Under this section, as under former Section 9-506, the debtor or another secured party may redeem collateral as long as the secured party has not collected (Section 9-607), disposed of or contracted for the disposition of (Section 9-610), or accepted (Section 9-620) the collateral. Although this section generally follows former Section 9-506, it extends the right of redemption to holders of nonconsensual liens. To redeem the collateral a person must tender fulllment of all obligations secured, plus certain expenses. If the entire balance of a secured obligation has been accelerated, it would be necessary to tender the entire balance. A tender of fulllment obviously means more than a new promise to perform an existing promise. It requires payment in full of all monetary obligations then due and performance in full of all other obligations then matured. If unmatured secured obligations remain, the security interest continues to secure them (i.e., as if there had been no default). 3. Redemption of Remaining Collateral Following Partial Enforcement. Under Section 9-610 a secured party may make successive dispositions of portions of its collateral. These dispositions would not aect the debtor's, another secured party's, or a lienholder's right to redeem the remaining collateral. 4. Eect of Repledging. Section 9-207 generally permits a secured party having possession or control of collateral to create a security interest in the collateral. As explained in the Comments to that section, the debtor's right (as opposed to its practical ability) to redeem collateral is not aected by, and does not aect, the priority of a security interest created by the debtor's secured party.

9-624. Waiver. (a) [Waiver of disposition notication.] A debtor or secondary obligor may waive the right to notication of disposition of collateral under Section
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9-611 only by an agreement to that eect entered into and authenticated after default. (b) [Waiver of mandatory disposition.] A debtor may waive the right to require disposition of collateral under Section 9-620(e) only by an agreement to that eect entered into and authenticated after default. (c) [Waiver of redemption right.] Except in a consumer-goods transaction, a debtor or secondary obligor may waive the right to redeem collateral under Section 9-623 only by an agreement to that eect entered into and authenticated after default. Ocial Comment
1. Source. Former Sections 9-504(3), 9-505, 9-506. 2. Waiver. This section is a limited exception to Section 9-602, which generally prohibits waiver by debtors and obligors. It makes no provision for waiver of the rule prohibiting a secured party from buying at its own private disposition. Transactions of this kind are equivalent to strict foreclosures and are governed by Sections 9-620, 9-621, and 9-622.

[SUBPART 2. NONCOMPLIANCE WITH ARTICLE] 9-625. Remedies for Secured Party's Failure to Comply With Article. (a) [Judicial orders concerning noncompliance.] If it is established that a secured party is not proceeding in accordance with this article, a court may order or restrain collection, enforcement, or disposition of collateral on appropriate terms and conditions. (b) [Damages for noncompliance.] Subject to subsections (c), (d), and (f), a person is liable for damages in the amount of any loss caused by a failure to comply with this article. Loss caused by a failure to comply may include loss resulting from the debtor's inability to obtain, or increased costs of, alternative nancing. (c) [Persons entitled to recover damages; statutory damages in consumer-goods transaction.] Except as otherwise provided in Section 9-628: (1) a person that, at the time of the failure, was a debtor, was an obligor, or held a security interest in or other lien on the collateral may recover damages under subsection (b) for its loss; and (2) if the collateral is consumer goods, a person that was a debtor or a secondary obligor at the time a secured party failed to comply with this part may recover for that failure in any event an amount not less than the credit service charge plus 10 percent of the principal amount of the obligation or the time-price dierential plus 10 percent of the cash price. (d) [Recovery when deciency eliminated or reduced.] A debtor whose deciency is eliminated under Section 9-626 may recover damages for the loss of any surplus. However, a debtor or secondary obligor whose deciency is eliminated or reduced under Section 9-626 may not otherwise recover under subsection (b) for noncompliance with the provisions of this part relating to collection, enforcement, disposition, or acceptance. (e) [Statutory damages: noncompliance with specied provisions.] In addition to any damages recoverable under subsection (b), the debtor, consumer obligor, or person named as a debtor in a led record, as applicable, may recover $500 in each case from a person that:
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(1) fails to comply with Section 9-208; (2) fails to comply with Section 9-209; (3) les a record that the person is not entitled to le under Section 9-509(a); (4) fails to cause the secured party of record to le or send a termination statement as required by Section 9-513(a) or (c); (5) fails to comply with Section 9-616(b)(1) and whose failure is part of a pattern, or consistent with a practice, of noncompliance; or (6) fails to comply with Section 9-616(b)(2). (f) [Statutory damages: noncompliance with Section 9-210.] A debtor or consumer obligor may recover damages under subsection (b) and, in addition, $500 in each case from a person that, without reasonable cause, fails to comply with a request under Section 9-210. A recipient of a request under Section 9-210 which never claimed an interest in the collateral or obligations that are the subject of a request under that section has a reasonable excuse for failure to comply with the request within the meaning of this subsection. (g) [Limitation of security interest: noncompliance with Section 9-210.] If a secured party fails to comply with a request regarding a list of collateral or a statement of account under Section 9-210, the secured party may claim a security interest only as shown in the list or statement included in the request as against a person that is reasonably misled by the failure. As amended in 2000.
See Appendix P for material relating to changes made in text in 2000.

Ocial Comment
1. Source. Former Section 9-507. 2. Remedies for Noncompliance; Scope. Subsections (a) and (b) provide the basic remedies aorded to those aggrieved by a secured party's failure to comply with this Article. Like all provisions that create liability, they are subject to Section 9-628, which should be read in conjunction with Section 9-605. The principal limitations under this Part on a secured party's right to enforce its security interest against collateral are the requirements that it proceed in good faith (Section 1-203), in a commercially reasonable manner (Sections 9-607 and 9-610), and, in most cases, with reasonable notication (Sections 9-611 through 9-614). Following former Section 9-507, under subsection (a) an aggrieved person may seek injunctive relief, and under subsection (b) the person may recover damages for losses caused by noncompliance. Unlike former Section 9-507, however, subsections (a) and (b) are not limited to noncompliance with provisions of this Part of Article 9. Rather, they apply to noncompliance with any provision of this Article. The change makes this section applicable to noncompliance with Sections 9-207 (duties of secured party in possession of collateral), 9-208 (duties of secured party having control over deposit account), 9-209 (duties of secured party if account debtor has been notied of an assignment), 9-210 (duty to comply with request for accounting, etc.), 9-509(a) (duty to refrain from ling unauthorized nancing statement), and 9-513(a) or (c) (duty to provide termination statement). Subsection (a) also modies the rst sentence of former Section 9-507(1) by adding the references to collection and enforcement. Subsection (c)(2), which gives a minimum damage recovery in consumer-goods transactions, applies only to noncompliance with the provisions of this Part. 3. Damages for Noncompliance with This Article. Subsection (b) sets forth the basic remedy for failure to comply with the requirements of this Article: a damage recovery in the amount of loss caused by the noncompliance. Subsection (c) identies who may recover under subsection (b). It aords a remedy to any aggrieved person who is a debtor or obligor. 1078

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However, a principal obligor who is not a debtor may recover damages only for noncompliance with Section 9-616, inasmuch as none of the other rights and duties in this Article run in favor of such a principal obligor. Such a principal obligor could not suer any loss or damage on account of noncompliance with rights or duties of which it is not a beneciary. Subsection (c) also aords a remedy to an aggrieved person who holds a competing security interest or other lien, regardless of whether the aggrieved person is entitled to notication under Part 6. The remedy is available even to holders of senior security interests and other liens. The exercise of this remedy is subject to the normal rules of pleading and proof. A person who has delegated the duties of a secured party but who remains obligated to perform them is liable under this subsection. The last sentence of subsection (d) eliminates the possibility of double recovery or other over-compensation arising out of a reduction or elimination of a deciency under Section 9-626, based on noncompliance with the provisions of this Part relating to collection, enforcement, disposition, or acceptance. Assuming no double recovery, a debtor whose deciency is eliminated under Section 9-626 may pursue a claim for a surplus. Because Section 9-626 does not apply to consumer transactions, the statute is silent as to whether a double recovery or other over-compensation is possible in a consumer transaction. Damages for violation of the requirements of this Article, including Section 9-609, are those reasonably calculated to put an eligible claimant in the position that it would have occupied had no violation occurred. See Section 1-106. Subsection (b) supports the recovery of actual damages for committing a breach of the peace in violation of Section 9-609, and principles of tort law supplement this subsection. See Section 1-103. However, to the extent that damages in tort compensate the debtor for the same loss dealt with by this Article, the debtor should be entitled to only one recovery. 4. Minimum Damages in Consumer-Goods Transactions. Subsection (c)(2) provides a minimum, statutory, damage recovery for a debtor and secondary obligor in a consumergoods transaction. It is patterned on former Section 9-507(1) and is designed to ensure that every noncompliance with the requirements of Part 6 in a consumer-goods transaction results in liability, regardless of any injury that may have resulted. Subsection (c)(2) leaves the treatment of statutory damages as it was under former Article 9. A secured party is not liable for statutory damages under this subsection more than once with respect to any one secured obligation (see Section 9-628(e)), nor is a secured party liable under this subsection for failure to comply with Section 9-616 (see Section 9-628(d)). Following former Section 9-507(1), this Article does not include a denition or explanation of the terms credit service charge, principal amount, time-price dierential, or cash price, as used in subsection (c)(2). It leaves their construction and application to the court, taking into account the subsection's purpose of providing a minimum recovery in consumer-goods transactions. 5. Supplemental Damages. Subsections (e) and (f) provide damages that supplement the recovery, if any, under subsection (b). Subsection (e) imposes an additional $500 liability upon a person who fails to comply with the provisions specied in that subsection, and subsection (f) imposes like damages on a person who, without reasonable excuse, fails to comply with a request for an accounting or a request regarding a list of collateral or statement of account under Section 9-210. However, under subsection (f), a person has a reasonable excuse for the failure if the person never claimed an interest in the collateral or obligations that were the subject of the request. 6. Estoppel. Subsection (g) limits the extent to which a secured party who fails to comply with a request regarding a list of collateral or statement of account may claim a security interest.

9-626. Action in Which Deciency or Surplus Is in Issue. (a) [Applicable rules if amount of deciency or surplus in issue.] In an action arising from a transaction, other than a consumer transaction, in which the amount of a deciency or surplus is in issue, the following rules apply: (1) A secured party need not prove compliance with the provisions of this part relating to collection, enforcement, disposition, or acceptance unless the debtor or a secondary obligor places the secured party's compliance in issue.
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(2) If the secured party's compliance is placed in issue, the secured party has the burden of establishing that the collection, enforcement, disposition, or acceptance was conducted in accordance with this part. (3) Except as otherwise provided in Section 9-628, if a secured party fails to prove that the collection, enforcement, disposition, or acceptance was conducted in accordance with the provisions of this part relating to collection, enforcement, disposition, or acceptance, the liability of a debtor or a secondary obligor for a deciency is limited to an amount by which the sum of the secured obligation, expenses, and attorney's fees exceeds the greater of: (A) the proceeds of the collection, enforcement, disposition, or acceptance; or (B) the amount of proceeds that would have been realized had the noncomplying secured party proceeded in accordance with the provisions of this part relating to collection, enforcement, disposition, or acceptance. (4) For purposes of paragraph (3)(B), the amount of proceeds that would have been realized is equal to the sum of the secured obligation, expenses, and attorney's fees unless the secured party proves that the amount is less than that sum. (5) If a deciency or surplus is calculated under Section 9-615(f), the debtor or obligor has the burden of establishing that the amount of proceeds of the disposition is signicantly below the range of prices that a complying disposition to a person other than the secured party, a person related to the secured party, or a secondary obligor would have brought. (b) [Non-consumer transactions; no inference.] The limitation of the rules in subsection (a) to transactions other than consumer transactions is intended to leave to the court the determination of the proper rules in consumer transactions. The court may not infer from that limitation the nature of the proper rule in consumer transactions and may continue to apply established approaches. Ocial Comment
1. Source. New. 2. Scope. The basic damage remedy under Section 9-625(b) is subject to the special rules in this section for transactions other than consumer transactions. This section addresses situations in which the amount of a deciency or surplus is in issue, i.e., situations in which the secured party has collected, enforced, disposed of, or accepted the collateral. It contains special rules applicable to a determination of the amount of a deciency or surplus. Because this section aects a person's liability for a deciency, it is subject to Section 9-628, which should be read in conjunction with Section 9-605. The rules in this section apply only to noncompliance in connection with the collection, enforcement, disposition, or acceptance under Part 6. For other types of noncompliance with Part 6, the general liability rule of Section 9-625(b)recovery of actual damagesapplies. Consider, for example, a repossession that does not comply with Section 9-609 for want of a default. The debtor's remedy is under Section 9-625(b). In a proper case, the secured party also may be liable for conversion under non-UCC law. If the secured party thereafter disposed of the collateral, however, it would violate Section 9-610 at that time, and this section would apply. 3. Rebuttable Presumption Rule. Subsection (a) establishes the rebuttable presumption rule for transactions other than consumer transactions. Under paragraph (1), the secured party need not prove compliance with the relevant provisions of this Part as part of its prima facie case. If, however, the debtor or a secondary obligor raises the issue (in accor1080

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dance with the forum's rules of pleading and practice), then the secured party bears the burden of proving that the collection, enforcement, disposition, or acceptance complied. In the event the secured party is unable to meet this burden, then paragraph (3) explains how to calculate the deciency. Under this rebuttable presumption rule, the debtor or obligor is to be credited with the greater of the actual proceeds of the disposition or the proceeds that would have been realized had the secured party complied with the relevant provisions. If a deciency remains, then the secured party is entitled to recover it. The references to the secured obligation, expenses, and attorney's fees in paragraphs (3) and (4) embrace the application rules in Sections 9-608(a) and 9-615(a). Unless the secured party proves that compliance with the relevant provisions would have yielded a smaller amount, under paragraph (4) the amount that a complying collection, enforcement, or disposition would have yielded is deemed to be equal to the amount of the secured obligation, together with expenses and attorney's fees. Thus, the secured party may not recover any deciency unless it meets this burden. 4. Consumer Transactions. Although subsection (a) adopts a version of the rebuttable presumption rule for transactions other than consumer transactions, with certain exceptions Part 6 does not specify the eect of a secured party's noncompliance in consumer transactions. (The exceptions are the provisions for the recovery of damages in Section 9-625.) Subsection (b) provides that the limitation of subsection (a) to transactions other than consumer transactions is intended to leave to the court the determination of the proper rules in consumer transactions. It also instructs the court not to draw any inference from the limitation as to the proper rules for consumer transactions and leaves the court free to continue to apply established approaches to those transactions. Courts construing former Section 9-507 disagreed about the consequences of a secured party's failure to comply with the requirements of former Part 5. Three general approaches emerged. Some courts have held that a noncomplying secured party may not recover a deciency (the absolute bar rule). A few courts held that the debtor can oset against a claim to a deciency all damages recoverable under former Section 9-507 resulting from the secured party's noncompliance (the oset rule). A plurality of courts considering the issue held that the noncomplying secured party is barred from recovering a deciency unless it overcomes a rebuttable presumption that compliance with former Part 5 would have yielded an amount sucient to satisfy the secured debt. In addition to the nonuniformity resulting from court decisions, some States enacted special rules governing the availability of deciencies. 5. Burden of Proof When Section 9-615(f) Applies. In a non-consumer transaction, subsection (a)(5) imposes upon a debtor or obligor the burden of proving that the proceeds of a disposition are so low that, under Section 9-615(f), the actual proceeds should not serve as the basis upon which a deciency or surplus is calculated. Were the burden placed on the secured party, then debtors might be encouraged to challenge the price received in every disposition to the secured party, a person related to the secured party, or a secondary obligor. 6. Delay in Applying This Section. There is an inevitable delay between the time a secured party engages in a noncomplying collection, enforcement, disposition, or acceptance and the time of a subsequent judicial determination that the secured party did not comply with Part 6. During the interim, the secured party, believing that the secured obligation is larger than it ultimately is determined to be, may continue to enforce its security interest in collateral. If some or all of the secured indebtedness ultimately is discharged under this section, a reasonable application of this section would impose liability on the secured party for the amount of any excess, unwarranted recoveries but would not make the enforcement eorts wrongful.

9-627. Determination of Whether Conduct Was Commercially Reasonable. (a) [Greater amount obtainable under other circumstances; no preclusion of commercial reasonableness.] The fact that a greater amount could have been obtained by a collection, enforcement, disposition, or acceptance at a dierent time or in a dierent method from that selected by the secured party is not of itself sucient to preclude the secured party
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from establishing that the collection, enforcement, disposition, or acceptance was made in a commercially reasonable manner. (b) [Dispositions that are commercially reasonable.] A disposition of collateral is made in a commercially reasonable manner if the disposition is made: (1) in the usual manner on any recognized market; (2) at the price current in any recognized market at the time of the disposition; or (3) otherwise in conformity with reasonable commercial practices among dealers in the type of property that was the subject of the disposition. (c) [Approval by court or on behalf of creditors.] A collection, enforcement, disposition, or acceptance is commercially reasonable if it has been approved: (1) in a judicial proceeding; (2) by a bona de creditors' committee; (3) by a representative of creditors; or (4) by an assignee for the benet of creditors. (d) [Approval under subsection (c) not necessary; absence of approval has no eect.] Approval under subsection (c) need not be obtained, and lack of approval does not mean that the collection, enforcement, disposition, or acceptance is not commercially reasonable. Ocial Comment
1. Source. Former Section 9-507(2). 2. Relationship of Price to Commercial Reasonableness. Some observers have found the notion contained in subsection (a) (derived from former Section 9-507(2)) (the fact that a better price could have been obtained does not establish lack of commercial reasonableness) to be inconsistent with that found in Section 9-610(b) (derived from former Section 9-504(3)) (every aspect of the disposition, including its terms, must be commercially reasonable). There is no such inconsistency. While not itself sucient to establish a violation of this Part, a low price suggests that a court should scrutinize carefully all aspects of a disposition to ensure that each aspect was commercially reasonable. The law long has grappled with the problem of dispositions of personal and real property which comply with applicable procedural requirements (e.g., advertising, notication to interested persons, etc.) but which yield a price that seems low. This Article addresses that issue in Section 9-615(f). That section applies only when the transferee is the secured party, a person related to the secured party, or a secondary obligor. It contains a special rule for calculating a deciency or surplus in a complying disposition that yields a price that is signicantly below the range of proceeds that a complying disposition to a person other than the secured party, a person related to the secured party, or a secondary obligor would have brought. 3. Determination of Commercial Reasonableness; Advance Approval. It is important to make clear the conduct and procedures that are commercially reasonable and to provide a secured party with the means of obtaining, by court order or negotiation with a creditors' committee or a representative of creditors, advance approval of a proposed method of enforcement as commercially reasonable. This section contains rules that assist in that determination and provides for advance approval in appropriate situations. However, none of the specic methods of disposition specied in subsection (b) is required or exclusive. 4. Recognized Market. As in Sections 9-610(c) and 9-611(d), the concept of a recognized market in subsections (b)(1) and (2) is quite limited; it applies only to markets in which there are standardized price quotations for property that is essentially fungible, such as stock exchanges. 1082

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9-628. Nonliability and Limitation on Liability of Secured Party; Liability of Secondary Obligor. (a) [Limitation of liability of secured party for noncompliance with article.] Unless a secured party knows that a person is a debtor or obligor, knows the identity of the person, and knows how to communicate with the person: (1) the secured party is not liable to the person, or to a secured party or lienholder that has led a nancing statement against the person, for failure to comply with this article; and (2) the secured party's failure to comply with this article does not affect the liability of the person for a deciency. (b) [Limitation of liability based on status as secured party.] A secured party is not liable because of its status as secured party: (1) to a person that is a debtor or obligor, unless the secured party knows: (A) that the person is a debtor or obligor; (B) the identity of the person; and (C) how to communicate with the person; or (2) to a secured party or lienholder that has led a nancing statement against a person, unless the secured party knows: (A) that the person is a debtor; and (B) the identity of the person. (c) [Limitation of liability if reasonable belief that transaction not a consumer-goods transaction or consumer transaction.] A secured party is not liable to any person, and a person's liability for a deciency is not aected, because of any act or omission arising out of the secured party's reasonable belief that a transaction is not a consumergoods transaction or a consumer transaction or that goods are not consumer goods, if the secured party's belief is based on its reasonable reliance on: (1) a debtor's representation concerning the purpose for which collateral was to be used, acquired, or held; or (2) an obligor's representation concerning the purpose for which a secured obligation was incurred. (d) [Limitation of liability for statutory damages.] A secured party is not liable to any person under Section 9-625(c)(2) for its failure to comply with Section 9-616. (e) [Limitation of multiple liability for statutory damages.] A secured party is not liable under Section 9-625(c)(2) more than once with respect to any one secured obligation. Ocial Comment
1. Source. New. 2. Exculpatory Provisions. Subsections (a), (b), and (c) contain exculpatory provisions that should be read in conjunction with Section 9-605. Without this group of provisions, a secured party could incur liability to unknown persons and under circumstances that would not allow the secured party to protect itself. The broadened denition of the term debtor underscores the need for these provisions. If a secured party reasonably, but mistakenly, believes that a consumer transaction or 1083

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consumer-goods transaction is a non-consumer transaction or non-consumer-goods transaction, and if the secured party's belief is based on its reasonable reliance on a representation of the type specied in subsection (c)(1) or (c)(2), then this Article should be applied as if the facts reasonably believed and the representation reasonably relied upon were true. For example, if a secured party reasonably believed that a transaction was a non-consumer transaction and its belief was based on reasonable reliance on the debtor's representation that the collateral secured an obligation incurred for business purposes, the secured party is not liable to any person, and the debtor's liability for a deciency is not aected, because of any act or omission of the secured party which arises out of the reasonable belief. Of course, if the secured party's belief is not reasonable or, even if reasonable, is not based on reasonable reliance on the debtor's representation, this limitation on liability is inapplicable. 3. Inapplicability of Statutory Damages to Section 9-616. Subsection (d) excludes noncompliance with Section 9-616 entirely from the scope of statutory damage liability under Section 9-625(c)(2). 4. Single Liability for Statutory Minimum Damages. Subsection (e) ensures that a secured party will incur statutory damages only once in connection with any one secured obligation.

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

PART 7. TRANSITION
9-701. Eective Date. This [Act] takes eect on July 1, 2001. Ocial Comment
A uniform law as complex as Article 9 necessarily gives rise to dicult problems and uncertainties during the transition to the new law. As is customary for uniform laws, this Article is based on the general assumption that all States will have enacted substantially identical versions. While always important, uniformity is essential to the success of this Article. If former Article 9 is in eect in some jurisdictions, and this Article is in eect in others, horrendous complications may arise. For example, the proper place in which to le to perfect a security interest (and thus the status of a particular security interest as perfected or unperfected) would depend on whether the matter was litigated in a State in which former Article 9 was in eect or a State in which this Article was in eect. Accordingly, this section contemplates that States will adopt a uniform eective date for this Article. Any one State's failure to adopt the uniform eective date will greatly increase the cost and uncertainty surrounding the transition. Other problems arise from transactions and relationships that were entered into under former Article 9 or under non-UCC law and which remain outstanding on the eective date of this Article. The diculties arise primarily because this Article expands the scope of former Article 9 to cover additional types of collateral and transactions and because it provides new methods of perfection for some types of collateral, dierent priority rules, and dierent choice-of-law rules governing perfection and priority. This Section and the other sections in this Part address primarily this second set of problems.

9-702. Savings Clause. (a) [Pre-eective-date transactions or liens.] Except as otherwise provided in this part, this [Act] applies to a transaction or lien within its scope, even if the transaction or lien was entered into or created before this [Act] takes eect. (b) [Continuing validity.] Except as otherwise provided in subsection (c) and Sections 9-703 through 9-709: (1) transactions and liens that were not governed by [former Article 9],
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were validly entered into or created before this [Act] takes eect, and would be subject to this [Act] if they had been entered into or created after this [Act] takes eect, and the rights, duties, and interests owing from those transactions and liens remain valid after this [Act] takes effect; and (2) the transactions and liens may be terminated, completed, consummated, and enforced as required or permitted by this [Act] or by the law that otherwise would apply if this [Act] had not taken eect. (c) [Pre-eective-date proceedings.] This [Act] does not aect an action, case, or proceeding commenced before this [Act] takes eect. As amended in 2000.
See Appendix P for material relating to changes made in text in 2000.

Ocial Comment
1. Pre-Eective-Date Transactions. Subsection (a) contains the general rule that this Article applies to transactions, security interests, and other liens within its scope (see Section 9-109), even if the transaction or lien was entered into or created before the eective date. Thus, secured transactions entered into under former Article 9 must be terminated, completed, consummated, and enforced under this Article. Subsection (b) is an exception to the general rule. It applies to valid, pre-eective-date transactions and liens that were not governed by former Article 9 but would be governed by this Article if they had been entered into or created after this Article takes eect. Under subsection (b), these valid transactions, such as the creation of agricultural liens and security interests in commercial tort claims, retain their validity under this Article and may be terminated, completed, consummated, and enforced under this Article. However, these transactions also may be terminated, completed, consummated, and enforced by the law that otherwise would apply had this Article not taken eect. 2. Judicial Proceedings Commenced Before Eective Date. As is usual in transition provisions, subsection (c) provides that this Article does not aect litigation pending on the eective date.

9-703. Security Interest Perfected Before Eective Date. (a) [Continuing priority over lien creditor: perfection requirements satised.] A security interest that is enforceable immediately before this [Act] takes eect and would have priority over the rights of a person that becomes a lien creditor at that time is a perfected security interest under this [Act] if, when this [Act] takes eect, the applicable requirements for enforceability and perfection under this [Act] are satised without further action. (b) [Continuing priority over lien creditor: perfection requirements not satised.] Except as otherwise provided in Section 9-705, if, immediately before this [Act] takes eect, a security interest is enforceable and would have priority over the rights of a person that becomes a lien creditor at that time, but the applicable requirements for enforceability or perfection under this [Act] are not satised when this [Act] takes eect, the security interest: (1) is a perfected security interest for one year after this [Act] takes effect; (2) remains enforceable thereafter only if the security interest becomes enforceable under Section 9-203 before the year expires; and (3) remains perfected thereafter only if the applicable requirements for perfection under this [Act] are satised before the year expires.
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Ocial Comment
1. Perfected Security Interests Under Former Article 9 and This Article. This section deals with security interests that are perfected (i.e., that are enforceable and have priority over the rights of a lien creditor) under former Article 9 or other applicable law immediately before this Article takes eect. Subsection (a) provides, not surprisingly, that if the security interest would be a perfected security interest under this Article (i.e., if the transaction satises this Article's requirements for enforceability (attachment) and perfection), no further action need be taken for the security interest to be a perfected security interest. 2. Security Interests Enforceable and Perfected Under Former Article 9 but Unenforceable or Unperfected Under This Article. Subsection (b) deals with security interests that are enforceable and perfected under former Article 9 or other applicable law immediately before this Article takes eect but do not satisfy the requirements for enforceability (attachment) or perfection under this Article. Except as otherwise provided in Section 9-705, these security interests are perfected security interests for one year after the eective date. If the security interest satises the requirements for attachment and perfection within that period, the security interest remains perfected thereafter. If the security interest satises only the requirements for attachment within that period, the security interest becomes unperfected at the end of the one-year period. Example 1: A pre-eective-date security agreement in a consumer transaction covers all securities accounts. The security interest is properly perfected. The collateral description was adequate under former Article 9 (see former Section 9-115(3)) but is insucient under this Article (see Section 9-108(e)(2)). Unless the debtor authenticates a new security agreement describing the collateral other than by type (or Section 9-203(b) (3) otherwise is satised) within the one-year period following the eective date, the security interest becomes unenforceable at the end of that period. Other examples under former Article 9 or other applicable law that may be eective as attachment or enforceability steps but may be ineective under this Article include an oral agreement to sell a payment intangible or possession by virtue of a notication to a bailee under former Section 9-305. Neither the oral agreement nor the notication would satisfy the revised Section 9-203 requirements for attachment. Example 2: A pre-eective-date possessory security interest in instruments is perfected by a bailee's receipt of notication under former 9-305. The bailee has not, however, acknowledged that it holds for the secured party's benet under revised Section 9-313. Unless the bailee authenticates a record acknowledging that it holds for the secured party (or another appropriate perfection step is taken) within the one-year period following the eective date, the security interest becomes unperfected at the end of that period. 3. Interpretation of Pre-Eective-Date Security Agreements. Section 9-102 denes security agreement as an agreement that creates or provides for a security interest. Under Section 1-201(3), an agreement is a bargain of the parties in fact. If parties to a pre-eective-date security agreement describe the collateral by using a term dened in former Article 9 in one way and dened in this Article in another way, in most cases it should be presumed that the bargain of the parties contemplated the meaning of the term under former Article 9. Example 3: A pre-eective-date security agreement covers all accounts of a debtor. As dened under former Article 9, an account did not include a right to payment for lottery winnings. These rights to payment are accounts under this Article, however. The agreement of the parties presumptively created a security interest in accounts as dened in former Article 9. A dierent result might be appropriate, for example, if the security agreement explicitly contemplated future changes in the Article 9 denitions of types of collaterale.g., Accounts means accounts as dened in the UCC Article 9 of [State X], as that denition may be amended from time to time. Whether a dierent approach is appropriate in any given case depends on the bargain of the parties, as determined by applying ordinary principles of contract construction.

9-704. Security Interest Unperfected Before Eective Date. A security interest that is enforceable immediately before this [Act] takes eect but which would be subordinate to the rights of a person that becomes a lien creditor at that time:
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(1) remains an enforceable security interest for one year after this [Act] takes eect; (2) remains enforceable thereafter if the security interest becomes enforceable under Section 9-203 when this [Act] takes eect or within one year thereafter; and (3) becomes perfected: (A) without further action, when this [Act] takes eect if the applicable requirements for perfection under this [Act] are satised before or at that time; or (B) when the applicable requirements for perfection are satised if the requirements are satised after that time. Ocial Comment
This section deals with security interests that are enforceable but unperfected (i.e., subordinate to the rights of a person who becomes a lien creditor) under former Article 9 or other applicable law immediately before this Article takes eect. These security interests remain enforceable for one year after the eective date, and thereafter if the appropriate steps for attachment under this Article are taken before the one-year period expires. (This section's treatment of enforceability is the same as that of Section 9-703.) The security interest becomes a perfected security interest on the eective date if, at that time, the security interest satises the requirements for perfection under this Article. If the security interest does not satisfy the requirements for perfection until sometime thereafter, it becomes a perfected security interest at that later time. Example: A security interest has attached under former Article 9 but is unperfected because the led nancing statement covers all of debtor's personal property and controlling case law in the applicable jurisdiction has determined that this identication of collateral in a nancing statement is insucient. Upon the eective date of this Article, the nancing statement becomes sucient under Section 9-504(2). On that date the security interest becomes perfected. (This assumes, of course, that the nancing statement is led in the proper ling oce under this Article.)

9-705. Eectiveness of Action Taken Before Eective Date. (a) [Pre-eective-date action; one-year perfection period unless reperfected.] If action, other than the ling of a nancing statement, is taken before this [Act] takes eect and the action would have resulted in priority of a security interest over the rights of a person that becomes a lien creditor had the security interest become enforceable before this [Act] takes eect, the action is eective to perfect a security interest that attaches under this [Act] within one year after this [Act] takes eect. An attached security interest becomes unperfected one year after this [Act] takes eect unless the security interest becomes a perfected security interest under this [Act] before the expiration of that period. (b) [Pre-eective-date ling.] The ling of a nancing statement before this [Act] takes eect is eective to perfect a security interest to the extent the ling would satisfy the applicable requirements for perfection under this [Act]. (c) [Pre-eective-date ling in jurisdiction formerly governing perfection.] This [Act] does not render ineective an eective nancing statement that, before this [Act] takes eect, is led and satises the applicable requirements for perfection under the law of the jurisdiction governing perfection as provided in [former Section 9-103]. However, except as otherwise provided in subsections (d) and (e) and Section 9-706, the nancing statement ceases to be eective at the earlier of:
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(1) the time the nancing statement would have ceased to be eective under the law of the jurisdiction in which it is led; or (2) June 30, 2006. (d) [Continuation statement.] The ling of a continuation statement after this [Act] takes eect does not continue the eectiveness of the nancing statement led before this [Act] takes eect. However, upon the timely ling of a continuation statement after this [Act] takes eect and in accordance with the law of the jurisdiction governing perfection as provided in Part 3, the eectiveness of a nancing statement led in the same oce in that jurisdiction before this [Act] takes eect continues for the period provided by the law of that jurisdiction. (e) [Application of subsection (c)(2) to transmitting utility nancing statement.] Subsection (c)(2) applies to a nancing statement that, before this [Act] takes eect, is led against a transmitting utility and satises the applicable requirements for perfection under the law of the jurisdiction governing perfection as provided in [former Section 9-103] only to the extent that Part 3 provides that the law of a jurisdiction other than the jurisdiction in which the nancing statement is led governs perfection of a security interest in collateral covered by the nancing statement. (f) [Application of Part 5.] A nancing statement that includes a nancing statement led before this [Act] takes eect and a continuation statement led after this [Act] takes eect is eective only to the extent that it satises the requirements of Part 5 for an initial nancing statement. Ocial Comment
1. General. This section addresses primarily the situation in which the perfection step is taken under former Article 9 or other applicable law before the eective date of this Article, but the security interest does not attach until after that date. 2. Perfection Other Than by Filing. Subsection (a) applies when the perfection step is a step other than the ling of a nancing statement. If the step that would be a valid perfection step under former Article 9 or other law is taken before this Article takes eect, and if a security interest attaches within one year after this Article takes eect, then the security interest becomes a perfected security interest upon attachment. However, the security interest becomes unperfected one year after the eective date unless the requirements for attachment and perfection under this Article are satised within that period. 3. Perfection by Filing: Ineective Filings Made Eective. Subsection (b) deals with nancing statements that were led under former Article 9 and which would not have perfected a security interest under the former Article (because, e.g., they did not accurately describe the collateral or were led in the wrong place), but which would perfect a security interest under this Article. Under subsection (b), such a nancing statement is eective to perfect a security interest to the extent it complies with this Article. Subsection (b) applies regardless of the reason for the ling. For example, a secured party need not wait until the eective date to respond to the change this Article makes with respect to the jurisdiction whose law governs perfection of certain security interests. Rather, a secured party may wish to prepare for this change by ling a nancing statement before the eective date in the jurisdiction whose law governs perfection under this Article. When this Article takes effect, the ling becomes eective to perfect a security interest (assuming the ling satises the perfection requirements of this Article). Note, however, that Section 9-706 determines whether a nancing statement led before the eective date operates to continue the effectiveness of a nancing statement led in another oce before the eective date. 4. Perfection by Filing: Change in Applicable Law or Filing Oce. Subsection (c) provides that a nancing statement led in the proper jurisdiction under former Section 9-103 remains eective for all purposes, despite the fact that this Article would require ling of a nancing statement in a dierent jurisdiction or in a dierent oce in the same 1088

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jurisdiction. This means that, during the early years of this Article's eectiveness, it may be necessary to search not only in the ling oce of the jurisdiction whose law governs perfection under this Article but also (if dierent) in the jurisdiction(s) and ling oce(s) designated by Article 9. To limit this burden, subsection (c) provides that a nancing statement led in the jurisdiction determined by former Section 9-103 becomes ineective at the earlier of the time it would become ineective under the law of that jurisdiction or June 30, 2006. The June 30, 2006, limitation addresses some nonuniform versions of former Article 9 that extended the eectiveness of a nancing statement beyond ve years. Note that a nancing statement led before the eective date may remain eective beyond June 30, 2006, if subsection (d) (concerning continuation statements) or (e) (concerning transmitting utilities) or Section 9-706 (concerning initial nancing statements that operate to continue pre-eective-date nancing statements) so provides. Subsection (c) is an exception to Section 9-703(b). Under the general rule in Section 9-703(b), a security interest that is enforceable and perfected on the eective date of this Article is a perfected security interest for one year after this Article takes eect, even if the security interest is not enforceable under this Article and the applicable requirements for perfection under this Article have not been met. However, in some cases subsection (c) may shorten the one-year period of perfection; in others, if the security interest is enforceable under Section 9-203, it may extend the period of perfection. Example 1: On July 3, 1996, D, a State X corporation, creates a security interest in certain manufacturing equipment located in State Y. On July 6, 1996, SP perfects a security interest in the equipment under former Article 9 by ling in the oce of the State Y Secretary of State. See former Section 9-103(1)(b). This Article takes eect in States X and Y on July 1, 2001. Under Section 9-705(c), the nancing statement remains eective until it lapses in July 2001. See former Section 9-403. Had SP continued the eectiveness of the nancing statement by ling a continuation statement in State Y under former Article 9 before July 1, 2001, the nancing statement would have remained eective to perfect the security interest through June 30, 2006. See subsection (c)(2). Alternatively, SP could have led an initial nancing statement in State X under subsection (b) or Section 9-706 before the State Y nancing statement lapsed. Had SP done so, the security interest would have remained perfected without interruption until the State X nancing statement lapsed. 5. Continuing Eectiveness of Filed Financing Statement. A nancing statement led before the eective date of this Article may be continued only by ling in the State and oce designated by this Article. This result is accomplished in the following manner: Subsection (d) indicates that, as a general matter, a continuation statement led after the eective date of this Article does not continue the eectiveness of a nancing statement led under the law designated by former Section 9-103. Instead, an initial nancing statement must be led under Section 9-706. The second sentence of subsection (d) contains an exception to the general rule. It provides that a continuation statement is eective to continue the eectiveness of a nancing statement led before this Article takes eect if this Article prescribes not only the same jurisdiction but also the same ling oce. Example 2: On November 8, 2000, D, a State X corporation, creates a security interest in certain manufacturing equipment located in State Y. On November 15, 2000, SP perfects a security interest in the equipment under former Article 9 by ling in oce of the State Y Secretary of State. See former Section 9-103(1)(b). This Article takes eect in States X and Y on July 1, 2001. Under Section 9-705(c), the nancing statement ceases to be eective in November, 2005, when it lapses. See Section 9-515. Under this Article, the law of D's location (State X, see Section 9-307) governs perfection. See Section 9-301. Thus, the ling of a continuation statement in State Y after the eective date would not continue the eectiveness of the nancing statement. See subsection (d). However, the eectiveness of the nancing statement could be continued under Section 9-706. Example 3: The facts are as in Example 2, except that D is a State Y corporation. Assume State Y adopted former Section 9-401(1) (second alternative). State Y law governs perfection under Part 3 of this Article. (See Sections 9-301, 9-307.) Under the second sentence of subsection (d), the timely ling of a continuation statement in accordance with the law of State Y continues the eectiveness of the nancing statement. Example 4: The facts are as in Example 3, except that the collateral is equipment used in farming operations and, in accordance with former Section 9-401(1) (second alternative) as enacted in State Y, the nancing statement was led in State Y, in the of1089

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ce of the Shelby County Recorder of Deeds. Under this Article, a continuation statement must be led in the oce of the State Y Secretary of State. See Section 9-501(a)(2). Under the second sentence of subsection (d), the timely ling of a continuation statement in accordance with the law of State Y operates to continue a pre-eective-date nancing statement only if the continuation statement is led in the same oce as the nancing statement. Accordingly, the continuation statement is not eective in this case, but the nancing statement may be continued under Section 9-706. Example 5: The facts are as in Example 3, except that State Y enacted former Section 9-401(1) (third alternative). As required by former Section 9-401(1), SP led nancing statements in both the oce of the State Y Secretary of State and the oce of the Shelby County Recorder of Deeds. Under this Article, a continuation statement must be led in the oce of the State Y Secretary of State. See Section 9-501(a)(2). The timely ling of a continuation statement in that oce after this Article takes eect would be eective to continue the eectiveness of the nancing statement (and thus continue the perfection of the security interest), even if the nancing statement led with the County Recorder lapses. 6. Continuation Statements. In some cases, this Article reclassies collateral covered by a nancing statement led under former Article 9. For example, collateral consisting of the right to payment for real property sold would be a general intangible under the former Article but an account under this Article. To continue perfection under those circumstances, a continuation statement must comply with the normal requirements for a continuation statement. See Section 9-515. In addition, the pre-eective-date nancing statement and continuation statement, taken together, must satisfy the requirements of this Article concerning the suciency of the debtor's name, secured party's name, and indication of collateral. See subsection (f). Example 6: A pre-eective-date nancing statement covers all general intangibles of a debtor. As dened under former Article 9, a general intangible, would include rights to payment for lottery winnings. These rights to payment are accounts under this Article, however. A post-eective-date continuation statement will not continue the eectiveness of the pre-eective-date nancing statement with respect to lottery winnings unless it amends the indication of collateral covered to include lottery winnings (e.g., by adding accounts, rights to payment for lottery winnings, or the like). If the continuation statement does not amend the indication of collateral, the continuation statement will be eective to continue the eectiveness of the nancing statement only with respect to general intangibles as dened in this Article. Example 7: The facts are as in Example 6, except that the pre-eective-date nancing statement covers all accounts and general intangibles. Even though rights to payment for lottery winnings are general intangibles under former Article 9 and accounts under this Article, a post-eective-date continuation statement would continue the effectiveness of the pre-eective-date nancing statement with respect to lottery winnings. There would be no need to amend the indication of collateral covered, inasmuch as the indication (accounts) satises the requirements of this Article.

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

9-706. When Initial Financing Statement Suces to Continue Eectiveness of Financing Statement. (a) [Initial nancing statement in lieu of continuation statement.] The ling of an initial nancing statement in the oce specied in Section 9-501 continues the eectiveness of a nancing statement led before this [Act] takes eect if: (1) the ling of an initial nancing statement in that oce would be eective to perfect a security interest under this [Act]; (2) the pre-eective-date nancing statement was led in an oce in another State or another oce in this State; and
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(3) the initial nancing statement satises subsection (c). (b) [Period of continued eectiveness.] The ling of an initial nancing statement under subsection (a) continues the eectiveness of the preeective-date nancing statement: (1) if the initial nancing statement is led before this [Act] takes effect, for the period provided in [former Section 9-403] with respect to a nancing statement; and (2) if the initial nancing statement is led after this [Act] takes effect, for the period provided in Section 9-515 with respect to an initial nancing statement. (c) [Requirements for initial nancing statement under subsection (a).] To be eective for purposes of subsection (a), an initial nancing statement must: (1) satisfy the requirements of Part 5 for an initial nancing statement; (2) identify the pre-eective-date nancing statement by indicating the oce in which the nancing statement was led and providing the dates of ling and le numbers, if any, of the nancing statement and of the most recent continuation statement led with respect to the nancing statement; and (3) indicate that the pre-eective-date nancing statement remains eective. Ocial Comment
1. Continuation of Financing Statements Not Filed in Proper Filing Oce Under This Article. This section deals with continuing the eectiveness of nancing statements that are led in the proper State and oce under former Article 9, but which would be led in the wrong State or in the wrong oce of the proper State under this Article. Section 9-705(d) provides that, under these circumstances, ling a continuation statement after the eective date of this Article in the oce designated by former Article 9 would not be eective. This section provides the means by which the eectiveness of such a nancing statement can be continued if this Article governs perfection under the applicable choice-oflaw rule: ling an initial nancing statement in the oce specied by Section 9-501. Although it has the eect of continuing the eectiveness of a pre-eective-date nancing statement, an initial nancing statement described in this section is not a continuation statement. Rather, it is governed by the rules applicable to initial nancing statements. (However, the debtor need not authorize the ling. See Section 9-708.) Unlike a continuation statement, the initial nancing statement described in this section may be led any time during the eectiveness of the pre-eective-date nancing statementeven before this Article is enactedand not only within the six months immediately prior to lapse. In contrast to a continuation statement, which extends the lapse date of a led nancing statement for ve years, the initial nancing statement has its own lapse date, which bears no relation to the lapse date of the pre-eective-date nancing statement whose eectiveness the initial nancing statement continues. See subsection (b). As subsection (a) makes clear, the ling of an initial nancing statement under this section continues the eectiveness of a pre-eective-date nancing statement. If the eectiveness of a pre-eective-date nancing statement lapses before the initial nancing statement is led, the eectiveness of the pre-eective-date nancing statement cannot be continued. Rather, unless the security interest is perfected otherwise, there will be a period during which the security interest is unperfected before becoming perfected again by the ling of the initial nancing statement under this section. If an initial nancing statement is led under this section before the eective date of this Article, it takes eect when this Article takes eect (assuming that it is ineective under former Article 9). Note, however, that former Article 9 determines whether the ling oce 1091

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is obligated to accept such an initial nancing statement. For the reason given in the preceding paragraph, an initial nancing statement led before the eective date of this Article does not continue the eectiveness of a pre-eective-date nancing statement unless the latter remains eective on the eective date of this Article. Thus, for example, if the effectiveness of the pre-eective-date nancing statement lapses before this Article takes effect, the initial nancing statement would not continue its eectiveness. 2. Requirements of Initial Financing Statement Filed in Lieu of Continuation Statement. Subsection (c) sets forth the requirements for the initial nancing statement under subsection (a). These requirements are needed to inform searchers that the initial nancing statement operates to continue a nancing statement led elsewhere and to enable searchers to locate and discover the attributes of the other nancing statement. A single initial nancing statement may continue the eectiveness of more than one nancing statement led before this Article's eective date. See Section 1-102(5)(a) (words in the singular include the plural). If a nancing statement has been led in more than one oce in a given jurisdiction, as may be the case if the jurisdiction had adopted former Section 9-401(1), third alternative, then an identication of the ling in the central ling oce sufces for purposes of subsection (c)(2). If under this Article the collateral is of a type dierent from its type under former Article 9as would be the case, e.g., with a right to payment of lottery winnings (a general intangible under former Article 9 and an account under this Article), then subsection (c) requires that the initial nancing statement indicate the type under this Article.

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

9-707. Amendment of Pre-Eective-Date Financing Statement. (a) [Pre-eective-date nancing statement.] In this section, Preeective-date nancing statement means a nancing statement led before this [Act] takes eect. (b) [Applicable law.] After this [Act] takes eect, a person may add or delete collateral covered by, continue or terminate the eectiveness of, or otherwise amend the information provided in, a pre-eective-date nancing statement only in accordance with the law of the jurisdiction governing perfection as provided in Part 3. However, the eectiveness of a preeective-date nancing statement also may be terminated in accordance with the law of the ,jurisdiction in which the nancing statement is led. (c) [Method of amending: general rule.] Except as otherwise provided in subsection (d), if the law of this State governs perfection of a security interest, the information in a pre-eective-date nancing statement may be amended after this [Act] takes eect only if: (1) the pre-eective-date nancing statement and an amendment are led in the oce specied in Section 9-501; (2) an amendment is led in the oce specied in Section 9-501 concurrently with, or after the ling in that oce of, an initial nancing statement that satises Section 9-706(c); or (3) an initial nancing statement that provides the information as amended and satises Section 9-706(c) is led in the oce specied in Section 9-501. (d) [Method of amending: continuation.] If the law of this State governs perfection of a security interest, the eectiveness of a pre-eectivedate nancing statement may be continued only under Section 9-705(d) and (f) or 9-706.
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(e) [Method of amending: additional termination rule.] Whether or not the law of this State governs perfection of a security interest, the effectiveness of a pre-eective-date nancing statement led in this State may be terminated after this [Act] takes eect by ling a termination statement in the oce in which the pre-eective-date nancing statement is led, unless an initial nancing statement that satises Section 9-706(c) has been led in the oce specied by the law of the jurisdiction governing perfection as provided in Part 3 as the oce in which to le a nancing statement. As added in 2000.
See Appendix P for material relating to adoption of section in 2000.

Ocial Comment
1. Scope of This Section. This section addresses post-eective-date amendments to preeective-date nancing statements. 2. Applicable Law. Determining how to amend a pre-eective-date nancing statement requires one rst to determine the jurisdiction whose law applies. Subsection (b) provides that, as a general matter, post-eective-date amendments to pre-eective-date nancing statements are eective only if they are accomplished in accordance with the substantive (or local) law of the jurisdiction governing perfection under Part 3 of this Article. However, under certain circumstances, the eectiveness of a nancing statement may be terminated in accordance with the substantive law of the jurisdiction in which the nancing statement is led. See Comment 5, below. Example 1: D is a corporation organized under the law of State Y. It owns equipment located in State X. Under former Article 9, SP properly perfected a security interest in the equipment by ling a nancing statement in State X. Under this Article, the law of State Y governs perfection of the security interest. See Sections 9-301, 9-307. After this Article takes eect, SP wishes to amend the nancing statement to reect a change in D's name. Under subsection (b), the nancing statement may be amended in accordance with the law of State Y, i.e., in accordance with subsection (c) as enacted in State Y. Example 2: The facts are as in Example 1, except that SP wishes to terminate the effectiveness of the State X ling. The rst sentence of subsection (b) provides that the nancing statement may be terminated after the eective date of this Article in accordance with the law of State Y, i.e., in accordance with subsection (c) as enacted in State Y. However, the second sentence provides that the nancing statement also may be terminated in accordance with the law of the jurisdiction in which it is led, i.e., in accordance with subsection (e) as enacted in State X. If the pre-eective-date nancing statement is led in the jurisdiction whose law governs perfection (here, State Y), then both sentences would designate the law of State Y as applicable to the termination of the nancing statement. That is, the nancing statement could be terminated in accordance with subsection (c) or (e) as enacted in State Y. 3. Method of Amending. Subsection (c) provides three methods of eectuating a posteective-date amendment to a pre-eective-date nancing statement. Under subsection (c)(1), if the nancing statement is led in the jurisdiction and oce determined by this Article, then an eective amendment may be led in the same oce. Example 3: D is a corporation organized under the law of State Z. It owns equipment located in State Z. Before the eective date of this Article, SP perfected a security interest in the equipment by ling in two oces in State Z, a local ling oce and the oce of the Secretary of State. See former Section 9-401(1) (third alternative). State Z enacts this Article and species in Section 9-501 that a nancing statement covering equipment is to be led in the oce of the Secretary of State. SP wishes to assign its power as secured party of record. Under subsection (b), the substantive law of State Z applies. Because the pre-eective-date nancing statement is led in the oce specied in subsection (c)(1) as enacted by State Z, SP may eectuate the assignment by ling an amendment under Section 9-514 with the oce of the Secretary of State. SP need not amend the local ling, and the priority of the security interest perfected by the ling of the nancing statement would not be aected by the failure to amend the local ling. 1093

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If a pre-eective-date nancing statement is led in an oce other than the one specied by Section 9-501 of the relevant jurisdiction, then ordinarily an amendment led in that ofce is ineective. (Subsection (e) provides an exception for termination statements.) Rather, the amendment must be eectuated by a ling in the jurisdiction and oce determined by this Article. That ling may consist of an initial nancing statement followed by an amendment, an initial nancing statement together with an amendment, or an initial nancing statement that indicates the information provided in the nancing statement, as amended. Subsection (c)(2) encompasses the rst two options; subsection (c)(3) contemplates the last. In each instance, the initial nancing statement must satisfy Section 9-706(c). 4. Continuation. Subsection (d) refers to the two methods by which a secured party may continue the eectiveness of a pre-eective-date nancing statement under this Part. The Comments to Sections 9-705 and 9-706 explain these methods. 5. Termination. The eectiveness of a pre-eective-date nancing statement may be terminated pursuant to subsection (c). This section also provides an alternative method for accomplishing this result: ling a termination statement in the oce in which the nancing statement is led. The alternative method becomes unavailable once an initial nancing statement that relates to the pre-eective-date nancing statement and satises Section 9-706(c) is led in the jurisdiction and oce determined by this Article. Example 4: The facts are as in Example 1, except that SP wishes to terminate a nancing statement led in State X. As explained in Example 1, the nancing statement may be amended in accordance with the law of the jurisdiction governing perfection under this Article, i.e., in accordance with the substantive law of State Y. As enacted in State Y, subsection (c)(1) is inapplicable because the nancing statement was not led in the State Y ling oce specied in Section 9-501. Under subsection (c)(2), the nancing statement may be amended by ling in the State Y ling oce an initial nancing statement followed by a termination statement. The ling of an initial nancing statement together with a termination statement also would be legally sucient under subsection (c)(2), but Section 9-512(a)(1) may render this method impractical. The nancing statement also may be amended under subsection (c)(3), but the resulting initial nancing statement is likely to be very confusing. In each instance, the initial nancing statement must satisfy Section 9-706(c). Applying the law of State Y, subsection (e) is inapplicable, because the nancing statement was not led in this State, i.e., State Y. This section aords another option to SP. Subsection (b) provides that the eectiveness of a nancing statement may be terminated either in accordance with the law of the jurisdiction governing perfection (here, State Y) or in accordance with the substantive law of the jurisdiction in which the nancing statement is led (here, State X). Applying the law of State X, the nancing statement is led in this State, i.e., State X, and subsection (e) applies. Accordingly, the eectiveness of the nancing statement can be terminated by ling a termination statement in the State X oce in which the nancing statement is led, unless an initial nancing statement that relates to the nancing statement and satises Section 9-706(c) as enacted in State X has been led in the jurisdiction and oce determined by this Article (here, the State Y ling oce).

As amended in 2000.
See Appendix P for material relating to changes made in Ocial Comment in 2000.

9-708. Persons Entitled to File Initial Financing Statement or Continuation Statement. A person may le an initial nancing statement or a continuation statement under this part if: (1) the secured party of record authorizes the ling; and (2) the ling is necessary under this part: (A) to continue the eectiveness of a nancing statement led before this [Act] takes eect; or (B) to perfect or continue the perfection of a security interest. As amended in 2000.
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See Appendix P for material relating to changes made in 2000.

Ocial Comment
This section permits a secured party to le an initial nancing statement or continuation statement necessary under this Part to continue the eectiveness of a nancing statement led before this Article takes eect or to perfect or otherwise continue the perfection of a security interest. Because a ling described in this section typically operates to continue the eectiveness of a nancing statement whose ling the debtor already has authorized, this section does not require authorization from the debtor.

9-709. Priority. (a) [Law governing priority.] This [Act] determines the priority of conicting claims to collateral. However, if the relative priorities of the claims were established before this [Act] takes eect, [former Article 9] determines priority. (b) [Priority if security interest becomes enforceable under Section 9-203.] For purposes of Section 9-322(a), the priority of a security interest that becomes enforceable under Section 9-203 of this [Act] dates from the time this [Act] takes eect if the security interest is perfected under this [Act] by the ling of a nancing statement before this [Act] takes eect which would not have been eective to perfect the security interest under [former Article 9]. This subsection does not apply to conicting security interests each of which is perfected by the ling of such a nancing statement. As amended in 2000.
See Appendix P for material relating to changes made in 2000.

Ocial Comment
1. Law Governing Priority. Ordinarily, this Article determines the priority of conicting claims to collateral. However, when the relative priorities of the claims were established before this Article takes eect, former Article 9 governs. Example 1: In 1999, SP-1 obtains a security interest in a right to payment for goods sold (account). SP-1 fails to le a nancing statement. This Article takes eect on July 1, 2001. Thereafter, on August 1, 2001, D creates a security interest in the same account in favor of SP-2, who les a nancing statement. This Article determines the relative priorities of the claims. SP-2's security interest has priority under Section 9-322(a)(1). Example 2: In 1999, SP-1 obtains a security interest in a right to payment for goods sold (account). SP-1 fails to le a nancing statement. In 2000, D creates a security interest in the same account in favor of SP-2, who likewise fails to le a nancing statement. This Article takes eect on July 1, 2001. Because the relative priorities of the security interests were established before the eective date of this Article, former Article 9 governs priority, and SP-1's security interest has priority under former Section 9-312(5)(b). Example 3: The facts are as in Example 2, except that, on August 1, 2001, SP-2 les a proper nancing statement under this Article. Until August 1, 2001, the relative priorities of the security interests were established before the eective date of this Article, as in Example 2. However, by taking the armative step of ling a nancing statement, SP-2 established anew the relative priority of the conicting claims after the eective date. Thus, this Article determines priority. SP-2's security interest has priority under Section 9-322(a)(1). As Example 3 illustrates, relative priorities that are established before the eective date do not necessarily remain unchanged following the eective date. Of course, unlike priority contests among unperfected security interests, some priorities are established permanently, e.g., the rights of a buyer of property who took free of a security interest under former Article 9. One consequence of the rule in subsection (a) is that the mere taking eect of this Article 1095

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does not of itself adversely aect the priority of conicting claims to collateral. Example 4: In 1999, SP-1 obtains a security interest in a right to payment for lottery winnings (a general intangible as dened in former Article 9 but an account as dened in this Article). SP-1's security interest is unperfected because its led nancing statement covers only accounts. In 2000, D creates a security interest in the same right to payment in favor of SP-2, who les a nancing statement covering accounts and general intangibles. Before this Article takes eect on July 1, 2001, SP-2's perfected security interest has priority over SP-1's unperfected security interest under former 9-312(5). Because the relative priorities of the security interests were established before the eective date of this Article, former Article 9 continues to govern priority after this Article takes eect. Thus, SP-2's priority is not adversely aected by this Article's having taken eect. Note that were this Article to govern priority, SP-2 would become subordinated to SP-1 under Section 9-322(a)(1), even though nothing changes other than this Article's having taken eect. Under Section 9-704, SP-1's security interest would become perfected; the nancing statement covering accounts adequately covers the lottery winnings and complies with the other perfection requirements of this Article, e.g., it is led in the proper oce. Example 5: In 1999, SP-1 obtains a security interest in a right to payment for lottery winningsa general intangible (as dened under former Article 9). SP-1's security interest is unperfected because its led nancing statement covers only accounts. In 2000, D creates a security interest in the same right to payment in favor of SP-2, who makes the same mistake and also les a nancing statement covering only accounts. Before this Article takes eect on July 1, 2001, SP-1's unperfected security interest has priority over SP-2's unperfected security interest, because SP-1's security interest was the rst to attach. See former Section 9-312(5)(b). Because the relative priorities of the security interests were established before the eective date of this Article, former Article 9 continues to govern priority after this Article takes eect. Although Section 9-704 makes both security interests perfected for purposes of this Article, both are unperfected under former Article 9, which determines their relative priorities. 2. Financing Statements Ineective Under Former Article 9 but Eective Under This Article. If this Article determines priority, subsection (b) may apply. It deals with the case in which a ling that occurs before the eective date of this Article would be ineective to perfect a security interest under former Article 9 but eective under this Article. For purposes of Section 9-322(a), the priority of a security interest that attaches after this Article takes eect and is perfected in this manner dates from the time this Article takes eect. Example 6: In 1999, SP-1 obtains a security interest in D's existing and afteracquired instruments and les a nancing statement covering instruments. In 2000, D grants a security interest in its existing and after-acquired accounts in favor of SP-2, who les a nancing statement covering accounts. After this Article takes eect on July 1, 2001, one of D's account debtors gives D a negotiable note to evidence its obligation to pay an overdue account. Under the rst-to-le-or-perfect rule in Section 9-322(a), SP-1 would have priority in the instrument, which constitutes SP-2's proceeds. SP-1's ling in 1999 was earlier than SP-2's in 2000. However, subsection (b) provides that, for purposes of Section 9-322(a), SP-1's priority dates from the time this Article takes eect (July 1, 2001). Under Section 9-322(b), SP-2's priority with respect to the proceeds (instrument) dates from its ling as to the original collateral (accounts). Accordingly, SP2's security interest would be senior. Subsection (b) does not apply to conicting security interests each of which is perfected by a pre-eective-date ling that was not eective under former Article 9 but is eective under this Article. Example 7: In 1999, SP-1 obtains a security interest in D's existing and afteracquired instruments and les a nancing statement covering instruments. In 2000, D grants a security interest in its existing and after-acquired instruments in favor of SP-2, who les a nancing statement covering instruments. After this Article takes eect on July 1, 2001, one of D's account debtors gives D a negotiable note to evidence its obligation to pay an overdue account. Under the rst-to-le-or-perfect rule in Section 9-322(a), SP-1 would have priority in the instrument. Both lings are eective under this Article, see Section 9-705(b), and SP-1's ling in 1999 was earlier than SP-2's in 2000. Subsec1096

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tion (b) does not change this result.

APPENDIX I. CONFORMING AMENDMENTS TO OTHER ARTICLES

1-105. Territorial Application of the Act; Parties' Power to Choose Applicable Law. * * * (2) Where one of the following provisions of this Act species the applicable law, that provision governs and a contrary agreement is eective only to the extent permitted by the law (including the conict of laws rules) so specied: Rights of creditors against sold goods. Section 2-402. Applicability of the Article on Leases. Sections 2A-105 and 2A-106. Applicability of the Article on Bank Deposits and Collections. Section 4-102. Governing law in the Article on Funds Transfers. Section 4A-507. Letters of Credit. Section 5-116. Bulk sales subject to the Article on Bulk Sales. Section 6-103. [If a State adopts the repealer of Article 6, then this item should be deleted.] Applicability of the Article on Investment Securities. Section 8-110. Perfection provisions of the Article on Secured Transactions. Section 9-103. Law governing perfection, the eect of perfection or nonperfection, and the priority of security interests and agricultural liens. Sections 9-301 through 9-307. Ocial Comment * * *
6. Section 9-103 Sections 9-301 through 9-307 should be consulted as to the rules for perfection of security interests and agricultural liens and the eects, the eect of perfection and nonperfection, and priority.

1-201. General Denitions. Subject to additional denitions contained in the subsequent Articles of this Act which are applicable to specic Articles or Parts thereof, and unless the context otherwise requires, in this Act: * * * (9) Buyer in ordinary course of business means a person who that buys goods in good faith, and without knowledge that the sale to him is in violation of violates the ownership rights or security interest of a third party another person in the goods, and buys in the ordinary course from a person, other than a pawnbroker, in the business of selling goods of that kind but does not include a pawnbroker. All persons who sell minerals or the like (including oil and gas) at wellhead or minehead shall be deemed to be persons A person buys goods in the ordinary course if the sale to the person comports with the usual or customary practices in the kind of business in which the seller is engaged or with the seller's own usual or customary practices. A person that sells oil, gas, or other
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minerals at the wellhead or minehead is a person in the business of selling goods of that kind. Buying A buyer in ordinary course of business may be buy for cash, or by exchange of other property, or on secured or unsecured credit, and includes receiving may acquire goods or documents of title under a pre-existing contract for sale but does not include a transfer in bulk or as security for or in total or partial satisfaction of a money debt. Only a buyer that takes possession of the goods or has a right to recover the goods from the seller under Article 2 may be a buyer in ordinary course of business. A person that acquires goods in a transfer in bulk or as security for or in total or partial satisfaction of a money debt is not a buyer in ordinary course of business. * * * (32) Purchase includes taking by sale, discount, negotiation, mortgage, pledge, lien, security interest, issue or re-issue, gift, or any other voluntary transaction creating an interest in property. * * * (37) Security interest means an interest in personal property or xtures which secures payment or performance of an obligation. The retention or reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer (Section 2-401) is limited in eect to a reservation of a security interest. The term also includes any interest of a consignor and a buyer of accounts, or chattel paper, which a payment intangible, or a promissory note in a transaction that is subject to Article 9. The special property interest of a buyer of goods on identication of those goods to a contract for sale under Section 2-40 is not a security interest, but a buyer may also acquire a security interest by complying with Article 9. Unless a consignment is intended as security, reservation of title thereunder is not a security interest, but a consignment in any event is subject to the provisions on consignment sales (Section 2-326). Except as otherwise provided in Section 2-505, the right of a seller or lessor of goods under Article 2 or 2A to retain or acquire possession of the goods is not a security interest, but a seller or lessor may also acquire a security interest by complying with Article 9. The retention or reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer (Section 2-401) is limited in eect to areservation of a security interest. * * * Ocial Comment * * *
9. Buyer in Ordinary Course of Business. From Section 1, Uniform Trust Receipts Act. The denition has been expanded to make clear the type of person protected. Its major signicance lies in Section 2-403 and in the Article on Secured Transactions (Article 9). The reference to minerals and the like makes clear that a buyer in ordinary course buying minerals under the circumstances described takes free of a prior mortgage created by the sellers. See Comment to Section 9-103. A pawnbroker cannot be a buyer in ordinary course of business because the person from whom he buys goods (or acquires ownership after foreclosing an initial pledge) is typically an ordinary user and not a person engaged in selling goods of that kind. The rst sentence of paragraph (9) makes clear that a buyer from a pawnbroker cannot be a buyer in ordinary course of business. The second sentence tracks Section 6-102(1)(m). It explains what it means to buy in the ordinary course. The penultimate sentence prevents a 1098

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buyer that does not have the right to possession as against the seller from being a buyer in ordinary course of business. Concerning when a buyer obtains possessory rights, see Sections 2-502 and 2-716. However, the penultimate sentence is not intended to aect a buyer's status as a buyer in ordinary course of business in cases (such as a drop shipment) involving delivery by the seller to a person buying from the buyer or a donee from the buyer. The requirement relates to whether as against the seller the buyer or one taking through the buyer has possessory rights.

* * *
32. Purchase. Section 58, Uniform Warehouse Receipts Act; Section 76, Uniform Sales Act; Section 53, Uniform Bills of Lading Act; Section 22, Uniform Stock Transfer Act; Section 1, Uniform Trust Receipts Act. Rephrased. With the addition of taking by . . . security interest, the revised denition makes explicit what formerly was implicit.

* * *
37. Security Interest. See Section 1, Uniform Trust Receipts Act. The present denition is elaborated, in view especially of the complete coverage of the subject in Article 9. Notice that in view of the Article the term includes the interest of certain outright buyers of certain kinds of property. Section 1-201(37) is being amended at the same time that the Article on Leases (Article 2A) is being promulgated as an amendment to this Act. The denition of security interest was revised in connection with the promulgation of Article 2A and also to take account of the expanded scope of Article 9 as revised in the 1998 Ocial Text. It includes the interest of a consignor and the interest of a buyer of accounts, chattel paper, payment intangibles, or promissory notes. See Section 9-109. It also makes clear that, with certain exceptions, in rem rights of sellers and lessors under Articles 2 and 2A are not security interests. Among the rights that are not security interests are the right to withhold delivery under Section 2-702(1), 2-703(a), or 2A-525, the right to stop delivery under Section 2-705 or 2A-526, and the right to reclaim under Section 2-507(2) or 2-702(2).

* * * 2-103. Denitions and Index of Denitions. * * * (3) The following denitions in other Articles apply to this Article: Check. Section 3-104. Consignee. Section 7-102. Consignor. Section 7-102. Consumer goods. Section 9-109 9-102. Dishonor. Section 3-507 3-502. Draft. Section 3-104. * * * 2-210. Delegation of Performance; Assignment of Rights. * * * (2) Unless Except as otherwise provided in Section 9-406, unless otherwise agreed, all rights of either seller or buyer can be assigned except where the assignment would materially change the duty of the other party, or increase materially the burden or risk imposed on him by his contract, or impair materially his chance of obtaining return performance. A right to damages for breach of the whole contract or a right arising out of the assignor's due performance of his entire obligation can be assigned despite agreement otherwise. (3) The creation, attachment, perfection, or enforcement of a security interest in the seller's interest under a contract is not a transfer that materially changes the duty of or increases materially the burden or risk imposed
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on the buyer or impairs materially the buyer's chance of obtaining return performance within the purview of subsection (2) unless, and then only to the extent that, enforcement actually results in a delegation of material performance of the seller. Even in that event, the creation, attachment, perfection, and enforcement of the security interest remain eective, but (i) the seller is liable to the buyer for damages caused by the delegation to the extent that the damages could not reasonably be prevented by the buyer, and (ii) a court having jurisdiction may grant other appropriate relief, including cancellation of the contract for sale or an injunction against enforcement of the security interest or consummation of the enforcement. * * *
Legislative Note: Succeeding subsections must be renumbered.

Ocial Comment
3. Under subsection (2) rights which are no longer executory such as a right to damages for breach or a right to payment of an account as dened in the Article on Secured Transactions (Article 9) may be assigned although the agreement prohibits assignment. In such cases no question of delegation of any performance is involved. The assignment of a contract right as dened in the Article on Secured Transactions (Article 9) is not covered by this subsection. Subsection (2) is subject to Section 9-406, which makes rights to payment for goods sold (accounts), whether or not earned, freely alienable notwithstanding a contrary agreement or rule of law.

* * * 2-312. Warranty of Title and Against Infringement; Buyer's Obligation Against Infringement. * * * Ocial Comment * * *
5. Subsection (2) recognizes that sales by sheris, executors, certain foreclosing lienors and persons similarly situated are may be so out of the ordinary commercial course that their peculiar character is immediately apparent to the buyer and therefore no personal obligation is imposed upon the seller who is purporting to sell only an unknown or limited right. This subsection does not touch upon and leaves open all questions of restitution arising in such cases, when a unique article so sold is reclaimed by a third party as the rightful owner. Foreclosure sales under Article 9 are another matter. Section 9-610 provides that a disposition of collateral under that section includes warranties such as those imposed by this section on a voluntary disposition of property of the kind involved. Consequently, unless properly excluded under subsection (2) or under the special provisions for exclusion in Section 9-610, a disposition under Section 9-610 of collateral consisting of goods includes the warranties imposed by subsection (1) and, if applicable, subsection (3).

* * * 2-326. Sale on Approval and Sale or Return; Consignment Sales and Rights of Creditors. (1) Unless otherwise agreed, if delivered goods may be returned by the buyer even though they conform to the contract, the transaction is (a) a sale on approval if the goods are delivered primarily for use, and (b) a sale or return if the goods are delivered primarily for resale. (2) Except as provided in subsection (3), goods Goods held on approval are not subject to the claims of the buyer's creditors until acceptance;
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goods held on sale or return are subject to such claims while in the buyer's possession. (3) Where goods are delivered to a person for sale and such person maintains a place of business at which he deals in goods of the kind involved, under a name other than the name of the person making delivery, then with respect to claims of creditors of the person conducting the business the goods are deemed to be on sale or return. The provisions of this subsection are applicable even though an agreement purports to reserve title to the person making delivery until payment or resale or uses such words as on consignment or on memorandum. However, this subsection is not applicable if the person making delivery (a) complies with an applicable law providing for a consignor's interest or the like to be evidenced by a sign, or (b) establishes that the person conducting the business is generally known by his creditors to be substantially engaged in selling the goods of others, or (c) complies with the ling provisions of the Article on Secured Transactions (Article 9). (4)(3) Any or return term of a contract for sale is to be treated as a separate contract for sale within the statute of frauds section of this Article (Section 2-201) and as contradicting the sale aspect of the contract within the provisions of this Article on parol or extrinsic evidence (Section 2-202). Ocial Comment
1. A Both a sale on approval or and a sale or return is distinct should be distinguished from other types of transactions with which they frequently have frequently been confused. The type of sale on approval, on trial or on satisfaction dealt A sale on approval, sometimes also called a sale on trial or on satisfaction, deals with a contract under which the seller undertakes a particular business risk in order to satisfy his its prospective buyer with the appearance or performance of the goods in question that are sold. The goods are delivered to the proposed purchaser but they remain the property of the seller until the buyer accepts them. The price has already been agreed. The buyer's willingness to receive and test the goods is the consideration for the seller's engagement to deliver and sell. The type of sale or return involved herein A sale or return, on the other hand, typically is a sale to a merchant whose unwillingness to buy is overcome only by the seller's engagement to take back the goods (or any commercial unit of goods) in lieu of payment if they fail to be resold. A sale or return is a present sale of goods which may be undone at the buyer's option. Accordingly, subsection (2) provides that goods delivered on approval are not subject to the prospective buyer's creditors until acceptance, and goods delivered in a sale or return are subject to the buyer's creditors while in the buyer's possession. These two transactions are so strongly delineated in practice and in general understanding that every presumption runs against a delivery to a consumer being a sale or return and against a delivery to a merchant for resale being a sale on approval. 2. The right to return goods for failure to conform to the contract of sale does not make the transaction a sale on approval or sale or return and has nothing to do with this section and the following section or Section 2-327. The present This section is not concerned with remedies for breach of contract. It deals instead with a power given by the contract to turn back the goods even though they are wholly as warranted. This section nevertheless presupposes that a contract for sale is contemplated by the parties, although that contract may be of the particular character here described that this section addresses (i.e., a sale on approval or a sale or return). Where the If a buyer's obligation as a buyer is conditioned not on its personal approval but on the article's passing a described objective test, the risk of loss by casualty pending the test is properly the seller's and proper return is at its expense. On the point of satisfaction as meaning reasonable satisfaction where when an industrial machine is involved, 1101

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this Article takes no position. 2. Pursuant to the general policies of this Act which require good faith not only between the parties to the sales contract, but as against interested third parties, subsection (3) resolves all reasonable doubts as to the nature of the transaction in favor of the general creditors of the buyer. As against such creditors words such as on consignment or on memorandum, with or without words of reservation of title in the seller, are disregarded when the buyer has a place of business at which he deals in goods of the kind involved. A necessary exception is made where the buyer is known to be engaged primarily in selling the goods of others or is selling under a relevant sign law, or the seller complies with the ling provisions of Article 9 as if his interest were a security interest. However, there is no intent in this Section to narrow the protection aorded to third parties in any jurisdiction which has a selling Factors Act. The purpose of the exception is merely to limit the eect of the present subsection itself, in the absence of any such Factors Act, to cases in which creditors of the buyer may reasonably be deemed to have been misled by the secret reservation. 3. Subsection (4) (3) resolves a conict in the pre-existing pre-UCC case law by recognition recognizing that an or return provision is so denitely at odds with any ordinary contract for sale of goods that where written agreements are if a written agreement is involved it the or return term must be contained in a written memorandum. The or return aspect of a sales contract must be treated as a separate contract under the Statute of Frauds section and as contradicting the sale insofar as questions of parol or extrinsic evidence are concerned. 4. Certain true consignment transactions were dealt with in former Sections 2-326(3) and 9-114. These provisions have been deleted and have been replaced by new provisions in Article 9. See, e.g., Sections 9-109(a)(4);9-103(b) 9-103(d); 9-319.

2-502. Buyer's Right to Goods on Seller's Repudiation, Failure to Deliver, or Insolvency. (1) Subject to subsections (2) and (3) and even though the goods have not been shipped a buyer who has paid a part or all of the price of goods in which he has a special property under the provisions of the immediately preceding section may on making and keeping good a tender of any unpaid portion of their price recover them from the seller if: (a) in the case of goods bought for personal, family, or household purposes, the seller repudiates or fails to deliver as required by the contract; or (b) in all cases, the seller becomes insolvent within ten days after receipt of the rst installment on their price. (2) The buyer's right to recover the goods under subsection (1)(a) vests upon acquisition of a special property, even if the seller had not then repudiated or failed to deliver. (3) If the identication creating his special property has been made by the buyer he acquires the right to recover the goods only if they conform to the contract for sale. Ocial Comment
1. This section gives an additional right to the buyer as a result of identication of the goods to the contract in the manner provided in Section 2-501. The buyer is given a right to recover the goods on the seller's insolvency occurring, conditioned upon making and keeping good a tender of any unpaid portion of the price, in two limited circumstances. First, the buyer may recover goods bought for personal, family, or household purposes if the seller repudiates the contract or fails to deliver the goods. Second, in any case, the buyer may recover the goods if the seller becomes insolvent within 10 days after he the seller receives the rst installment on their price. The buyer's right to recover the goods under this section is an exception to the usual rule, under which the disappointed buyer must resort to an action to recover damages. 1102

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2. The question of whether the buyer also acquires a security interest in identied goods and has rights to the goods when insolvency takes place after the ten-day period provided in this section depends upon compliance with the provisions of the Article on Secured Transactions (Article 9). 3. Under subsection (2), the buyer's right to recover consumer goods under subsection (1)(a) vests upon acquisition of a special property, which occurs upon identication of the goods to the contract. See Section 2-501. Inasmuch as a secured party normally acquires no greater rights in its collateral that its debtor had or had power to convey, see Section 2-403(1) (rst sentence), a buyer who acquires a right to recover under this section will take free of a security interest created by the seller if it attaches to the goods after the goods have been identied to the contract. The buyer will take free, even if the buyer does not buy in ordinary course and even if the security interest is perfected. Of course, to the extent that the buyer pays the price after the security interest attaches, the payments will constitute proceeds of the security interest. 3. 4. Subsection (2) (3) is included to preclude the possibility of unjust enrichment, which exists would exist if the buyer were permitted to recover goods even though they were greatly superior in quality or quantity to that called for by the contract for sale.

2-716. Buyer's Right to Specic Performance or Replevin. (1) Specic performance may be decreed where the goods are unique or in other proper circumstances. (2) The decree for specic performance may include such terms and conditions as to payment of the price, damages, or other relief as the court may deem just. (3) The buyer has a right of replevin for goods identied to the contract if after reasonable eort he is unable to eect cover for such goods or the circumstances reasonably indicate that such eort will be unavailing or if the goods have been shipped under reservation and satisfaction of the security interest in them has been made or tendered. In the case of goods bought for personal, family, or household purposes, the buyer's right of replevin vests upon acquisition of a special property, even if the seller had not then repudiated or failed to deliver. Ocial Comment * * *
3. The legal remedy of replevin is given to the buyer in cases in which cover is reasonably unavailable and goods have been identied to the contract. This is in addition to the buyer's right to recover identied goods on the seller's insolvency (Section 2-502) under Section 2-502. For consumer goods, the buyer's right to replevin vests upon the buyer's acquisition of a special property, which occurs upon identication of the goods to the contract. See Section 2-501. Inasmuch as a secured party normally acquires no greater rights in its collateral that its debtor had or had power to convey, see Section 2-403(1) (rst sentence), a buyer who acquires a right of replevin under subsection (3) will take free of a security interest created by the seller if it attaches to the goods after the goods have been identied to the contract. The buyer will take free, even if the buyer does not buy in ordinary course and even if the security interest is perfected. Of course, to the extent that the buyer pays the price after the security interest attaches, the payments will constitute proceeds of the security interest.

* * * 2A-103. Denitions and Index of Denitions. * * * (3) The following denitions in other Articles apply to this Article: Account. Section 9-106 9-102(a)(2). Between merchants. Section 2-104(3).
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Buyer. Section 2-103(1)(a). Chattel paper. Section 9-105(1)(b) 9-102(a)(11). Consumer goods. Section 9-109(1) 9-102(a)(23). Document. Section 9-105(1)(f) 9-102(a)(30). Entrusting. Section 2-403(3). General intangibles. Section 9-106. General intangible. Section 9-102(a)(42). Good faith. Section 2-103(1)(b). Instrument. Section 9-105(1)(i) 9-102(a)(47). Merchant. Section 2-104(1). Mortgage. Section 9-105(1)(j) 9-102(a)(55). Pursuant to commitment. Section 9-105(1)(k) 9-102(a)(68). Receipt. Section 2-103(1)(c). Sale. Section 2-106(1). Sale on approval. Section 2-326. Sale or return. Section 2-326. Seller. Section 2-103(1)(d). * * * 2A-303. Alienability of Party's Interest Under Lease Contract or of Lessor's Residual Interest in Goods; Delegation of Performance; Transfer of Rights. (1) As used in this section, creation of a security interest includes the sale of a lease contract that is subject to Article 9, Secured Transactions, by reason of Section 9-102(1)(b) 9-109(a)(3). (2) Except as provided in subsections subsection (3) and (4) Section 9-407, a provision in a lease agreement which (i) prohibits the voluntary or involuntary transfer, including a transfer by sale, sublease, creation or enforcement of a security interest, or attachment, levy, or other judicial process, of an interest of a party under the lease contract or of the lessor's residual interest in the goods, or (ii) makes such a transfer an event of default, gives rise to the rights and remedies provided in subsection (5) (4), but a transfer that is prohibited or is an event of default under the lease agreement is otherwise eective. (3) A provision in a lease agreement which (i) prohibits the creation or enforcement of a security interest in an interest of a party under the lease contract or in the lessor's residual interest in the goods, or (ii) makes such a transfer an event of default, is not enforceable unless, and then only to the extent that, there is an actual transfer by the lessee of the lessee's right of possession or use of the goods in violation of the provision or an actual delegation of a material performance of either party to the lease contract in violation of the provision. Neither the granting nor the enforcement of a security interest in (i) the lessor's interest under the lease contract or (ii) the lessor's residual interest in the goods is a transfer that materially impairs the prospect of obtaining return performance by, materially changes the duty of, or materially increases the burden or risk imposed on, the lessee within the purview of subsection (5) unless, and
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then only to the extent that, there is an actual delegation of a material performance of the lessor. (4)(3) A provision in a lease agreement which (i) prohibits a transfer of a right to damages for default with respect to the whole lease contract or of a right to payment arising out of the transferor's due performance of the transferor's entire obligation, or (ii) makes such a transfer an event of default, is not enforceable, and such a transfer is not a transfer that materially impairs the prospect of obtaining return performance by, materially changes the duty of, or materially increases the burden or risk imposed on, the other party to the lease contract within the purview of subsection (5) (4). (5)(4) Subject to subsections subsection (3) and (4) Section 9-407: (a) if a transfer is made which is made an event of default under a lease agreement, the party to the lease contract not making the transfer, unless that party waives the default or otherwise agrees, has the rights and remedies described in Section 2A-501(2); (b) if paragraph (a) is not applicable and if a transfer is made that (i) is prohibited under a lease agreement or (ii) materially impairs the prospect of obtaining return performance by, materially changes the duty of, or materially increases the burden or risk imposed on, the other party to the lease contract, unless the party not making the transfer agrees at any time to the transfer in the lease contract or otherwise, then, except as limited by contract, (i) the transferor is liable to the party not making the transfer for damages caused by the transfer to the extent that the damages could not reasonably be prevented by the party not making the transfer and (ii) a court having jurisdiction may grant other appropriate relief, including cancellation of the lease contract or an injunction against the transfer. (6) (5) A transfer of the lease or of all my rights under the lease, or a transfer in similar general terms, is a transfer of rights and, unless the language or the circumstances, as in a transfer for security, indicate the contrary, the transfer is a delegation of duties by the transferor to the transferee. Acceptance by the transferee constitutes a promise by the transferee to perform those duties. The promise is enforceable by either the transferor or the other party to the lease contract. (7)(6) Unless otherwise agreed by the lessor and the lessee, a delegation of performance does not relieve the transferor as against the other party of any duty to perform or of any liability for default. (8)(7) In a consumer lease, to prohibit the transfer of an interest of a party under the lease contract or to make a transfer an event of default, the language must be specic, by a writing, and conspicuous. Ocial Comment
1. Subsection (2) states a rule, consistent with Section 9-311 9-401(b), that voluntary and involuntary transfers of an interest of a party under the lease contract or of the lessor's residual interest, including by way of the creation or enforcement of a security interest, are eective, notwithstanding a provision in the lease agreement prohibiting the transfer or making the transfer an event of default. Although the transfers are eective, the provision in the lease agreement is nevertheless enforceable, but only as provided in subsection (5) (4). Under subsection (5) (4) the prejudiced party is limited to the remedies on default under the lease contract in this Article and, except as limited by this Article, as provided 1105

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in the lease agreement, if the transfer has been made an event of default. Section 2A501(2). Usually, there will be a specic provision to this eect or a general provision making a breach of a covenant an event of default. In those cases where the transfer is prohibited, but not made an event of default, the prejudiced party may recover damages; or, if the damage remedy would be ineective adequately to protect that party, the court can order cancellation of the lease contract or enjoin the transfer. This rule that such provisions generally are enforceable is subject to subsections (3) and (4) subsection (3) and Section 9-407, which make such provisions unenforceable in certain instances. 2. The rst such instance is described in subsection (3). A Under Section 9-407, a provision in a lease agreement which prohibits the creation or enforcement of a security interest, including sales of lease contracts subject to Article 9 (Sections 9-102(1)(b) and 9-104(f) Section 9-109(a)(3)), or makes it an event of default is generally not enforceable, reecting the policy of Section 9-406 and former Section 9-318(4). However, inasmuch as the creation of a security interest includes the sale of a lease contract, if there are then unperformed duties on the part of the lessor/seller, there could be a delegation of duties in the sale, and, if such a delegation actually takes place and is of a material performance, a provision in a lease agreement prohibiting it or making it an event of default would be enforceable, giving rise to the rights and remedies stated in subsection (5). The statute does not dene material. The parties may set standards to determine its meaning. The term is intended to exclude delegations of matters such as accounting to a professional accountant and the performance of, as opposed to the responsibility for, maintenance duties to a person in the maintenance service industry. 3. For similar reasons, the lessor is entitled to protect its residual interest in the goods by prohibiting anyone but the lessee from possessing or using them. Accordingly, under subsection (3) if there is an actual transfer by the lessee of its right of possession or use of the goods in violation of a provision in the lease agreement, such a provision likewise is enforceable, giving rise to the rights and remedies stated in subsection (5). A transfer of the lessee's right of possession or use of the goods resulting from the enforcement of a security interest granted by the lessee in its leasehold interest is a transfer by the lessee under this subsection. 4. Finally, subsection (3) protects against a claim that the creation or enforcement of a security interest in the lessor's interest under the lease contract or in the residual interest is a transfer that materially impairs the prospect of obtaining return performance by, materially changes the duty of, or materially increases the burden or risk imposed on the lessee so as to give rise to the rights and remedies stated in subsection (5), unless the transfer involves an actual delegation of a material performance of the lessor. 5. While it is not likely that a transfer by the lessor of its right to payment under the lease contract would impair at a future time the ability of the lessee to obtain the performance due the lessee under the lease contract from the lessor, if under the circumstances reasonable grounds for insecurity as to receiving that performance arise, the lessee may employ the provision of this Article for demanding adequate assurance of due performance and has the remedy provided in that circumstance. Section 2A-401. 6. Sections 9-206 and 9-318(1) through (3) also are relevant. Section 9-206 sanctions an agreement by a lessee not to assert certain types of claims or defenses against the lessor's assignee. Section 9-318(1) through (3) deal with, among other things, the other party's rights against the assignee where Section 9-206(1) does not apply. Since the denition of contract under Section 1-201(11) includes a lease agreement, the denition of account debtor under Section 9-105(1)(a) includes a lessee of goods. As a result, Section 9-206 applies to lease agreements, and there is no need to restate those sections in this Article. The reference to defenses or claims arising out of a sale in Section 9-318(1) should be interpreted broadly to include defenses or claims arising out of a lease inasmuch as that section codies the common law rule with respect to contracts, including lease contracts. 7.3. Subsection (4) (3) is based upon Section 2-210(2) and Section 9-318(4) 9-406. It makes unenforceable a prohibition against transfers of certain rights to payment or a provision making the transfer an event of default. It also provides that such transfers do not materially impair the prospect of obtaining return performance by, materially change the duty of, or materially increase the burden or risk imposed on, the other party to the lease contract so as to give rise to the rights and remedies stated in subsection (5) (4). Accordingly, a transfer of a right to payment cannot be prohibited or made an event of default, or be one that materially impairs performance, changes duties or increases risk, if the right is 1106

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already due or will become due without further performance being required by the party to receive payment. Thus, a lessor can transfer the right to future payments under the lease contract, including by way of a grant of a security interest, and the transfer will not give rise to the rights and remedies stated in subsection (5) (4) if the lessor has no remaining performance under the lease contract. The mere fact that the lessor is obligated to allow the lessee to remain in possession and to use the goods as long as the lessee is not in default does not mean that there is remaining performance on the part of the lessor. Likewise, the fact that the lessor has potential liability under a non-operating lease contract for breaches of warranty does not mean that there is remaining performance. In contrast, the lessor would have remaining performance under a lease contract requiring the lessor to regularly maintain and service the goods or to provide upgrades of the equipment on a periodic basis in order to avoid obsolescence. The basic distinction is between a mere potential duty to respond which is not remaining performance, and an armative duty to render stipulated performance. Although the distinction may be dicult to draw in some cases, it is instructive to focus on the dierence between operating and nonoperating leases as generally understood in the marketplace. Even if there is remaining performance under a lease contract, a transfer for security of a right to payment that is made an event of default or that is in violation of a prohibition against transfer does not give rise to the rights and remedies under subsection (5) (4) if it does not constitute an actual delegation of a material performance under subsection (3) Section 9-407. 8.4. The application of either the rule of subsection (3) Section 9-407 or the rule of subsection (4) (3) to the grant by the lessor of a security interest in the lessor's right to future payment under the lease contract may produce the same result. Both subsections provisions generally protect security transfers by the lessor in particular because the creation by the lessor of a security interest or the enforcement of that interest generally will not prejudice the lessee's rights if it does not result in a delegation of the lessor's duties. To the contrary, the receipt of loan proceeds or relief from the enforcement of an antecedent debt normally should enhance the lessor's ability to perform its duties under the lease contract. Nevertheless, there are circumstances where relief might be justied. For example, if ownership of the goods is transferred pursuant to enforcement of a security interest to a party whose ownership would prevent the lessee from continuing to possess the goods, relief might be warranted. See 49 U.S.C. 1401(a) and (b) which places limitations on the operation of aircraft in the United States based on the citizenship or corporate qualication of the registrant. 9.5. Relief on the ground of material prejudice when the lease agreement does not prohibit the transfer or make it an event of default should be aorded only in extreme circumstances, considering the fact that the party asserting material prejudice did not insist upon a provision in the lease agreement that would protect against such a transfer. 10.6. Subsection (5) (4) implements the rule of subsection (2). Subsection (2) provides that, even though a transfer is eective, a provision in the lease agreement prohibiting it or making it an event of default may be enforceable as provided in subsection (5) (4). See Brummund v. First National Bank of Clovis, 656 P.2d 884, 35 U.C.C. Rep.Serv. (Callaghan) 1311 (N.Mex.1983), stating the analogous rule for Section 9-311. If the transfer prohibited by the lease agreement is made an event of default, then, under subsection 5(a) (4)(a), unless the default is waived or there is an agreement otherwise, the aggrieved party has the rights and remedies referred to in Section 2A-501(2), viz. those in this Article and, except as limited in the Article, those provided in the lease agreement. In the unlikely circumstance that the lease agreement prohibits the transfer without making a violation of the prohibition an event of default or, even if there is no prohibition against the transfer, and the transfer is one that materially impairs performance, changes duties, or increases risk (for example, a sublease or assignment to a party using the goods improperly or for an illegal purpose), then subsection 5(b) (4)(b) is applicable. In that circumstance, unless the party aggrieved by the transfer has otherwise agreed in the lease contract, such as by assenting to a particular transfer or to transfers in general, or agrees in some other manner, the aggrieved party has the right to recover damages from the transferor and a court may, in appropriate circumstances, grant other relief, such as cancellation of the lease contract or an injunction against the transfer. 11.7. If a transfer gives rise to the rights and remedies provided in subsection (5) (4), the transferee as an alternative may propose, and the other party may accept, adequate cure or compensation for past defaults and adequate assurance of future due performance under 1107

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the lease contract. Subsection (5) (4) does not preclude any other relief that may be available to a party to the lease contract aggrieved by a transfer subject to an enforceable prohibition, such as an action for interference with contractual relations. 12.8. Subsection (8) (7) requires that a provision in a consumer lease prohibiting a transfer, or making it an event of default, must be specic, written and conspicuous. See Section 1-201(10). This assists in protecting a consumer lessee against surprise assertions of default. 13.9. Subsection (6) (5) is taken almost verbatim from the provisions of Section 2-210(4) 2-210(5). The subsection states a rule of construction that distinguishes a commercial assignment, which substitutes the assignee for the assignor as to rights and duties, and an assignment for security or nancing assignment, which substitutes the assignee for the assignor only as to rights. Note that the assignment for security or nancing assignment is a subset of all security interests. Security interest is dened to include any interest of a buyer of . . . chattel paper. Section 1-201(37). Chattel paper is dened to include a lease. Section 9-105(1)(b) 9-102. Thus, a buyer of leases is the holder of a security interest in the leases. That conclusion should not inuence this issue, as the policy is quite dierent. Whether a buyer of leases is the holder of a commercial assignment, or an assignment for security or nancing assignment should be determined by the language of the assignment or the circumstances of the assignment.

2A-307. Priority of Liens Arising by Attachment or Levy on, Security Interests in, and Other Claims to Goods. (1) Except as otherwise provided in Section 2A-306, a creditor of a lessee takes subject to the lease contract. (2) Except as otherwise provided in subsections subsection (3) and (4) and in Sections 2A-306 and 2A-308, a creditor of a lessor takes subject to the lease contract unless: (a) the creditor holds a lien that attached to the goods before the lease contract became enforceable, (b) the creditor holds a security interest in the goods and the lessee did not give value and receive delivery of the goods without knowledge of the security interest; or (c) the creditor holds a security interest in the goods which was perfected (Section 9-303) before the lease contract became enforceable. (3) A lessee in the ordinary course of business takes the leasehold interest free of a security interest in the goods created by the lessor even though the security interest is perfected (Section 9-303) and the lessee knows of its existence. (4) A lessee other than a lessee in the ordinary course of business takes the leasehold interest free of a security interest to the extent that it secures future advances made after the secured party acquires knowledge of the lease or more than 45 days after the lease contract becomes enforceable, whichever rst occurs, unless the future advances are made pursuant to a commitment entered into without knowledge of the lease and before the expiration of the 45-day period. (3) Except as otherwise provided in Sections 9-317, 9-321, and 9-323, a lessee takes a leasehold interest subject to a security interest held by a creditor of the lessor. Ocial Comment * * *
3. To take priority over the lease contract, and the interests derived therefrom, the creditor must come within one of three exceptions the exception stated within the rule. First, in 1108

Art. 9

Secured Transactions

App. I
4-210

subsection (2)(a) or within one of the provisions of Article 9 mentioned in subsection (3). Subsection (2) provides that where the creditor holds a lien (Section 2A-103(1)(r)) that attached before the lease contract became enforceable (Section 2A-301), the creditor does not take subject to the lease. Second, subsection (2)(b) provides that when the creditor holds a security interest (Section 1-201(37)), whether or not perfected, the creditor has priority over a lessee who did not give value (Section 1-201(44)) and receive delivery of the goods without knowledge (Section 1-201(25)) of the security interest. As to other lessees, under subsection (2)(c) a secured creditor holding a perfected security interest before the time the lease contract became enforceable (Section 2A-301) does not take subject to the lease. With respect to this provision, the lessee in these circumstances is treated like a buyer so that perfection of a purchase money security interest does not relate back (Section 9-301). Subsection (3) provides that a lessee takes its leasehold interest subject to a security interest except as otherwise provided in Sections 9-317, 9-321, or 9-323. 4. The rules of this section operate in favor of whichever party to the lease contract may enforce it, even if one party perhaps may not, e.g., under Section 2A-201(1)(b). 5. The rules stated in subsections (2)(b) and (c), and the rule in subsection (3), are is best understood by reviewing a hypothetical. Assume that a merchant engaged in the business of selling and leasing musical instruments obtained possession of a truck load of musical instruments on deferred payment terms from a supplier of musical instruments on January 6. To secure payment of such credit the merchant granted the supplier a security interest in the instruments; the security interest was perfected by ling on January 15. The merchant, as lessor, entered into a lease to an individual of one of the musical instruments supplied by the supplier; the lease became enforceable on January 10. Under subsection (2)(b) the lessee will prevail (assuming the lessee qualies thereunder) unless subsection (c) provides otherwise. Under the rule stated in subsection (2)(c) a priority dispute between the supplier, as the lessor's secured creditor, and the lessee would be determined by ascertaining on January 10 (the day the lease became enforceable) the validity and perfected status of the security interest in the musical instrument and the enforceability of the lease contract by the lessee. Nothing more appearing, under the rule stated in subsection (2)(c), the supplier's security interest in the musical instrument would not have priority over the lease contract. Moreover, subsection (2) states that its rules are subject to the rules of subsections (3) and (4). Under this hypothetical the lessee should qualify as a lessee in the ordinary course of business. Section 2A-103(1)(o). Subsection (3) also makes clear that the lessee in the ordinary course of business will win even if he or she knows of the existence of the supplier's security interest. 6. Subsections (3) and (4), which are modeled on the provisions of Section 9-307(1) and (3), respectively, state two exceptions to the priority rule stated in subsection (2) with respect to a creditor who holds a security interest. The lessee in the ordinary course of business will be treated in the same fashion as the buyer in the ordinary course of business, given a priority dispute with a secured creditor over goods subject to a lease contract.

2A-309. Lessor's and Lessee's Rights When Goods Become Fixtures. (1) In this section: * * * (b) a xture ling is the ling, in the oce where a record of a mortgage on the real estate would be led or recorded, of a nancing statement covering goods that are or are to become xtures and conforming to the requirements of Section 9-402(5) 9-502(a) and (b); * * * 4-210. Security Interest of Collecting Bank in Items, Accompanying Documents and Proceeds. * * * (c) Receipt by a collecting bank of a nal settlement for an item is a realization on its security interest in the item, accompanying documents,
1109

App. I
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Art. 9

and proceeds. So long as the bank does not receive nal settlement for the item or give up possession of the item or accompanying documents for purposes other than collection, the security interest continues to that extent and is subject to Article 9, but: (1) no security agreement is necessary to make the security interest enforceable (Section 9-203(1)(a) 9-203(b)(3)(A)); (2) no ling is required to perfect the security interest; and (3) the security interest has priority over conicting perfected security interests in the item, accompanying documents, or proceeds. 5-118. Security Interest of Issuer or Nominated Person. (a) An issuer or nominated person has a security interest in a document presented under a letter of credit to the extent that the issuer or nominated person honors or gives value for the presentation. (b) So long as and to the extent that an issuer or nominated person has not been reimbursed or has not otherwise recovered the value given with respect to a security interest in a document under subsection (a), the security interest continues and is subject to Article 9, but: (1) a security agreement is not necessary to make the security interest enforceable under Section 9-203(b)(3); (2) if the document is presented in a medium other than a written or other tangible medium, the security interest is perfected; and (3) if the document is presented in a written or other tangible medium and is not a certicated security, chattel paper, a document of title, an instrument, or a letter of credit, the security interest is perfected and has priority over a conicting security interest in the document so long as the debtor does not have possession of the document. Ocial Comment
1. This section gives the issuer of a letter of credit or a nominated person thereunder an automatic perfected security interest in a document (as that term is dened in Section 5-102(a)(6)). The security interest arises only if the document is presented to the issuer or nominated person under the letter of credit and only to the extent of the value that is given. This security interest is analogous to that awarded to a collecting bank under Section 4-210. Subsection (b) contains special rules governing the security interest arising under this section. In all other respects, a security interest arising under this section is subject to Article 9. See Section 9-109. Thus, for example, a security interest arising under this section may give rise to a security interest in proceeds under Section 9-315. 2. Subsection (b)(1) makes a security agreement unnecessary to the creation of a security interest under this section. Under subsection (b)(2), a security interest arising under this section is perfected if the document is presented in a medium other than a written or tangible medium. Documents that are written and that are not an otherwise-dened type of collateral under Article 9 (e.g., an invoice or inspection certicate) may be goods, in which an issuer or nominated person could perfect its security interest by possession. Because the denition of document in Section 5-102(a)(6) includes records (e.g., electronic records) that may not be goods, subsection (b)(2) provides for automatic perfection (i.e., without ling or possession). Under subsection (b)(3), if the document (i) is in a written or tangible medium, (ii) is not a certicated security, chattel paper, a document of title, an instrument, or a letter of credit, and (iii) is not in the debtor's possession, the security interest is perfected and has priority over a conicting security interest. If the document is a type of tangible collateral that subsection (b)(3) excludes from its perfection and priority rules, the issuer or nominated person must comply with the normal method of perfection (e.g., possession of an instrument) and is subject to the applicable Article 9 priority rules. Documents to which subsection (b)(3) 1110

Art. 9

Secured Transactions

App. I
7-503

applies may be important to an issuer or nominated person. For example, a conrmer who pays the beneciary must be assured that its rights to all documents are not impaired. It will nd it necessary to present all of the required documents to the issuer in order to be reimbursed. Moreover, when a nominated person sends documents to an issuer in connection with the nominated person's reimbursement, that activity is not a collection, enforcement, or disposition of collateral under Article 9. One purpose of this section is to protect an issuer or nominated person from claims of a beneciary's creditors. It is a fallback provision inasmuch as issuers and nominated persons frequently may obtain and perfect security interests under the usual Article 9 rules, and, in many cases, the documents will be owned by the issuer, nominated person, or applicant. UCC Article 6, Alternative A: Legislative Note: To take account of dierences between former Article 9 and revised Article 9, a State that repeals Article 6 after revised Article 9 takes eect must make the following changes to Alternative A. First, inasmuch as revised Article 9 contains no counterpart of former Section 9-111, the reference to that section in Section 1 of the repealer should be deleted, and Section 4 of the repeal bill should allude to former Section 9-111. Second, the last entry in Section 1-105(2) should be amended as shown above in this Appendix. UCC Article 6, Alternative B:

6-102. Denitions and Index of Denitions. (1) In this Article, unless the context otherwise requires: (a) Assets means the inventory that is the subject of a bulk sale and any tangible and intangible personal property used or held for use primarily in, or arising from, the seller's business and sold in connection with that inventory, but the term does not include: (i) xtures (Section 9-313(1)(a) 9-102(a)(41)) other than readily removable factory and oce machines; (ii) the lessee's interest in a lease of real property; or (iii) property to the extent it is generally exempt from creditor process under nonbankruptcy law. * * * (2) The following denitions in other Articles apply to this Article: (a) Buyer. Section 2-103(1)(a). (b) Equipment. Section 9-109(2) 9-102(a)(33). (c) Inventory. Section 9-109(4) 9-102(a)(48). (d) Sale. Section 2-106(1). (e) Seller. Section 2-103(1)(d). * * * 6-103. Applicability of Article. * * * (3) This Article does not apply to: (a) a transfer made to secure payment or performance of an obligation; (b) a transfer of collateral to a secured party pursuant to Section 9-503 9-609; (c) a sale disposition of collateral pursuant to Section 9-504 9-610; (d) retention of collateral pursuant to Section 9-505 9-620; * * * 7-503. Document of Title to Goods Defeated in Certain Cases. (1) A document of title confers no right in goods against a person who
1111

App. I
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Art. 9

before issuance of the document had a legal interest or a perfected security interest in them and who neither (a) delivered or entrusted them or any document of title covering them to the bailor or his nominee with actual or apparent authority to ship, store or sell or with power to obtain delivery under this Article (Section 7-403) or with power of disposition under this Act (Sections 2-403 and 9-307 9-320) or other statute or rule of law; nor (b) acquiesced in the procurement by the bailor or his nominee of any document of title. * * * 8-102. Denitions. * * * Ocial Comment * * *
7. Entitlement holder. This term designates those who hold nancial assets through intermediaries in the indirect holding system. Because many of the rules of Part 5 impose duties on securities intermediaries in favor of entitlement holders, the denition of entitlement holder is, in most cases, limited to the person specically designated as such on the records of the intermediary. The last sentence of the denition covers the relatively unusual cases where a person may acquire a security entitlement under Section 8-501 even though the person may not be specically designated as an entitlement holder on the records of the securities intermediary. A person may have an interest in a security entitlement, and may even have the right to give entitlement orders to the securities intermediary with respect to it, even though the person is not the entitlement holder. For example, a person who holds securities through a securities account in its own name may have given discretionary trading authority to another person, such as an investment adviser. Similarly, the control provisions in Section 8-106 and the related provisions in Article 9 are designed to facilitate transactions in which a person who holds securities through a securities account uses them as collateral in an arrangement where the securities intermediary has agreed that if the secured party so directs the intermediary will dispose of the positions. In such arrangements, the debtor remains the entitlement holder but has agreed that the secured party can initiate entitlement orders. Moreover, an entitlement holder may be acting for another person as a nominee, agent, trustee, or in another capacity. Unless the entitlement holder is itself acting as a securities intermediary for the other person, in which case the other person would be an entitlement holder with respect to the securities entitlement, the relationship between an entitlement holder and another person for whose benet the entitlement holder holds a securities entitlement is governed by other law. 8. Entitlement order. This term is dened as a notication communicated to a securities intermediary directing transfer or redemption of the nancial asset to which an entitlement holder has a security entitlement. The term is used in the rules for the indirect holding system in a fashion analogous to the use of the terms indorsement and instruction in the rules for the direct holding system. If a person directly holds a certicated security in registered form and wishes to transfer it, the means of transfer is an indorsement. If a person directly holds an uncerticated security and wishes to transfer it, the means of transfer is an instruction. If a person holds a security entitlement, the means of disposition is an entitlement order. An entitlement order includes a direction under Section 8-508 to the securities intermediary to transfer a nancial asset to the account of the entitlement holder at another nancial intermediary or to cause the nancial asset to be transferred to the entitlement holder in the direct holding system (e.g., the delivery of a securities certicate registered in the name of the former entitlement holder). As noted in Comment 7, an entitlement order need not be initiated by the entitlement holder in order to be eective, so long as the entitlement holder has authorized the other party to initiate entitlement orders. See Section 8-107(b).

* * *
1112

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8-106

8-103. Rules for Determining Whether Certain Obligations and Interests Are Securities or Financial Assets. * * * (f) A commodity contract, as dened in Section 9-115 9-102(a)(15), is not a security or a nancial asset. 8-106. Control. (a) A purchaser has control of a certicated security in bearer form if the certicated security is delivered to the purchaser. (b) A purchaser has control of a certicated security in registered form if the certicated security is delivered to the purchaser, and: (1) the certicate is indorsed to the purchaser or in blank by an eective indorsement; or (2) the certicate is registered in the name of the purchaser, upon original issue or registration of transfer by the issuer. (c) A purchaser has control of an uncerticated security if: (1) the uncerticated security is delivered to the purchaser; or (2) the issuer has agreed that it will comply with instructions originated by the purchaser without further consent by the registered owner. (d) A purchaser has control of a security entitlement if: (1) the purchaser becomes the entitlement holder; or (2) the securities intermediary has agreed that it will comply with entitlement orders originated by the purchaser without further consent by the entitlement holder; or (3) another person has control of the security entitlement on behalf of the purchaser or, having previously acquired control of the security entitlement, acknowledges that it has control on behalf of the purchaser. (e) If an interest in a security entitlement is granted by the entitlement holder to the entitlement holder's own securities intermediary, the securities intermediary has control. (f) A purchaser who has satised the requirements of subsection (c)(2) or (d)(2) has control, even if the registered owner in the case of subsection (c)(2) or the entitlement holder in the case of subsection (d)(2) retains the right to make substitutions for the uncerticated security or security entitlement, to originate instructions or entitlement orders to the issuer or securities intermediary, or otherwise to deal with the uncerticated security or security entitlement. (g) An issuer or a securities intermediary may not enter into an agreement of the kind described in subsection (c)(2) or (d)(2) without the consent of the registered owner or entitlement holder, but an issuer or a securities intermediary is not required to enter into such an agreement even though the registered owner or entitlement holder so directs. An issuer or securities intermediary that has entered into such an agreement is not required to conrm the existence of the agreement to another party unless requested to do so by the registered owner or entitlement holder. Ocial Comment
1. The concept of control plays a key role in various provisions dealing with the rights of purchasers, including secured parties. See Sections 8-303 (protected purchasers); 8-503(e) 1113

App. I
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Art. 9

(purchasers from securities intermediaries); 8-510 (purchasers of security entitlements from entitlement holders); -115(4) 9-314 (perfection of security interests); 9-115(5) 9-328 (priorities among conicting security interests). Obtaining control means that the purchaser has taken whatever steps are necessary, given the manner in which the securities are held, to place itself in a position where it can have the securities sold, without further action by the owner.

* * *
4. Subsection (d) species the means by which a purchaser can obtain control over of a security entitlement. Two Three mechanisms are possible, analogous to those provided in subsection (c) for uncerticated securities. Under subsection (d)(1), a purchaser has control if it is the entitlement holder. This subsection would apply whether the purchaser holds through the same intermediary that the debtor used, or has the securities position transferred to its own intermediary. Subsection (d)(2) provides that a purchaser has control if the securities intermediary has agreed to act on entitlement orders originated by the purchaser if no further consent by the entitlement holder is required. Under subsection (d)(2), control may be achieved even though the transferor original entitlement holder remains listed as the entitlement holder. Finally, a purchaser may obtain control under subsection (d)(3) if another person has control and the person acknowledges that it has control on the purchaser's behalf. Control under subsection (d)(3) parallels the delivery of certicated securities and uncerticated securities under Section 8-301. Of course, the acknowledging person cannot be the debtor. This section species only the minimum requirements that such an arrangement must meet to confer control; the details of the arrangement can be specied by agreement. The arrangement might cover all of the positions in a particular account or subaccount, or only specied positions. There is no requirement that the control party's right to give entitlement orders be exclusive. The arrangement might provide that only the control party can give entitlement orders, or that either the entitlement holder or the control party can give entitlement orders. See subsection (f). The following examples illustrate the rules application of subsection (d): Example 1. Debtor grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Alpha also has an account with Able. Debtor instructs Able to transfer the shares to Alpha, and Able does so by crediting the shares to Alpha's account. Alpha Bank has control of the 1000 shares under subsection (d)(1). Although Debtor may have become the benecial owner of the new securities entitlement, as between Debtor and Alpha, Able has agreed to act on Alpha's entitlement orders because, as between Able and Alpha, because Alpha Bank is has become the entitlement holder. See Section 8-506. Example 2. Debtor grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Alpha Bank does not have an account with Able. Alpha Bank uses Beta as its securities custodian. Debtor instructs Able to transfer the shares to Beta, for the account of Alpha Bank, and Able does so. Alpha Bank has control of the 1000 shares under subsection (d)(1). As in Example 1, although Debtor may have become the benecial owner of the new securities entitlement, as between Debtor and Alpha, Beta has agreed to act on Alpha's entitlement orders because, as between Beta and Alpha, because Alpha is has become the entitlement holder. Example 3. Debtor grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Debtor, Able, and Alpha Bank enter into an agreement under which Debtor will continue to receive dividends and distributions, and will continue to have the right to direct dispositions, but Alpha Bank also has the right to direct dispositions. Alpha Bank has control of the 1000 shares under subsection (d)(2). Example 4. Able & Co., a securities dealer, grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Able holds through an account with Clearing Corporation. Able causes Clearing Corporation to transfer the shares into Alpha Bank's Alpha's account at Clearing Corporation. As in Example 1, Alpha Bank has control of the 1000 shares under subsection (d)(1). Example 5. Able & Co., a securities dealer, grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Able holds through 1114

Art. 9

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an account with Clearing Corporation. Alpha Bank does not have an account with Clearing Corporation. It holds its securities through Beta Bank, which does have an account with Clearing Corporation. Able causes Clearing Corporation to transfer the shares into Beta Bank's Beta's account at Clearing Corporation. Beta Bank credits the position to Alpha's account with Beta Bank. As in Example 2, Alpha Bank has control of the 1000 shares under subsection (d)(1). Example 6. Able & Co., a securities dealer, grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Able holds through an account with Clearing Corporation. Able causes Clearing Corporation to transfer the shares into a pledge account, pursuant to an agreement under which Able will continue to receive dividends, distributions, and the like, but Alpha Bank has the right to direct dispositions. As in Example 3, Alpha Bank has control of the 1000 shares under subsection (d)(2). Example 7. Able & Co., a securities dealer, grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Able holds through an account with Clearing Corporation. Able, Alpha, and Clearing Corporation enter into an agreement under which Clearing Corporation will act on instructions from Alpha with respect to the XYZ Co. stock carried in Able's account, but Able will continue to receive dividends, distributions, and the like, and will also have the right to direct dispositions. As in Example 3, Alpha Bank has control of the 1000 shares under subsection (d)(2). Example 8. Able & Co., a securities dealer, holds a wide range of securities through its account at Clearing Corporation. Able enters into an arrangement with Alpha Bank pursuant to which Alpha provides nancing to Able secured by securities identied as the collateral on lists provided by Able to Alpha on a daily or other periodic basis. Able, Alpha, and Clearing Corporation enter into an agreement under which Clearing Corporation agrees that if at any time Alpha directs Clearing Corporation to do so, Clearing Corporation will transfer any securities from Able's account at Alpha's instructions. Because Clearing Corporation has agreed to act on Alpha's instructions with respect to any securities carried in Able's account, at the moment that Alpha's security interest attaches to securities listed by Able, Alpha obtains control of those securities under subsection (d)(2). There is no requirement that Clearing Corporation be informed of which securities Able has pledged to Alpha. Example 9. Debtor grants Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Beta Bank agrees with Alpha to act as Alpha's collateral agent with respect to the security entitlement. Debtor, Able, and Beta enter into an agreement under which Debtor will continue to receive dividends and distributions, and will continue to have the right to direct dispositions, but Beta also has the right to direct dispositions. Because Able has agreed that it will comply with entitlement orders originated by Beta without further consent by Debtor, Beta has control of the security entitlement (see Example 3). Because Beta has control on behalf of Alpha, Alpha also has control under subsection (d)(3). It is not necessary for Able to enter into an agreement directly with Alpha or for Able to be aware of Beta's agency relationship with Alpha.

* * *
7. The term control is used in a particular dened sense. The requirements for obtaining control are set out in this section. The concept is not to be interpreted by reference to similar concepts in other bodies of law. In particular, the requirements for possession derived from the common law of pledge are not to be used as a basis for interpreting subsection (c)(2) or (d)(2). Those provisions are designed to supplant the concepts of constructive possession and the like. A principal purpose of the control concept is to eliminate the uncertainty and confusion that results from attempting to apply common law possession concepts to modern securities holding practices. The key to the control concept is that the purchaser has the present ability to have the securities sold or transferred without further action by the transferor. There is no requirement that the powers held by the purchaser be exclusive. For example, in a secured lending arrangement, if the secured party wishes, it can allow the debtor to retain the right to make substitutions, or to direct the disposition of the uncerticated security or security entitlement, or otherwise to give instructions or entitlement orders. (As explained in Section 8-102, Comment 8, an entitlement order includes a direction under Section 8-508 to the securities intermediary to transfer a nancial asset to the account of the entitlement holder at 1115

App. I
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Uniform Commercial Code

Art. 9

another nancial intermediary or to cause the nancial asset to be transferred to the entitlement holder in the direct holding system (e.g., by delivery of a securities certicate registered in the name of the former entitlement holder).) Subsection (f) is included to make clear the general point stated in subsection subsections (c) and (d) that the test of control is whether the purchaser has obtained the requisite power, not whether the debtor has retained other powers. There is no implication that retention by the debtor of powers other than those mentioned in subsection (f) is inconsistent with the purchaser having control. Nor is there a requirement that the purchaser's powers be unconditional, provided that further consent of the entitlement holder is not a condition. Example 10. Debtor grants to Alpha Bank and to Beta Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. By agreement among the parties, Alpha's security interest is senior and Beta's is junior. Able agrees to act on the entitlement orders of either Alpha or Beta. Alpha and Beta each has control under subsection (d)(2). Moreover, Beta has control notwithstanding a term of Able's agreement to the eect that Able's obligation to act on Beta's entitlement orders is conditioned on the Alpha's consent. The crucial distinction is that Able's agreement to act on Beta's entitlement orders is not conditioned on Debtor's further consent. Example 11. Debtor grants to Alpha Bank a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Able agrees to act on the entitlement orders of Alpha, but Alpha's right to give entitlement orders to the securities intermediary is conditioned on the Debtor's default. Alternatively, Alpha's right to give entitlement orders is conditioned upon Alpha's statement to Able that Debtor is in default. Because Able's agreement to act on Beta's Alpha's* entitlement orders is not conditioned on Debtor's further consent, Alpha has control of the securities entitlement under either alternative. In many situations, it will be better practice for both the securities intermediary and the purchaser to insist that any conditions relating in any way to the entitlement holder be eective only as between the purchaser and the entitlement holder. That practice would avoid the risk that the securities intermediary could be caught between conicting assertions of the entitlement holder and the purchaser as to whether the conditions in fact have been met. Nonetheless, the existence of unfullled conditions eective against the intermediary would not preclude the purchaser from having control.

8-110. Applicability; Choice of Law. * * * (e) The following rules determine a securities intermediary's jurisdiction for purposes of this section: (1) If an agreement between the securities intermediary and its entitlement holder species that it is governed by the law of a particular jurisdiction governing the securities account expressly provides that a particular jurisdiction is the securities intermediary's jurisdiction for purposes of this part, this article, or this [Act], that jurisdiction is the securities intermediary's jurisdiction. (2) If paragraph (1) does not apply and an agreement between the securities intermediary and its entitlement holder governing the securities account expressly provides that the agreement is governed by the law of a particular jurisdiction, that jurisdiction is the securities intermediary's jurisdiction. (2)(3) If neither paragraph (1) nor paragraph (2) applies and an agreement between the securities intermediary and its entitlement holder
[Section 8-106] *Amendments in italics approved by 1116 the Permanent Editorial Board for Uniform Commercial Code January 15, 2000.

Art. 9

Secured Transactions

App. I
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does not specify the governing law as provided in paragraph (1), but governing the securities account expressly species provides that the securities account is maintained at an oce in a particular jurisdiction, that jurisdiction is the securities intermediary's jurisdiction. (3)(4) If an agreement between the securities intermediary and its entitlement holder does not specify a jurisdiction as provided in paragraph (1) or (2), none of the preceding paragraphs applies, the securities intermediary's jurisdiction is the jurisdiction in which is located the oce identied in an account statement as the oce serving the entitlement holder's account is located. (4)(5) If an agreement between the securities intermediary and its entitlement holder does not specify a jurisdiction as provided in paragraph (1) or (2) and an account statement does not identify an oce serving the entitlement holder's account as provided in paragraph (3), none of the preceding paragraphs applies, the securities intermediary's jurisdiction is the jurisdiction in which is located the chief executive ofce of the securities intermediary is located. (f) A securities intermediary's jurisdiction is not determined by the physical location of certicates representing nancial assets, or by the jurisdiction in which is organized the issuer of the nancial asset with respect to which an entitlement holder has a security entitlement, or by the location of facilities for data processing or other record keeping concerning the account. Ocial Comment * * *
3. Subsection (b) provides that the law of the securities intermediary's jurisdiction governs the issues concerning the indirect holding system that are dealt with in Article 8. Paragraphs (1) and (2) cover the matters dealt with in the Article 8 rules dening the concept of security entitlement and specifying the duties of securities intermediaries. Paragraph (3) provides that the law of the security intermediary's jurisdiction determines whether the intermediary owes any duties to an adverse claimant. Paragraph (4) provides that the law of the security intermediary's jurisdiction determines whether adverse claims can be asserted against entitlement holders and others. Subsection (e) determines what is a securities intermediary's jurisdiction. The policy of subsection (b) is to ensure that a securities intermediary and all of its entitlement holders can look to a single, readily-identiable body of law to determine their rights and duties. Accordingly, subsection (e) sets out a sequential series of tests to facilitate identication of that body of law. Paragraph (1) of subsection (e) permits specication of the governing law securities intermediary's jurisdiction by agreement. In the absence of such a specication, the law chosen by the parties to govern the securities account determines the securities intermediary's jurisdiction. See paragraph (2). Because the policy of this section is to enable parties to determine, in advance and with certainty, what law will apply to transactions governed by this Article, the validation of the parties' selection of governing law by agreement is not conditioned upon a determination that the jurisdiction whose law is chosen bear a reasonable relation to the transaction. See Section 4A-507; compare Section 1-105(1). That is also true with respect to the similar provisions in subsection (d) of this section and in Section 9-103(6) 9-305. The remaining paragraphs in subsection (e) contain additional default rules for determining the securities intermediary's jurisdiction.

* * *
5. The following examples illustrate how a court in a jurisdiction which has enacted this section would determine the governing law: Example 1. John Doe, a resident of Kansas, maintains a securities account with Able & Co. Able is incorporated in Delaware. Its chief executive oces are located in Illinois. 1117

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The oce where Doe transacts business with Able is located in Missouri. The agreement between Doe and Able species that it is governed by Illinois law is the securities intermediary's (Able's) jurisdiction. Through the account, Doe holds securities of a Colorado corporation, which Able holds through Clearing Corporation. The rules of Clearing Corporation provide that the rights and duties of Clearing Corporation and its participants are governed by New York law. Subsection (a) species that a controversy concerning the rights and duties as between the issuer and Clearing Corporation is governed by Colorado law. Subsections (b) and (e) specify that a controversy concerning the rights and duties as between the Clearing Corporation and Able is governed by New York law, and that a controversy concerning the rights and duties as between Able and Doe is governed by Illinois law.

* * *
7. The choice of law provisions concerning security interests in securities and security entitlements are set out in Section 9-103(6) 9-305.

8-301. Delivery. (a) Delivery of a certicated security to a purchaser occurs when: (1) the purchaser acquires possession of the security certicate; (2) another person, other than a securities intermediary, either acquires possession of the security certicate on behalf of the purchaser or, having previously acquired possession of the certicate, acknowledges that it holds for the purchaser; or (3) a securities intermediary acting on behalf of the purchaser acquires possession of the security certicate, only if the certicate is in registered form and has been is (i) registered in the name of the purchaser, (ii) payable to the order of the purchaser, or (iii) specially indorsed to the purchaser by an eective indorsement and has not been indorsed to the securities intermediary or in blank. * * * Ocial Comment * * *
2. Subsection (a) denes delivery with respect to certicated securities. Paragraph (1) deals with simple cases where purchasers themselves acquire physical possession of certicates. Paragraphs (2) and (3) of subsection (a) specify the circumstances in which delivery to a purchaser can occur although the certicate is in the possession of a person other than the purchaser. Paragraph (2) contains the general rule that a purchaser can take delivery through another person, so long as the other person is actually acting on behalf of the purchaser or acknowledges that it is holding on behalf of the purchaser. Paragraph (2) does not apply to acquisition of possession by a securities intermediary, because a person who holds securities through a securities account acquires a security entitlement, rather than having a direct interest. See Section 8-501. Subsection (a)(3) species the limited circumstances in which delivery of security certicates to a securities intermediary is treated as a delivery to the customer. Note that delivery is a method of perfecting a security interest in a certicated security. See Section 9-313(a), (e).

* * * 8-302. Rights of Purchaser. (a) Except as otherwise provided in subsections (b) and (c), a purchaser upon delivery of a certicated or uncerticated security to a purchaser, the purchaser acquires all rights in the security that the transferor had or had power to transfer. (b) A purchaser of a limited interest acquires rights only to the extent of the interest purchased.
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(c) A purchaser of a certicated security who as a previous holder had notice of an adverse claim does not improve its position by taking from a protected purchaser. Ocial Comment
1. Subsection (a) provides that if a purchaser of a certicated or uncerticated security is delivered (Section 8-301) to a purchaser in a transfer, the purchaser acquires all rights that the transferor had or had power to transfer. This statement of the familiar shelter principle is qualied by the exceptions that a purchaser of a limited interest acquires only that interest, subsection (b), and that a person who does not qualify as a protected purchaser cannot improve its position by taking from a subsequent protected purchaser, subsection (c). 2. Although this section provides that a purchaser acquires a property interest in a certicated or uncerticated security upon delivery,, it does not state that a person can acquire an interest in a security only by delivery purchase . Article 8 also is not a comprehensive codication of all of the law governing the creation or transfer of interests in securities by purchase.* For example, the grant of a security interest is a transfer of a property interest, but the formal steps necessary to eectuate such a transfer are governed by Article 9, not by Article 8. Under the Article 9 rules, a security interest in a certicated or uncerticated security can be created by execution of a security agreement under Section 9-203 and can be perfected by ling. A transfer of an Article 9 security interest can be implemented by an Article 8 delivery, but need not be. Similarly, Article 8 does not determine whether a property interest in certicated or uncerticated security is acquired under other law, such as the law of gifts, trusts, or equitable remedies. Nor does Article 8 deal with transfers by operation of law. For example, transfers from decedent to administrator, from ward to guardian, and from bankrupt to trustee in bankruptcy are governed by other law as to both the time they occur and the substance of the transfer. The Article 8 rules do, however, determine whether the issuer is obligated to recognize the rights that a third party, such as a transferee, may acquire under other law. See Sections 8-207, 8-401, and 8-404.

8-502. Assertion of Adverse Claim Against Entitlement Holder. * * * Ocial Comment * * *

3. The following examples illustrate the operation of Section 8-502. * * * Example 4. Debtor holds XYZ Co. shares in a securities account with Able & Co. As collateral for a loan from Bank, Debtor grants Bank a security interest in the security entitlement to the XYZ Co. shares. Bank perfects by a method which leaves Debtor with the ability to dispose of the shares. See Section 9-115 9-312. In violation of the security agreement, Debtor sells the XYZ Co. shares and absconds with the proceeds. Assume implausiblythat Bank is able to trace the XYZ Co. shares and show that the same shares ended up in Buyer's securities account with Baker & Co. Section 8-502 precludes any action by Bank against Buyer, whether framed in constructive trust or other theory, provided that Buyer acquired the security entitlement for value and without notice of adverse claims. * * * Example 6. Debtor grants Alpha Co. a security interest in a security entitlement that includes 1000 shares of XYZ Co. stock that Debtor holds through an account with Able & Co. Alpha also has an account with Able. Debtor instructs Able to transfer the shares to Alpha, and Able does so by crediting the shares to Alpha's account. Alpha has control of the 1000 shares under Section 8-106(d). (The facts to this point are identical to those in Section 8-106, Comment 4, Example 1, except that Alpha Co. was Alpha Bank.) Alpha next grants Beta Co. a security interest in the 1000 shares included in Alpha's security entitlement. See [Section 8-302] *Amendments in italics approved by the Permanent Editorial Board for Uniform Commercial Code January 15, 2000. 1119

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Section 9-207(c)(3). Alpha instructs Able to transfer the shares to Gamma Co., Beta's custodian. Able does so, and Gamma credits the 1000 shares to Beta's account. Beta now has control under Section 8-106(d). By virtue of Debtor's explicit permission or by virtue of the permission inherent in Debtor's creation of a security interest in favor of Alpha and Alpha's resulting power to grant a security interest under Section 9-207, Debtor has no adverse claim to assert against Beta, assuming implausibly that Debtor could trace an interest to the Gamma account. Moreover, even if Debtor did hold an adverse claim, if Beta did not have notice of Debtor's claim, Section 8-502 will preclude any action by Debtor against Beta, whether framed in constructive trust or other theory.

* * * 8-510. Rights of Purchaser of Security Entitlement From Entitlement Holder. (a) An In a case not covered by the priority rules in Article 9 or the rules stated in subsection (c), an action based on an adverse claim to a nancial asset or security entitlement, whether framed in conversion, replevin, constructive trust, equitable lien, or other theory, may not be asserted against a person who purchases a security entitlement, or an interest therein, from an entitlement holder if the purchaser gives value, does not have notice of the adverse claim, and obtains control. (b) If an adverse claim could not have been asserted against an entitlement holder under Section 8-502, the adverse claim cannot be asserted against a person who purchases a security entitlement, or an interest therein, from the entitlement holder. (c) In a case not covered by the priority rules in Article 9, a purchaser for value of a security entitlement, or an interest therein, who obtains control has priority over a purchaser of a security entitlement, or an interest therein, who does not obtain control. Purchasers Except as otherwise provided in subsection (d), purchasers who have control rank equally, except that a according to priority in time of: (1) the purchaser's becoming the person for whom the securities account, in which the security entitlement is carried, is maintained, if the purchaser obtained control under Section 8-106(d)(1); (2) the securities intermediary's agreement to comply with the purchaser's entitlement orders with respect to security entitlements carried or to be carried in the securities account in which the security entitlement is carried, if the purchaser obtained control under Section 8-106(d) (2); or (3) if the purchaser obtained control through another person under Section 8-106(d)(3), the time on which priority would be based under this subsection if the other person were the secured party. (d) A securities intermediary as purchaser has priority over a conicting purchaser who has control unless otherwise agreed by the securities intermediary. Ocial Comment * * *
4. Subsection (c) species a priority rule for cases where an entitlement holder transfers conicting interests in the same security entitlement to dierent purchasers. It follows the same principle as the Article 9 priority rule for investment property, that is, control trumps non-control. Indeed, the most signicant category of conicting purchasers may be secured parties. Priority questions for security interests, however, are governed by the rules in 1120

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Article 9. Subsection (c) applies only to cases not covered by the Article 9 rules. It is intended primarily for disputes over conicting claims arising out of repurchase agreement transactions that are not covered by the other rules set out in Articles 8 and 9. The following example illustrates subsection (c): Example 4. Dealer holds securities through an account at Alpha Bank. Alpha Bank in turns holds through a clearing corporation account. Dealer transfers securities to RP1 in a hold in custody repo transaction. Dealer then transfers the same securities to RP2 in another repo transaction. The repo to RP2 is implemented by transferring the securities from Dealer's regular account at Alpha Bank to a special account maintained by Alpha Bank for Dealer and RP2. The agreement among Dealer, RP2, and Alpha Bank provides that Dealer can make substitutions for the securities but RP2 can direct Alpha Bank to sell any securities held in the special account. Dealer becomes insolvent. RP1 claims a prior interest in the securities transferred to RP2. In this example Dealer remained the entitlement holder but agreed that RP2 could initiate entitlement orders to Dealer's security intermediary, Alpha Bank. If RP2 had become the entitlement holder, the adverse claim rule of Section 8-502 would apply. Even if RP2 does not become the entitlement holder, the arrangement among Dealer, Alpha Bank, and RP2 does suce to give RP2 control. Thus, under Section 8-510(c), RP2 has priority over RP1, because RP2 is a purchaser who obtained control, and RP1 is a purchaser who did not obtain control. The same result could be reached under Section 8-510(a) which provides that RP1's earlier in time interest cannot be asserted as an adverse claim against RP2. The same result would follow under the Article 9 priority rules if the interests of RP1 and RP2 are characterized as security interests, see Section 9-115(5)(a) 9-328(1). The main point of the rules of Section 8-510(c) is to ensure that there will be clear rules to cover the conicting claims of RP1 and RP2 without characterizing their interests as Article 9 security interests. The priority rules in Article 9 for conicting security interests also include a default temporal priority rule of pro rata treatment for cases where multiple secured parties have obtained control but omitted to specify their respective rights by agreement. See Section 9-115(5)(b) 9-328(2) and Comment 6 5 to Section 9-115 9-328. Because the purchaser priority rule in Section 8-510(c) is intended to track the Article 9 priority rules, it too has a pro rata temporal priority rule for cases where multiple non-secured party purchasers have obtained control but omitted to specify their respective rights by agreement. The rule is patterned on Section 9-328(2). 5. If a securities intermediary itself is a purchaser, subsection (d) provides that it has priority over the interest of another purchaser who has control. Article 9 contains a similar rule. See Section 9-328(3).

APPENDIX II. MODEL PROVISIONS FOR PRODUCTIONMONEY PRIORITY

Legislative Note: States that enact these model provisions should add the following denitions to Section 9-102(a) following the denition of proceeds and preceding the denition of promissory note, renumbering paragraphs in 9-102(a) accordingly: ( ) Production-money crops means crops that secure a production-money obligation incurred with respect to the production of those crops. ( ) Production-money obligation means an obligation of an obligor incurred for new value given to enable the debtor to produce crops if the value is in fact used for the production of the crops. ( ) Production of crops includes tilling and otherwise preparing land for growing, planting, cultivating, fertilizing, irrigating, harvesting, and gathering crops, and protecting them from damage or disease.

[MODEL SECTION [9-103A]. PRODUCTION-MONEY CROPS; PRODUCTION-MONEY OBLIGATION; PRODUCTION-MONEY SECURITY INTEREST; BURDEN OF ESTABLISHING. (a) A security interest in crops is a production-money security interest to the extent that the crops are production-money crops.
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(b) If the extent to which a security interest is a production-money security interest depends on the application of a payment to a particular obligation, the payment must be applied: (1) in accordance with any reasonable method of application to which the parties agree; (2) in the absence of the parties' agreement to a reasonable method, in accordance with any intention of the obligor manifested at or before the time of payment; or (3) in the absence of an agreement to a reasonable method and a timely manifestation of the obligor's intention, in the following order: (A) to obligations that are not secured; and (B) if more than one obligation is secured, to obligations secured by production-money security interests in the order in which those obligations were incurred. (c) A production-money security interest does not lose its status as such, even if: (1) the production-money crops also secure an obligation that is not a production-money obligation; (2) collateral that is not production-money crops also secures the production-money obligation; or (3) the production-money obligation has been renewed, renanced, or restructured. (d) A secured party claiming a production-money security interest has the burden of establishing the extent to which the security interest is a production-money security interest.
Legislative Note: This section is optional. States that enact this section should place it between Sections 9-103 and 9-104 and number it accordingly, e.g., as Section 9-103A or 9-103.1.

Ocial Comment
1. Source. New. 2. Production-Money Priority; Production-Money Security Interest. This section is patterned closely on Section 9-103, which denes purchase-money security interest. Subsection (b) makes clear that a security interest can obtain production-money status only to the extent that it secures value that actually can be traced to the direct production of crops. To the extent that a security interest secures indirect costs of production, such as general living expenses, the security interest is not entitled to production-money treatment.

[MODEL SECTION [9-324A]. PRIORITY OF PRODUCTIONMONEY SECURITY INTERESTS AND AGRICULTURAL LIENS. (a) Except as otherwise provided in subsections (c), (d), and (e), if the requirements of subsection (b) are satised, a perfected production-money security interest in production-money crops has priority over a conicting security interest in the same crops and, except as otherwise provided in Section 9-327, also has priority in their identiable proceeds. (b) A production-money security interest has priority under subsection (a) if: (1) the production-money security interest is perfected by ling when the production-money secured party rst gives new value to enable the debtor to produce the crops;
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(2) the production-money secured party sends an authenticated notication to the holder of the conicting security interest not less than 10 or more than 30 days before the production-money secured party rst gives new value to enable the debtor to produce the crops if the holder had led a nancing statement covering the crops before the date of the ling made by the production-money secured party; and (3) the notication states that the production-money secured party has or expects to acquire a production-money security interest in the debtor's crops and provides a description of the crops. (c) Except as otherwise provided in subsection (d) or (e), if more than one security interest qualies for priority in the same collateral under subsection (a), the security interests rank according to priority in time of ling under Section 9-322(a). (d) To the extent that a person holding a perfected security interest in production-money crops that are the subject of a production-money security interest gives new value to enable the debtor to produce the production-money crops and the value is in fact used for the production of the production-money crops, the security interests rank according to priority in time of ling under Section 9-322(a). (e) To the extent that a person holds both an agricultural lien and a production-money security interest in the same collateral securing the same obligations, the rules of priority applicable to agricultural liens govern priority.]
Legislative Note: This section is optional. States that enact this section should place it between Sections 9-324 and 9-325 and number it accordingly, e.g., as Section 9-324A or 9-324.1.

Ocial Comment
1. Source. New; replaces former Section 9-312(2). 2. Priority of Production-Money Security Interests and Conicting Security Interests. This section replaces the limited priority in crops aorded by former Section 9-312(2). That priority generally has been thought to be of little value for its intended beneciaries. This section attempts to balance the interests of the production-money secured party with those of a secured party who has previously led a nancing statement covering the crops that are to be produced. For example, to qualify for priority under this section, the production-money secured party must notify the earlier-led secured party prior to extending the production-money credit. The notication aords the earlier secured party the opportunity to prevent subordination by extending the credit itself. Subsection (d) makes this explicit. If the holder of a security interest in production-money crops which conicts with a production-money security interest gives new value for the production of the crops, the security interests rank according to priority in time of ling under Section 9-322(a). 3. Multiple Production-Money Security Interests. In the case of multiple productionmoney security interests that qualify for priority under subsection (a), the rst to le has priority. See subsection (c). Note that only a security interest perfected by ling is entitled to production-money priority. See subsection (b)(1). Consequently, subsection (c) does not adopt the rst-to-le-or-perfect formulation. 4. Holder of Agricultural Lien and Production-Money Security Interest. Subsection (e) deals with a creditor who holds both an agricultural lien and an Article 9 productionmoney security interest in the same collateral. In these cases, the priority rules applicable to agricultural liens govern. The creditor can avoid this result by waiving its agricultural lien. 1123

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APPENDIX III. PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE
REPORT EFFECT OF NON-UNIFORM SCOPE PROVISIONS IN REVISED ARTICLE 9 OF THE UNIFORM COMMERCIAL CODE I. Introduction Revised Article 9 has now been enacted in all 50 states and in the District of Columbia. As has been the case with other Articles of the Uniform Commercial Code, the various state enactments contain a number of deviations from the Ocial Text of Revised Article 9. While some deviations from the Ocial Text reect accommodation of uniquely local issues, others represent substantive policy choices by the enacting legislatures to dier from the national model provided by the Ofcial Text of Revised Article 9. While non-uniformities in the latter category are inconsistent with the ideal of a truly Uniform Commercial Code, they are, of course, inevitable in a democratic system that entrusts enactment to 51 dierent legislatures. Moreover, it must be recognized that the Uniform Commercial Code has never been enacted in a truly uniform way. There have been local variations ever since the widespread enactment of the Code, including variations in Article 9. The substantive nonuniformities in the enactment of Revised Article 9 are well-catalogued in two articles by Penelope L. Christophorou, Kenneth C. Kettering, Lynn A. Soukup, and Steven O. Weise: Under the Surface of Revised Article 9: Selected Variations in State Enactments from the Ocial Text of Revised Article 91, and Analysis of State Variations2. Such non-uniformities have the potential to be problematic in our national economy, where transactions frequently cross state lines and where more than one jurisdiction can be the forum in which litigation establishing the rights of parties can be instituted. Nonetheless, most of the deviations from the Ocial Text of Revised Article 9 will not cause serious transactional diculties so long as the parties involved educate themselves as to the applicable law. There is one group of non-uniformities, though, that has the potential to cause transactional diculty and legal uncertainty, because these nonuniformities can create dicult conict of laws issues. This group of nonuniform enactments relates to the scope provisions of Revised Article 9. II. Uncertainties Arising from Non-uniformities as to Scope Uniform Commercial Code Section 9-109(a)3 provides that, [e]xcept as otherwise provided in subsections (c) and (d), Revised Article 9 applies, inter alia, to all transactions, regardless of their form, that create a security interest in personal property or xtures by contract and to sales of ac1 34 Uniform Commercial Code Law Journal 331 (2002). 2 34 Uniform Commercial Code Law Journal 358 (2002) (hereinafter referred to

as State Variations). 3 Unless otherwise noted, all references to Article 9 are to the Ocial Text of Revised Article 9.

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counts, chattel paper, payment intangibles, or promissory notes. Section 9-109(c) excludes application of Revised Article 9 in certain situations to the extent that the transactions are governed by other law referred to in that subsection4. Section 9-109(d) excludes application of Revised Article 9 altogether to the transactions and interests listed in that subsection.5 While there are non-uniformities in enactment with respect to subsection (c), variations with respect to subsection (d) raise more dicult issues. In most cases, these non-uniform enactments add further exclusions to the 13 listed exclusions in the Ocial Text of the subsection. Thus, Article 9 as enacted in a state with such a non-uniform enactment does not govern some transactions that are governed by Article 9 in states that have followed the Ocial Text. In a few states, however, the non-uniform varia4

Section 9-109(c) provides:

This article does not apply to the extent that: (1) a statute, regulation, or treaty of the United States preempts this article; (2) another statute of this State expressly governs the creation, perfection, priority, or enforcement of a security interest created by this State or a governmental unit of this State; (3) a statute of another State, a foreign country, or a governmental unit of another State or a foreign country, other than a statute generally applicable to security interests, expressly governs creation, perfection, priority, or enforcement of a security interest created by the State, country, or governmental unit; or (4) the rights of a transferee beneciary or nominated person under a letter of credit are independent and superior under Section 5-114.
5

Section 9-109(d) provides:

This article does not apply to: (1) a landlord's lien, other than an agricultural lien; (2) a lien, other than an agricultural lien, given by statute or other rule of law for services or materials, but Section 9-333 applies with respect to priority of the lien; (3) an assignment of a claim for wages, salary, or other compensation of an employee; (4) a sale of accounts, chattel paper, payment intangibles, or promissory notes as part of a sale of the business out of which they arose; (5) an assignment of accounts, chattel paper, payment intangibles, or promissory notes which is for the purpose of collection only; (6) an assignment of a right to payment under a contract to an assignee that is also obligated to perform under the contract;

(7) an assignment of a single account, payment intangible, or promissory note to an assignee in full or partial satisfaction of a preexisting indebtedness; (8) a transfer of an interest in or an assignment of a claim under a policy of insurance, other than an assignment by or to a health-care provider of a health-careinsurance receivable and any subsequent assignment of the right to payment, but Sections 9-315 and 9-322 apply with respect to proceeds and priorities in proceeds; (9) an assignment of a right represented by a judgment, other than a judgment taken on a right to payment that was collateral; (10) a right of recoupment or set-o, but: (A) Section 9-340 applies with respect to the eectiveness of rights of recoupment or set-o against deposit accounts; and (B) Section 9-404 applies with respect to defenses or claims of an account debtor; (11) the creation or transfer of an interest in or lien on real property, including a lease or rents thereunder, except to the extent that provision is made for: (A) liens on real property in Sections 9-203 and 9-308; (B) xtures in Section 9-334; (C) xture lings in Sections 9-501, 9-502, 9-512, 9-516, and 9-519; and (D) security agreements covering personal and real property in Section 9-604; (12) an assignment of a claim arising in tort, other than a commercial tort claim, but Sections 9-315 and 9-322 apply with respect to proceeds and priorities in proceeds; or (13) an assignment of a deposit account in a consumer transaction, but Sections 9-315 and 9-322 apply with respect to proceeds and priorities in proceeds.

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tions delete an exclusion that appears in subsection (d) of the Ocial Text, with the result that transactions not governed by Article 9 in states that have followed the Ocial Text are governed by Article 9 of such states. A. Non-Uniform Exclusions For purposes of this Report, attention is drawn particularly to the most common types of non-uniform enactments of Section 9-109(d)those that exclude from the scope of Article 9 transactions that are otherwise within the scope of the Ocial Text of the Article: (i) 18 states exclude from Article 9 transfers by the government of any state6, (ii) 18 states exclude from Article 9 transfers of interests in workers compensation and similar programs7, and (iii)13 states exclude from Article 9 transfers of interests in special needs trusts8. The relatively large number of states with these nonuniform exclusions makes it likely that conict of laws issues will arise with some frequency. If a transaction that is the subject of a non-uniform exclusion from Article 9 does not have a relationship to any state other than the state that has excluded that transaction from Article 9, and litigation takes place in a forum in that state, Revised Article 9 would not be applicable to the transaction. However, such a purely local transaction (accompanied by local litigation) may not be the norm. In many cases, the parties (or some other aspect of the transaction) may relate to a state that has not excluded the transaction from Article 9, or the litigation may take place in a state that has not excluded the transaction from Article 9. Accordingly, conict of laws issues must be addressed. 1. Litigation in non-excluding forum What happens if litigation concerning a security interest excluded from the scope of Article 9 as enacted in State X is instituted in the courts of State Y, which has not excluded the transaction from the scope of Article 9? In such a case, the conict of laws rules of State Y determine which state's law applies. The Uniform Commercial Code of State Y contains two sets of rules that determine the state whose law will govern secured transactions issues in the litigation. With respect to issues of perfection and priority, UCC Sections 9-301 through 9-307 of State Y provide the rules that determine which state's law governs9. With respect to issues of enforceability, attachment, and other rights and duties between debtor and secured party, though, the applicable law is determined by the conict of laws rules in UCC Article 1 of State Y. Article 1's conict of laws rules appear in Section 1-301 of Revised Article 1 and Section 1-105 of former Article 1. As the following analysis demonstrates, it is possible for a court in State Y to conclude, by application of that forum's conict of laws rules, that the law of State Y (or another state that has not excluded the transacSee State Variations at 36182. Thirteen other states exclude transfers only by this state. By their limited nature, these exclusions are likely to cause fewer choice of law problems. See id. 7 See id. 1126
6 8 9

See id.

More precisely, these sections govern issues of perfection, the eect of perfection or nonperfection, and the priority of a security interest in collateral.

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tion from the scope of Article 9) is applicable, even if the transaction has signicant contacts with State X. a. Enforceability, attachment, and other rights between the parties If litigation concerning a transaction that is excluded from the scope of Article 9 in State X takes place in the courts of State Y, which has not excluded the transaction from its Article 9, the law that governs enforceability, attachment, and other rights between the parties will be determined by application of Revised Section 1-301 or former Section 1-105, as enacted in the forum state. If application of Revised Section 1-301 or former Section 1-105 directs the State Y court to apply the law of State X, the court will apply that lawwhich, as a result of the exclusion in State X, will not be Article 9, but, rather, whatever other law of State X governs in light of the fact that the transaction has been excluded from State X's Article 9.10 It is possible, of course, for Revised Section 1-301 or former Section 1-105 to direct the State Y court to apply the law of State Y (or another state that has not excluded the transaction from Article 9) even though the transaction has some connection to State X. In this regard, it should be noted that both Revised Section 1-301 and former Section 1-105 provide the parties to a transaction with some autonomy as to selection of the governing law.11 b. Perfection and priority If, under the law of the state determined to be applicable pursuant to State Y's enactment of Revised Section 1-301 or former Section 1-105 (whether the applicable law is the non-Article 9 law of State X or Article 9 of State Y), the security interest in question is enforceable and attached, issues of perfection of that security interest and the priority of that security interest are likely to arise. If the litigation concerning these issues takes place in the courts of State Y, those courts must apply the conict of laws rules in UCC Sections 9-301 through 9-307 to determine which state's law governs issues of perfection and priority. Once again, depending on the situation, the State Y court might be directed by these sections to apply the non-Article 9 law of State X for either or both of these issues, or it might be directed to apply the law of State Y (or another state that has not excluded application of Article 9 to the transaction at hand)12; in the latter case, the rules in Article 9 of State Y or such other state would apply even though the transaction has some connection with State X.
It is important in this regard to recall that excluding a transaction from the scope of Article 9 is not the same thing as prohibiting that transaction. Exclusion from Article 9 merely means that other law governs the transaction. Only if other law prohibits the transaction is the transaction prohibited. As a practical matter, though, parties may be unwilling to enter into a transaction if the other law that would govern it is uncertain or antiquated.
10

Section 1-301 provides somewhat greater party autonomy in non-consumer transactions but is also explicitly limited by considerations of public policy. See Revised UCC Section 1-301(f). The conict of laws rules in Sections 9-301 through 9-307, unlike those in Revised Section 1-301 and former Section 1-105, do not generally defer to choices made by the parties. 1127
12

11

App. III
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Uniform Commercial Code

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2. Litigation in excluding forum It is also possible for litigation concerning a security interest excluded from the scope of Article 9 in State X to be instituted in the courts of State X, even if the transaction has signicant contacts with State Y, which has not excluded the transaction from its enactment of Article 9. In such a case, the conict of laws rules of State X determine which state's law applies. If all aspects of the transaction relate to no state other than State X, the analysis is likely trivial, resulting in application of the law of State X to all aspects of the transaction; but, as noted above, such a purely local transaction may not be the norm. In cases in which the law of a state other than State X might conceivably apply, the analysis is made much more dicult by the fact that the conict of laws rules that will determine the applicable law may not be the conict of laws rules found in the Uniform Commercial Code. a. Enforceability, attachment, and other rights between the parties If litigation concerning a transaction that is excluded from the scope of Article 9 in State X takes place in a court of State X, it is not clear which conict of laws rules the court must apply in order to determine the state whose law governs enforceability, attachment, and other rights between the parties. If no other aspect of the transaction is within the scope of Article 9 of State X or within the scope of another Article of the Uniform Commercial Code of State X, it is likely that the conict of laws rules in UCC Article 1 do not apply. This result is stated explicitly in Revised UCC Section 1-301(b), and is implicit in former Section 1-105. Thus, the general conict of laws principles of State X determine whether the non-Article 9 law of State X applies to these issues or, rather, whether the Article 9 of State Y (or another state that has not excluded the transaction from Article 9) applies. Because conict of laws rules outside the UCC are not uniform in the various states, it may be dicult to predict which state's law would be applied by the courts of a state that has excluded a transaction from Article 9. It is the view of the Permanent Editorial Board that a court in a state that has excluded from the scope of its Article 9 a transaction that would otherwise be within the scope of that Article should give serious consideration to applying to such a transaction the conict of laws rules in that state's enactment of Article 1, even though those rules may not, strictly speaking, be binding on the court, on the theory that those rules represent a general statement of legislative policy as to conict of laws issues in secured transactions. b. Perfection and priority If litigation concerning a transaction that is excluded from the scope of Article 9 in State X takes place in a court of State X, and, under the law applied by that court (whether that law is the non-Article 9 law of State X or Article 9 of State Y), the security interest granted by the debtor to the secured party is enforceable and attached, issues of perfection of that security interest and the priority of that security interest are likely to arise. In such a case, it is also not clear which conict of laws rules the court must apply in order to determine the state whose law governs issues of perfec1128

Art. 9

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tion and priority. In this situation, UCC Sections 9-301 through 9-307 of State X are not, strictly speaking, applicable to determine which state's law governs issues of perfection and priority. This is because Sections 9-301 through 9-307 are part of Article 9, and, as a result of State X's nonuniform scope provision, Article 9 of State X (including Sections 9-301 through 9-307) does not apply to the transaction. As a result, a State X court will be required to determine (without the explicit legislative guidance in the Uniform Commercial Code) the nature of State X's conict of laws rule for issues relating to perfection and priority of security interests that are outside the scope of State X's Article 9. A search for such conict of laws rules might be quite dicult, and the search could conceivably lead to a rule directing the court to apply the law of a state other than the state whose law that would be applicable by virtue of UCC Sections 9-301 through 9-307. Such a result would be unfortunate, because it would necessitate parties to secured transactions that are excluded from the scope of Article 9 in any state to consider the possibility that litigation concerning the security interest might take place in such a state, and that the courts of that state might look to the law of a dierent state for perfection (and, thus, the location of any required ling) than would a state that has enacted the Ocial Text of Article 9. Requiring parties to perform such complex conict of laws analyses not based on application of the conict of laws rules of the Uniform Commercial Code, and to make protective lings in various states in order to be sure of perfection regardless of where litigation takes place, is wasteful. Accordingly, it is the view of the Permanent Editorial Board that a court in a state that has excluded from the scope of its Article 9 a transaction that would otherwise be within the scope of that Article should give serious consideration to applying to such a transaction the conict of laws rules in that state's enactment of Sections 9-301 through 9-307, even though those rules may not, strictly speaking, be binding on the court, on the theory that those rules represent a general statement of legislative policy as to conict of laws issues in secured transactions. B. Non-uniform Inclusions For purposes of this Report, attention is drawn to non-uniform enactments of UCC Section 9-109(d) which delete the exclusion in Section 9-109(d) (13) for an assignment of a deposit account in a consumer transaction.13 This exclusion is deleted in the enactment of Revised Article 9 in four statesIdaho, Illinois, Mississippi, and North Dakota. As in the case of non-uniform exclusions from the scope of Article 9, this leads to the possibility of diering determinations of applicable law depending on whether a dispute is litigated in a state that has enacted the Ocial Text of Article 9 or a state that has enacted this non-uniform inclusion with respect to Article 9. The basic conict of laws analysis for this non-uniform inclusion is the same as described in Part A of this Report. If an issue concerning a security interest in a deposit account in a consumer transaction is litigated in a state that has enacted the Ocial Text of Revised Article 9 and, thus, in
Section 9-109(d)(13) provides, however, that sections 9-315 and 9-322 apply
13

with respect to proceeds and priorities in proceeds. 1129

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which assignments of deposit accounts in consumer transactions are outside the scope of Article 9, neither the conict of laws rules in Revised Section 1-301 or former Section 1-105 (governing attachment, enforceability, and other bilateral issues) nor the conict of laws rules in Sections 9-301 through 9-307 (governing perfection and priority) are applicable. This can lead to uncertainty as to the applicability of Article 9 if the transaction also touches upon one of the states that has enacted the non-uniform inclusion of deposit accounts in consumer transactions. As is the case with respect to non-uniform exclusions from the scope of Article 9, discussed in Part A, it is the view of the Permanent Editorial Board that a court in a state that has followed the Ocial Text of Revised Article 9 and, accordingly, has enacted the exclusion of assignments of deposit accounts in consumer transactions from the scope of Article 9, should consider its legislature's enactment of the conict of laws rules in that state's enactment of Article 1 and Sections 9-301 through 9-307 as general statements of legislative policy as to conict of laws issues in secured transactions and apply the principles of those sections to conict of laws issues relating to assignments of such deposit accounts even though, strictly speaking, they may not be binding on the court. If, on the other hand, an issue concerning a security interest in a deposit account in a consumer transaction is litigated in a state that has enacted the non-uniform inclusion of these transactions in the scope of Article 9, the conict of laws rules in Revised Section 1-301 and former Section 1-105 (governing attachment, enforceability, and other bilateral issues) and the conict of laws rules in Sections 9-301 through 9-307 (governing perfection and priority) are applicable. III. Conclusion The non-uniform enactments of the scope provisions of Revised Article 9 leads to the possibility of non-uniform determinations of which state's law governs legal issues arising from a secured transaction. As a result, dierent rules could be applied to a secured transaction depending on the location of the court in which litigation takes place. This situation would impose signicant costs and uncertainty on transactions that are the subject of non-uniform scope provisions. This diculty can be avoided if courts in states with non-uniform scope provisions nonetheless consider their legislatures' enactments of Revised Section 1-301 or former Section 1-105 and Sections 9-301 through 9-307 as general statements of legislative policy as to conict of laws issues in secured transactions and apply the principles of those sections even though, strictly speaking, they may not be binding on the court. If this practice is followed, all U.S. courts should make the same determination of which state's law governs issues arising under a secured transaction that is within the scope of Article 9 in some, but not all, states.

1130

Art. 9

Secured Transactions

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APPENDIX IV. PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE
REPORT MAINTAINING PERFECTION BEYOND JUNE 30, 2006 OF SECURITY INTERESTS CREATED AND PERFECTED BY FILING UNDER FORMER ARTICLE 9 A. Introduction Revised Article 9 of the Uniform Commercial Code has been in eect since July 1, 20011 (the eective date), yet aspects of former Article 9 still have legal eect. In particular, revised UCC Section 9-705(c) provides that a nancing statement that was eective under former Article 9 remains effective under revised Article 9 (even if the nancing statement was led in a jurisdiction that is not the jurisdiction whose law governs perfection under the conict of laws rules in revised Article 9). The period of effectiveness of such a nancing statement under revised Article 9 is limited, though. UCC Section 9-705(c) goes on to provide that the pre-eective-date nancing statement ceases being eective under revised Article 9 at the earlier of (i) the time the nancing statement would have ceased to be effective under the law of the jurisdiction in which it was led and (ii) June 30, 2006 (the cuto date). As the cuto date approaches, secured parties must plan carefully to assure that the perfected status of their security interests that remained eective under UCC Section 9-705(c) continues after that date. This Report generally describes the eect of the cuto date and the actions that secured parties may take to maintain the perfection of their security interests and analyzes in particular detail the eect of the cuto date on certain nancing statements that were continued during the rst half of 2001. As discussed in detail below, there is an interpretive issue concerning the further continuation of certain nancing statements that were continued during the rst half of 2001. In particular, application of UCC Section 9-705(c) to such continued nancing statements that are led in the same oce in the same state as required by revised Article 9 is particularly problematic and may not have been intended by the drafters.2 Consequently, resolution of the interpretive issue must be accomplished either by interpretation of UCC Section 9-705 in light of both its text and the absence of clear evidence of statutory intent or by concluding that Section 9-705 does not address such continued nancing statements and, thus, the cuto date is inapplicable to them. This Report takes no position as to the
1 See UCC 9-701. All references in this report are to the Uniform Commercial Code are to the 2004 Ocial Text, unless otherwise indicated. The analysis in this report assumes the enactment of the Ocial Text. It should be noted, though, that four states enacted non-uniform versions of 9701, resulting in eective dates of October 1, 2001 (Connecticut) and January 1, 2002 (Alabama, Mississippi, and Florida).

While this situation brings about uncertainty with respect to further continuation of those nancing statements, it should be noted that this uncertainty will aect only a small number of nancing statements inasmuch as the aected class of nancing statements is not large and only a small number of nancing statements are continued twice. 1131

App. IV
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correct interpretation. As this Report indicates, though, under any interpretation a secured party wishing to continue such a nancing statement can avoid the risk of an untimely3 (and, therefore, ineective) continuation if it les a new continuation statement during a period that begins six months before the eectiveness of the nancing statement would otherwise lapse without regard to the June 30, 2006, cuto date and that ends on June 30, 2006. It should be noted, however, that this safe harbor window for ling a continuation statement does not provide the full six-month period for ling continuation statements contemplated by both former UCC Section 9-403(3) and revised UCC Section 9-515(d)4. B. Eect of the Cuto DateGenerally As stated above, revised UCC Section 9-705(c) provides that the eectiveness of a pre-eective-date nancing statement terminates at the earlier of the time the nancing statement would have ceased to be eective under the law of the jurisdiction in which it was led and June 30, 2006. Continuation of eectiveness of such a nancing statement beyond that date may be accomplished only by following the appropriate procedure set out in Part 7 of revised Article 9. Part 7 sets out two dierent procedures, each applying to one of two mutually exclusive scenarios. First, if the preeective-date nancing statement was led in the same oce in the same jurisdiction as would be required by the conict of laws rules and ling ofce rules of revised Article 9, UCC Section 9-705(d) provides that the effectiveness of that nancing statement can be continued by the ling of a continuation statement. Second, if the rst rule does not apply, the secured party must le an initial nancing statement in lieu of continuation statement (an in lieu nancing statement) under revised UCC Section 9-706. This in lieu ling must be made in the jurisdiction whose law governs perfection under the conict of laws rules of revised Article 9. The vast majority of lings made under former Article 9 (i.e., before July 1, 2001) had only a ve-year lifespan5 and, thus, will cease to be eective on or before the June 30, 2006, cuto date under the rst prong of UCC Section 9-705(c). Thus, the number of situations in which the cuto date could shorten the period of eectiveness of a pre-eective-date nancing statement is minimal. Indeed, it might appear at rst that, except for situations in which a pre-eective-date nancing statement had a lifespan of longer than ve years under former Article 9 (because either former UCC Section 9-403(6) or a non-uniform rule in eect in the relevant state provided for a longer duration), the cuto date established by the second prong of UCC Section 9-705(c) would have no eect.
As described in more detail in this Report, a continuation statement is eective to continue the eectiveness of a nancing statement only if it is led within a statutorily described window. See generally UCC 9-515(d). Thus, a continuation statement may be untimely if it is led either too early or too late. 4 Indeed, as noted in Part F of this Report, the safe harbor period grows pro1132
3

gressively shorter as the date on which effectiveness of the nancing statement would otherwise cease if 9-705(c) were inapplicable is later in 2006. The only exceptions in the Ocial Text of former Article 9 were for lings that identied the debtor as a transmitting utility and for real estate mortgages eective as xture lings. See former UCC 9-403(6).
5

Art. 9

Secured Transactions

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C. Eect of the Cuto Date on Certain Financing Statements Continued in 2001 As noted above, however, there is another set of cases in which the June 30, 2006, cuto date is relevant even in states that had a ve-year lifespan for nancing statements led in that state under former Article 9. For some of these cases, as explained below, the structure of Part 7 of Article 9 does not work well to provide clear answers to questions about maintaining eectiveness after June 30, 2006, of a nancing statement led under former Article 9. The drafters may not have anticipated and considered these specic cases in crafting the rules in Part 7. Consider a nancing statement that originally was led under former Article 9 in the second half of 1996. Under former Article 9, that ling would have expired ve years laterin the second half of 2001, after the eective date of revised Article 9. Although the second half of 2001 was after the eective date, former Article 9 provided that a continuation statement led at any time in the six-month period prior to the expiration of a nancing statements ve-year lifespan continued the eectiveness of that nancing statement for an additional ve years from the original lapse date.6 Thus, the six-month continuation window for a nancing statement originally led in the second half of 1996 began sometime in the rst half of 2001while former Article 9 was still in eect. As a result, it was possible to le a continuation statement under former Article 9 to continue the eectiveness of such a nancing statement, even though its eectiveness would have continued until after revised Article 9 came into eect. Under the rules of former Article 9, such a continuation statement continued the eectiveness of the nancing statement for an additional ve years from its original lapse date in the second half of 2001 and, therefore, to a date after June 30, 2006. For example, if the original nancing statement was led on November 1, 1996, the secured party could have led a continuation statement under former Article 9 as early as May 1, 2001 (before the eective date of July 1, 2001). Under the rules of former Article 9, this would have continued the eectiveness of that nancing statement until November 1, 2006. At this point, several questions must be answered. First, when does the effectiveness of such a nancing statement (an aected nancing statement) lapse under the rules of revised Article 9? Second, what actions must be taken by a secured party who wishes to continue the eectiveness of an aected nancing statement beyond that date? Third, when must such actions be taken? The rst two questions are addressed immediately below. The third question is addressed in Parts D and E of this Report. 1. When Does Eectiveness of an Aected Financing Statement Lapse? To answer this question, the analysis must rst return to revised UCC Section 9-705(c), which tells us that nancing statements that were eective before the eective date of revised Article 9 cease to be eective no later than June 30, 2006. If action is not taken by that date to continue
6

Former UCC 9-403(2). 1133

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the eectiveness of an aected nancing statement, UCC Section 9-705(c) tells us that the eectiveness of the nancing statement will cease and, thus, that any later action will be too late to maintain continuity of perfection. Because many secured parties wait until shortly before the expiration of the initial ve-year period of eectiveness (or any additional ve-year period obtained by virtue of a continuation statement) or rely on automated or other calendaring systems that might have been programmed to remind the secured party of the necessity to continue the eectiveness of such lings only shortly before the expiration of that ve-year period, it is critically important for secured parties to be aware that application of the cuto rule in UCC Section 9-705(c) would lead to the conclusion that aected nancing statements would cease to be eective on the cuto datebefore the expiration of that ve year period7. The preceding discussion assumes that the cuto date in UCC Section 9-705(c) applies to all aected nancing statements. An argument could be made, though, that there is a class of aected nancing statements to which that subsection is inapplicable. If the aected nancing statement is led in the same oce and same jurisdiction as would be required for an initial nancing statement under revised Article 9 and also meets all of the requirements of Part 5 of revised Article 9 for an initial nancing statement (such as the rules for the debtors name and the indication of collateral), it might be argued that UCC Section 9-705(b) (which provides that the ling of a nancing statement before the eective date is eective to perfect a security interest after the eective date to the extent the ling would satisfy the applicable requirements for perfection under revised Article 9) governs this aected nancing statement and UCC Section 9-705(c) was not intended by the drafters to address this particular case and is inapplicable.8 In such a case,9 because UCC Section 9-705(b) contains no cuto date, the aected nancing statement would remain eective
7 While the primary focus of this Report is identication of the time period during which the eectiveness of an aected nancing statement must be continued in order to remain eective, even a secured party who does not expect again to continue the effectiveness of an aected nancing statement beyond the ve-year continuation period should note the eect of 9-705(c). For example, a secured party who expects the secured obligation to be satised after June 30, 2006, but before the expiration of the existing ve-year continuation period and who, therefore, does not take action on or before the cuto date to continue the effectiveness of its aected nancing statement (expecting to le a continuation statement only if the obligation is not satised by the expiration of the ve-year period) would also be adversely aected by the application of the cuto date of 9-705(c)(2). To avoid the possibility of such an adverse eect, such a secured party should take ac-

tion to continue the eectiveness of its affected nancing statement on or before the cuto date in accordance with the suggestions of this Report. 8 Comment 3 to revised UCC Section 9-705 suggests that subsection (b) was not intended to apply to this situation, which provides some evidence against this argument. Moreover, Example 1 to Comment 4 to the same section applies the June 30, 2006 cuto date of subsection (c) to a nancing statement that would have expired in July 2001 but was continued by the ling of a continuation statement under former Article 9 before July 1, 2001, further suggesting that subsection (c) rather than subsection (b) is applicable. Comment 4, however, as stated in its rst sentence, appears to be discussing the application of subsection (c) only in the circumstance where this Article would require ling of a nancing statement in a dierent jurisdiction or in a dierent oce in the same juris-

1134

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until the end of its full ve-year period of eectivenesseven if (as in the case of a nancing statement that would have expired on or after July 1, 2001, but was continued by the timely ling of a continuation statement before that date) that occurs after June 30, 2006. Similarly, it can be argued that, in light of the Comments to UCC Section 9-705,10 neither subsection (b) nor subsection (c) applies to these aected nancing statements and, therefore, that nothing in Section 9-705 shortens their period of eectiveness as originally determined under former Article 9. 2. What Actions Must Be Taken to Continue the Eectiveness of an Aected Financing Statement? What can secured parties in this circumstance do on or before the date on which their aected nancing statements will cease to be eective in order to assure that their perfected status will continue without interruption beyond that date? The answer depends on whether the aected nancing statement is led in the same oce and same jurisdiction as would be required for an initial nancing statement under revised Article 9. If the aected nancing statement is led in that oce in that jurisdiction, revised UCC Section 9-705(d) indicates that the secured party may continue the eectiveness of that nancing statement by ling a continuation statement in that oce.11 If, on the other hand, the current nancing statement is led in a dierent state than the state whose law governs perfection of the security interest under revised Article 9 or, even if led in that state, is not led in the oce in that state mandated by revised Article 9, the secured party must le an in lieu nancing statement under revised UCC Section 9-706. D. When May an In Lieu Financing Statement be Filed in Order to Continue the Eectiveness of a Financing Statement Whose Eectiveness is Cut O by UCC Section 9705(c)(2)? For cases in which the eectiveness of an aected nancing statement may be continued only by the ling of an in lieu nancing statement, two questions about the timing of the ling of the in lieu nancing statement must be answered. First, by when must the in lieu nancing statement be led in order to continue the eectiveness of an aected nancing statement and maintain continuity of perfection? The answer is obviousthe
diction and the facts in Example 1 involve that circumstance. Comment 4 is not directed to the circumstance of aected nancing statements on le in the same jurisdiction and same oce as required by revised Article 9. This would be consistent with a conclusion that the drafters did not intend to address that particular issue in the statute and, thus, leaves it open to interpret the text of the statute to mean that the cuto date in subsection (c) is not applicable to the particular circumstance of the aected nancing statement. 9 As noted in the previous sentence, the aected nancing statements to which this argument applies are those that are led in the same oce and same jurisdiction as would be required for an initial nancing statement under revised Article 9 and also meet all of the requirements of Part 5 of revised Article 9 for an initial nancing statement.
10 11

See note 8, supra.

Note, however, that 9-705(f) provides that, taken together, the pre-eective date nancing statement and the posteective date continuation statement must satisfy the requirements of Part 5 of revised Article 9 for an initial nancing statement. 1135

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date by which such a ling must be made is the date on which eectiveness would otherwise cease under revised UCC Section 9-705(c) (i.e., the earlier of the date on which the aected nancing statement would cease to be eective under the law of the jurisdiction in which it was led and June 30, 2006).12 Second, what is the earliest date on which such an in lieu ling can be made? The answer here is quite simple as wellan in lieu nancing statement may be led at any time.13 E. When May a Continuation Statement be Filed in Order to Continue the Eectiveness of an Aected Financing Statement? For cases in which the eectiveness of an aected nancing statement may be continued by the ling of a continuation statement in the same oce and same state as the original nancing statement, the same two questions must be answered about the timing of the continuation statement. First, by when must the continuation statement be led in order to continue the eectiveness of an aected nancing statement and maintain continuity of perfection? The answer, of course, is the date on which effectiveness of the aected nancing statement would cease under revised Article 9either June 30, 2006, or the expiration of the standard ve-year period of continued eectiveness, depending on which interpretation described in Part C1 of this Report is adopted. Second, what is the earliest date on which such a continuation statement may be led? The answer to the second question is uncertain. Revised UCC Section 9-705(d) states that eectiveness of the pre-eective-date nancing statement may be continued upon the timely ling of a continuation statement. What is a timely ling in the context of an aected nancing statement? Both former UCC Section 9-403(3) and revised UCC Section 9-515(d) provide that a continuation statement may be led within six months prior to the expiration of the ve-year period [of eectiveness of the existing nancing statement].14 In contexts other than those involving affected nancing statements, the application of revised UCC Section 9-515(d) is clear. Yet, in the case of aected nancing statements whose effectiveness may be continued by the ling of a continuation statement under revised Article 9, the analysis is more complicatedin part because of the uncertainty described in Part C1 of this Report as to when such nancing statements cease to be eective. Under the interpretation described in the rst paragraph of Part C1, UCC Section 9-705(c)(2) is applicable to an aected nancing statement, and the application of its June 30, 2006, cuto date shortens the period of eectiveness of an aected nancing statement to less than ve years. Thus, applying the cuto date of UCC Section 9-705(c)(2), the rules for the continuation period in revised UCC Section 9-515(d) cannot be applied literally to such aected nancing statements because there is no ve-year period of eectiveness. The statutory language lends itself to two possible
12 For cases in which an in lieu nancing statement is required, there is no doubt that 9-705(c) provides the applicable cuto date. By its own terms 9-705(b) does not apply to such a situation and it is clear

from Comment 4 to 9-705 that 9-705(c) is intended to apply.

13 14

See 9-706, comment 1, par. 2. Emphasis added.

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App. IV
8-510

constructions. First, the continuation period could begin six months prior to the early expiration of the nancing statement on the cuto date (June 30, 2006), even though that lapse date is less than ve years after the start of the most recent period of eectiveness of the nancing statement. This would mean that an aected nancing statement whose eectiveness is brought to an early end (i.e., on the June 30, 2006, cuto date) by operation of UCC Section 9-705(c)(2) could be the subject of a continuation statement led at any time during the six months preceding June 30, 2006. Alternatively, the continuation period could begin six months prior to the expiration of the ve-year period of eectiveness that the aected nancing statement would have had but for the cuto date. For example, this would mean that an aected nancing statement that, but for the cuto date, would lapse on November 1, 2006, could be continued only during a period beginning six months before November 1, 2006i.e., no earlier than May 1, 2006even though, as a result of the cuto date, eectiveness of the nancing statement would cease on June 30, 2006, with the result being a continuation period shorter than the standard six months. Indeed, under this interpretation the period for ling a continuation statement could be as short as one day if the aected nancing statement would lapse, but for the cuto date, on December 30, 2006. While the PEB does not believe that it was the intent of the drafters of revised Article 9 that the period for ling a continuation statement in these circumstances would be less than the standard six months (as would occur under the second construction described in the previous paragraph), the possibility that a court could read the relevant provisions of Article 9 to bring about such a result cannot be dismissed. Under the interpretation described in the second paragraph of Part C1 above, UCC Section 9-705(c)(2) does not cut o on June 30, 2006, the effectiveness of an aected nancing statementwhose eectiveness may be further continued by the ling of a continuation statement. Rather, under this interpretation, such a nancing statement remains eective until the end of the ve-year period of additional eectiveness resulting from the ling of the previous continuation statement under former Article 9. Thus, under the interpretation described in the second paragraph of Part C1, there is no diculty in applying the rules in UCC Section 9-515(d) to a continuation statement led under revised Article 9 inasmuch as the previous ling did have a ve-year period of eectiveness. Accordingly, if this interpretation is applied, the continuation statement may be led at any time within six months prior to the expiration of the ve-year period of continued eectiveness of the aected nancing statement. For example, if the aected nancing statement will lapse on November 1, 2006, under this interpretation, a continuation statement with respect to that nancing statement may be led at any time during the six month period prior to November 1, 2006. F. What Can Secured Parties Do to Avoid Uncertainty Created by Dierent Possible Interpretations? In the case of aected nancing statements that are on le in the same state and same oce as are required by revised Article 9 (and, thus, whose eectiveness may be continued under revised Article 9 by the ling of a
1137

App. IV
8-510

Uniform Commercial Code

Art. 9

continuation statement), this Report has described uncertainty as to two important matters: (i) the date on which the eectiveness of the aected nancing statement will cease if a continuation statement is not led, and (ii) the period during which a continuation statement may be led with respect to such an aected nancing statement. The PEB does not take a position as to how that uncertainty should be resolved by courts if either issue becomes the subject of litigation. The PEB notes, however, that a secured party wishing to maintain continued eectiveness of such an aected nancing statement has a course of action available to it that will enable it be successful in maintaining continued eectiveness under any of the possible statutory interpretations described in this Report. So long as such a secured party les its continuation statement no earlier than six months before the date on which the effectiveness of the aected nancing statement would have ceased under former Article 9 (in order for the continuation statement to be timely if the cuto date of UCC Section 9-705(c)(2) does not apply), but no later than June 30, 2006 (in order to be timely if the cuto date does apply), its continuation statement will be timely under any of those interpretations. Accordingly, secured parties in this situation are well-advised to le their continuation statements for aected nancing statement during the safe harbor window described in the previous sentence to avoid litigation and uncertainties that would otherwise arise from the interpretative diculties described in this Report. The duration of the safe harbor window will vary, though, depending on when the eectiveness of the aected nancing statement would have ceased under former Article 9. The later that the eectiveness would have ceased under former Article 9, the shorter the window is. Assume, for example, that an initial nancing statement was originally led on July 2, 1996, and was continued by the timely ling of a continuation statement on June 30, 2001. In that case, the safe harbor window will open on January 2, 2006six months before the date on which eectiveness of the aected nancing statement would have ceased under former Article 9and close on June 30, 2006. By way of contrast, assume that an initial nancing statement was originally led on December 30, 1996, and was continued by the timely ling of a continuation statement on June 30, 2001. In that extreme case, the window will open on June 30, 2006six months before the date on which eectiveness of the aected nancing statement would have ceased under former Article 9and close on the very same day. Thus, the safe harbor window identied in this paragraph can, in an extreme case, be as short as one day.

1138

ARTICLE 10. EFFECTIVE DATE AND REPEALER*

10-101. 10-102. 10-103. 10-104. Eective Date. Specic Repealer; Provision for Transition. General Repealer. Laws Not Repealed.

10-101. Eective Date. This Act shall become eective at midnight on December 31st following its enactment. It applies to transactions entered into and events occurring after that date. Ocial Comment
This eective date is suggested so that there may be ample time for all those who will be aected by the provisions of the Code to become familiar with them.

10-102. Specic Repealer; Provision for Transition. (1) The following acts and all other acts and parts of acts inconsistent herewith are hereby repealed: (Here should follow the acts to be specically repealed including the following: Uniform Negotiable Instruments Act Uniform Warehouse Receipts Act Uniform Sales Act Uniform Bills of Lading Act Uniform Stock Transfer Act Uniform Conditional Sales Act Uniform Trust Receipts Act Also any acts regulating: Bank collections Bulk sales Chattel mortgages Conditional sales Factor's lien acts Farm storage of grain and similar acts Assignment of accounts receivable) (2) Transactions validly entered into before the eective date specied in Section 10-101 and the rights, duties and interests owing from them remain valid thereafter and may be terminated, completed, consummated
*See Article 11 for Transition Provisions for those jurisdictions adopting the 1972 amendments.

1139

 10-102

Uniform Commercial Code

Art. 10

or enforced as required or permitted by any statute or other law amended or repealed by this Act as though such repeal or amendment had not occurred.
Note
Subsection (1) should be separately prepared for each state. The foregoing is a list of statutes to be checked.

Ocial Comment
Subsection (1) provides for the repeal of present uniform and other acts superseded by this Act. Subsection (2) provides for the transition to the Code.

10-103. General Repealer. Except as provided in the following section, all acts and parts of acts inconsistent with this Act are hereby repealed. Ocial Comment
This section provides for the repeal of all other legislation inconsistent with this Act.

10-104. Laws Not Repealed. [ (1) ] The Article on Documents of Title (Article 7) does not repeal or modify any laws prescribing the form or contents of documents of title or the services or facilities to be aorded by bailees, or otherwise regulating bailees' businesses in respects not specically dealt with herein; but the fact that such laws are violated does not aect the status of a document of title which otherwise complies with the denition of a document of title (Section 1-201). As amended in 1962 and 1994.
See Appendix K for material relating to changes made in text in 1994.

Ocial Comment
This section subordinates the Article of this Act on Documents of Title (Article 7) to the more specialized regulations of particular classes of bailees under other legislation and international treaties. Particularly, the provisions of that Article are superseded by applicable inconsistent provisions regarding the obligation of carriers and the limitation of their liability found in federal legislation dealing with transportation by water (including the Harter Act, Act of February 13, 1893, 27 Stat. 445, and the Carriage of Goods by Sea Act, Act of April 16, 1936, 49 Stat. 1207); the Warsaw Convention on International Air Transportation, 49 Stat. 3000, and Section 20(11) of the Interstate Commerce Act, Act of February 20, 1887, 24 Stat. 386, as amended. The Documents of Title provisions of this Act supplement such legislation largely in matters other than obligation of the bailee, e.g., form and eects of negotiation, procedure in the case of lost documents, eect of overissue, possibility of rapid transmission. Cross Reference: Section 7-103.

1140

ARTICLE 11. EFFECTIVE DATE AND TRANSITION PROVISIONS*

11-101. 11-102. 11-103. 11-104. 11-105. 11-106. 11-107. 11-108. Eective Date. Preservation of Old Transition Provision. Transition to [New Code]General Rule. Transition Provision on Change of Requirement of Filing. Transition Provision on Change of Place of Filing. Required Relings. Transition Provisions as to Priorities. Presumption That Rule of Law Continues Unchanged.

11-101. Eective Date. This Act shall become eective at 12:01 A.M. on , 19 . 11-102. Preservation of Old Transition Provision. The provisions of [here insert reference to the original transition provision in the particular state] shall continue to apply to [the new U.C.C.] and for this purpose the [old U.C.C. and new U.C.C.] shall be considered one continuous statute. 11-103. Transition to [New Code]General Rule. Transactions validly entered into after [eective date of old U.C.C.] and before [eective date of new U.C.C.], and which were subject to the provisions of [old U.C.C.] and which would be subject to this Act as amended if they had been entered into after the eective date of [new U.C.C.] and the rights, duties and interests owing from such transactions remain valid after the latter date and may be terminated, completed, consummated or enforced as required or permitted by the [new U.C.C.]. Security interests arising out of such transactions which are perfected when [new U.C.C.] becomes eective shall remain perfected until they lapse as provided in [new U.C.C.], and may be continued as permitted by [new U.C.C.], except as stated in Section 11-105.
*This material has been numbered Article 11 to distinguish it from Article 10, the transition provision of the 1962 Code, which may still remain in eect in some states to cover transition problems from preCode law to the original Uniform Commercial Code. Adaptation may be necessary in particular states. The terms [old Code] and [new Code] and [old U.C.C.] and [new U.C.C.] are used herein, and should be suitably changed in each state. This draft was prepared by the Reporters and has not been passed upon by the Review Committee, the Permanent Editorial Board, the American Law Institute, or the National Conference of Commissioners on Uniform State Laws. It is submitted as a working draft which may be adapted as appropriate in each state. The Discussions were written by the Reporters to assist in understanding the purpose of the drafts. 1141

 11-104

Uniform Commercial Code

Art. 11

11-104. Transition Provision on Change of Requirement of Filing. A security interest for the perfection of which ling or the taking of possession was required under [old U.C.C.] and which attached prior to the effective date of [new U.C.C.] but was not perfected shall be deemed perfected on the eective date of [new U.C.C.] if [new U.C.C.] permits perfection without ling or authorizes ling in the oce or oces where a prior ineective ling was made. 11-105. Transition Provision on Change of Place of Filing. (1) A nancing statement or continuation statement led prior to [eective date of new U.C.C.] which shall not have lapsed prior to [the eective date of new U.C.C.] shall remain eective for the period provided in the [old Code], but not less than ve years after the ling. (2) With respect to any collateral acquired by the debtor subsequent to the eective date of [new U.C.C.], any eective nancing statement or continuation statement described in this section shall apply only if the ling or lings are in the oce or oces that would be appropriate to perfect the security interests in the new collateral under [new U.C.C.]. (3) The eectiveness of any nancing statement or continuation statement led prior to [eective date of new U.C.C.] may be continued by a continuation statement as permitted by [new U.C.C.], except that if [new U.C.C.] requires a ling in an oce where there was no previous nancing statement, a new nancing statement conforming to Section 11-106 shall be led in that oce. (4) If the record of a mortgage of real estate would have been eective as a xture ling of goods described therein if [new U.C.C.] had been in eect on the date of recording the mortgage, the mortgage shall be deemed eective as a xture ling as to such goods under subsection (6) of Section 9-402 of the [new U.C.C.] on the eective date of [new U.C.C.]. 11-106. Required Relings. (1) If a security interest is perfected or has priority when this Act takes eect as to all persons or as to certain persons without any ling or recording, and if the ling of a nancing statement would be required for the perfection or priority of the security interest against those persons under [new U.C.C.], the perfection and priority rights of the security interest continue until 3 years after the eective date of [new U.C.C.]. The perfection will then lapse unless a nancing statement is led as provided in subsection (4) or unless the security interest is perfected otherwise than by ling. (2) If a security interest is perfected when [new U.C.C.] takes eect under a law other than [U.C.C.] which requires no further ling, reling or recording to continue its perfection, perfection continues until and will lapse 3 years after [new U.C.C.] takes eect, unless a nancing statement is led as provided in subsection (4) or unless the security interest is perfected otherwise than by ling, or unless under subsection (3) of Section 9-302 the other law continues to govern ling. (3) If a security interest is perfected by a ling, reling or recording
1142

Art. 11

Effective Date and Transition

11-108

under a law repealed by this Act which required further ling, reling or recording to continue its perfection, perfection continues and will lapse on the date provided by the law so repealed for such further ling, reling or recording unless a nancing statement is led as provided in subsection (4) or unless the security interest is perfected otherwise than by ling. (4) A nancing statement may be led within six months before the perfection of a security interest would otherwise lapse. Any such nancing statement may be signed by either the debtor or the secured party. It must identify the security agreement, statement or notice (however denominated in any statute or other law repealed or modied by this Act), state the ofce where and the date when the last ling, reling or recording, if any, was made with respect thereto, and the ling number, if any, or book and page, if any, of recording and further state that the security agreement, statement or notice, however denominated, in another ling oce under the [U.C.C.] or under any statute or other law repealed or modied by this Act is still eective. Section 9-401 and Section 9-103 determine the proper place to le such a nancing statement. Except as specied in this subsection, the provisions of Section 9-403(3) for continuation statements apply to such a nancing statement. 11-107. Transition Provisions as to Priorities. Except as otherwise provided in [Article 11], [old U.C.C.] shall apply to any questions of priority if the positions of the parties were xed prior to the eective date of [new U.C.C.]. In other cases questions of priority shall be determined by [new U.C.C.]. 11-108. Presumption That Rule of Law Continues Unchanged. Unless a change in law has clearly been made, the provisions of [new U.C.C.] shall be deemed declaratory of the meaning of the [old U.C.C.].

1143

APPENDIX A PEB Commentaries on the Uniform Commercial Code COMMENTARIES 17 FINAL DRAFT

PEB RESOLUTION ON PURPOSES, STANDARDS AND PROCEDURES FOR PEB COMMENTARY TO THE UCC PEB COMMENTARY NO. 1 SECTION 2-507(2) PEB COMMENTARY NO. 2 SECTION 9-301(4) PEB COMMENTARY NO. 3 SECTIONS 9-306(2) AND 9-402(7) PEB COMMENTARY NO. 4 SECTION 8-207(1) PEB COMMENTARY NO. 5 SECTION 9-306(5) PEB COMMENTARY NO. 6 SECTION 9-301(1) PEB COMMENTARY NO. 7 THE RELATIVE PRIORITIES OF SECURITY INTERESTS IN THE CASH PROCEEDS OF ACCOUNTS, CHATTEL PAPER, AND GENERAL INTANGIBLES
COMMENTARY NO. 8 FINAL DRAFT

PEB COMMENTARY NO. 8 (AS AMENDED TO APPLY TO REVISED ARTICLE 9) SECTION 9-330
COMMENTARY NO. 9 FINAL DRAFT

PEB COMMENTARY NO. 9 SECTION 9-306(1)

COMMENTARY NO. 10 (SECTION 1-203) FINAL DRAFT

PEB COMMENTARY NO. 10 SECTION 1-203

COMMENTARY NO. 11 (SURETYSHIP ISSUES UNDER SECTIONS 3-116, 3-305, 3-415, 3-419, AND 3-605) FINAL DRAFT

PEB COMMENTARY NO. 11 (AS AMENDED TO APPLY TO REVISED ARTICLE 9) SURETYSHIP ISSUES UNDER SECTIONS 3-116, 3-305, 3-415, 3-419, AND 3-605
1144

PEB Commentaries

COMMENTARY NO. 12 (SECTION 9-302) FINAL DRAFT

PEB COMMENTARY NO. 12 SECTION 9-302

COMMENTARY NO. 13 (THE PLACE OF ARTICLE 4A IN A WORLD OF ELECTRONIC FUNDS TRANSFERS) FINAL DRAFT

PEB COMMENTARY NO. 13 THE PLACE OF ARTICLE 4A IN A WORLD OF ELECTRONIC FUNDS TRANSFERS
COMMENTARY NO. 14 (SECTION 9-102(1)(B)) FINAL DRAFT

PEB COMMENTARY NO. 14 SECTION 9-102(1)(B) PEB COMMENTARY NO. 15 ELECTRONIC FILING UNDER ARTICLE 9
PEB COMMENTARY NO 16 SECTIONS 4A-502(D) AND 4A-503

PEB COMMENTARY NO 16 SECTIONS 4A-502(D) AND 4A-503

1145

COMMENTARIES 17 FINAL DRAFT (March 10, 1990) Permanent Editorial Board for the Uniform Commercial Code, 4025 Chestnut Street, Philadelphia, Pennsylvania 19104. 1990 by The American Law Institute and the National Conference of Commissioners on Uniform State Laws. All Rights Reserved
PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE CHAIRMAN Geoffrey C. Hazard, Jr., New Haven, Connecticut MEMBERS Boris Auerbach, Cincinnati, Ohio Marion W. Benfield, Jr., Champaign, Illinois William M. Burke, Los Angeles, California Ronald DeKoven, New York, New York William D. Hawkland, Baton Rouge, Louisiana Robert Haydock, Jr., Boston, Massachusetts William E. Hogan, New York, New York Frederick H. Miller, Norman, Oklahoma William J. Pierce, Ann Arbor, Michigan Donald J. Rapson, Livingston, New Jersey Carlyle C. Ring, Jr., Alexandria, Virginia EMERITUS MEMBER Homer Kripke, San Diego, California SECRETARY Paul A. Wolkin, Philadelphia, Pennsylvania COUNSELLOR EMERITUS Martin J. Aronstein, Philadelphia, Pennsylvania ABA LIAISONADVISER Charles W. Mooney, Jr., Philadelphia, Pennsylvania CONTENTS PEB Resolution on Purposes, Standards and Procedures for PEB Commentary to the UCC PEB Commentary No. 1, Section 2-507(2) PEB Commentary No. 2, Section 9-301(4) PEB Commentary No. 3, Sections 9-306(2) and 9-402(7) PEB Commentary No. 4, Section 8-207(1) PEB Commentary No. 5, Section 9-306(5) PEB Commentary No. 6, Section 9-301(1) PEB Commentary No. 7, The Relative Priorities of Security Interests in the Cash Proceeds of Accounts, Chattel Paper, and General Intangibles

1146

PEB RESOLUTION ON PURPOSES, STANDARDS AND PROCEDURES FOR PEB COMMENTARY TO THE UCC
1. The Permanent Editorial Board (PEB), in accordance with the standards and procedures set out in this resolution of March 14, 1987, and the authority given in the agreement between the American Law Institute and the National Conference of Commissioners on Uniform State Laws dated July 31, 1986, will issue supplemental commentary on the Uniform Commercial Code (UCC) from time to time. a. The supplemental commentary of the PEB generally will be known as PEB Commentary, to distinguish it from the Ocial Comments to the UCC, and will be preserved separately from the Ocial Comments. b. The underlying purposes and policies of the PEB Commentary are those specied in UCC 1-102(2). A PEB Commentary should come within one or more of the following specic purposes, which should be made apparent at the inception of the Commentary: (1) to resolve an ambiguity in the UCC by restating more clearly what the PEB considers to be the legal rule; (2) to state a preferred resolution of an issue on which judicial opinion or scholarly writing diverges; (3) to elaborate on the application of the UCC where the statute and/or the Ofcial Comment leaves doubt as to inclusion or exclusion of, or application to, particular circumstances or transactions; (4) consistent with UCC 1-102(2)(b), to apply the principles of the UCC to new or changed circumstances; (5) to clarify or elaborate upon the operation of the UCC as it relates to other statutes (such as the Bankruptcy Code and various federal and state consumer protection statutes) and general principles of law and equity pursuant to UCC 1-103; or (6) to otherwise improve the operation of the UCC. c. The format of the PEB Commentary normally will consist of an identication of the issue, a discussion concerning the possible resolutions of the issue to be addressed, and a statement of the view of the PEB as to how the issue should be resolved. On a carefully selected basis supplemental commentary may be issued as an identied supplement to the Ocial Comments, in which case it generally should take the form of a brief exposition modeled substantially on the form and style of the Ocial Comments. d. Topics for PEB Commentary will be selected periodically by the PEB from suggestions, accompanied by supporting reasons, made by PEB members and by other persons. PEB Commentary may be issued whether or not a perceived issue has been litigated or is in litigation, and whether or not the position taken by the PEB accords with the weight of authority on the issue. The number of topics and topics that are chosen at any given time will be determined by the PEB weighing criteria appropriate under the circumstances, which may include the practical importance of the issue, the absence of other means of resolution, the time and eort to be involved in the preparation of the
1147

Appendix A

PEB Commentary, the extent to which the PEB Commentary is likely to be successful in addressing an issue, whether it is known to the PEB that the topic of the PEB Commentary is in specic litigation and, if so, the probable impact upon that litigation, and the availability of resources. However, normally no PEB Commentary should be begun with respect to a UCC Article that is undergoing amendment or initial promulgation except upon consultation with and concurrence of the study or drafting committee for such amendment or initial promulgation. Moreover, except in extraordinary cases and in the case of PEB Commentary identied as specic supplements to Ocial Comments, an Ocial Comment, as opposed to the text of the UCC, should not be the specic subject of PEB Commentary. e. For a variety of reasons, topics initially identied by the PEB for PEB Commentary and advisors' drafts of PEB Commentary (discussed in paragraph 2 below) may not result in the nal approval of PEB Commentary. Such reasons might include the failure of a consensus to emerge on the substance of an issue or a conclusion that the issue would better be treated by a change in the UCC Ocial Text. No inference should be drawn from, and no weight should be accorded to, any withdrawal of an advisor's draft or any failure to proceed with a PEB Commentary on any particular topic. 2. The process by which PEB Commentary is prepared and issued by the PEB should be exible, but usually should include: a. periodic publication of the topics under consideration by the PEB with a request for comment by interested persons by a stated date as to whether any listed topic should be deleted or a related topic added and as to the appropriate resolution of the issues presented by the topics under consideration; b. selection of one or more appropriate advisers, who are not members of the PEB, to review any comments submitted by interested persons and other relevant materials and to prepare a tentative adviser's draft of the proposed PEB Commentary; c. publication of the adviser's draft of the PEB Commentary, after supervisory review of the PEB, soliciting comments by interested persons by a stated date on the substance and style of the work; d. approval by the PEB of the substance and style of the PEB Commentary as nally submitted by the adviser(s) and comments submitted by interested persons or, when warranted, the withdrawal of the proposal with the reasons for withdrawal stated; and e. periodic publication of such PEB Commentary as is approved by the PEB on a regular schedule. Approval by the PEB of PEB Commentary shall be by three quarters of the members of the PEB voting on the Commentary. The manner of publication of PEB Commentary by the PEB will be in accordance with procedures formulated under a resolution related to that subject generally.

1148

PEB COMMENTARY NO. 1 SECTION 2-507(2)

ISSUE A cash seller has the right to be paid upon delivery of goods and, if not paid, to reclaim the goods. This right is codied by 2-507(2). Payment may be made by a check, but such payment is conditional and defeated by dishonor of the check giving rise to the seller's right of reclamation. Comment 3 to 2-507(2) states:
Subsection (2) deals with the eect of a conditional delivery by the seller and in such a situation makes the buyer's right as against the seller conditional upon payment. These words are used as words of limitation to conform with the policy set forth in the bona de purchase sections of this Article. Should the seller after making such a conditional delivery fail to follow up his rights, the condition is waived. The provision of this Article for a ten day limit within which the seller may reclaim goods delivered on credit to an insolvent buyer is also applicable here. (emphasis supplied)

If the payment is tendered by check, the seller payee will only learn that the check has been or will be dishonored after the goods are delivered. The seller will gain this information either by learning from the bank where the check was deposited that it had been dishonored by the payor bank; or, sometimes by inquiring directly of the payor bank and being told that there is no such account or there is an account but with insucient funds to cover the check. Oftentimes, the seller may not learn of the dishonor or anticipated dishonor until more than ten days after delivery of the goods.1 Does the reference in the Comment to the requirement of 2-702(2) requiring a credit seller to demand reclamation of the goods within ten days after the receipt mean that the cash seller also loses the right of reclamation where demand is made more than ten days after delivery of the goods, even though the seller did not learn of the dishonor before then? DISCUSSION The cash seller's right of reclamation was a common law remedy in the nature of a lien. The ground upon which an unpaid seller is allowed a lien and kindred remedies is the inherent injustice of depriving him of goods with which he has not nally parted where it is evident that he has not been paid or will not be paid the price for them when it is due. Williston, Sales, 99 (1948). The cash sale is expressly mentioned in the voidable title provision of
This problem should become less signicant under Federal Reserve Board Regulation CC, 12 CFR Part 229, issued pursuant to the Expedited Funds Availability Act, 12 USC Section 4001 et seq. Under Section 229.30, the payor bank has a duty to eect an expeditious return of the check and if the check is for $2,500 or more, Section 229.33 requires that it provide no1

tice of non-payment that is received by the depositary bank by 4:00 P.M. on the second business day following the banking day on which the check was presented; and that the depositary bank send notice to its customer by midnight of the banking day following its receipt of the notice or within a reasonable longer time. 1149

Appendix A

2-403(1)(c) (along with payment by check ( 2-403(1)(b))), but the right of reclamation is not specically mentioned. Instead, it is implicit in 2-507(2) and 2-511(3). As noted by the First Circuit in Szabo v. Vinton Motors, 630 F.2d 1, 3, 29 UCC Rep.Serv. (Callaghan) 737 (1st Cir.1980):
Although the right of such a cash seller to reclaim goods sold in a bad check transaction is not specically set forth in the Code provisions, [footnote omitted] such a reclamation right is inherent in 2-507(2) and 2-511(3) of the Code, Mass. Gen. Laws ch. 106, 2-507(2), 2-511(3). In re Mort Co., 208 F.Supp. 309, 310 [1 UCC Rep. 166] (ED Pa.1962); In re Helms Veneer Corp., 287 F.Supp. 840, 84546 [5 UCC Rep. 977, 9834] (WD Va.1968). See generally Mann & Phillips, The Cash Seller Under the Uniform Commercial Code, 20 B.C.L.Rev. 370, 37584 (1979). Section 2-507(2) makes a buyer's right as against the seller to retain or dispose of [the goods] . . . conditional upon his making the payment due. Section 2-511(3), in turn, provides that payment by check is conditional and is defeated as between the parties by dishonor of the check on due presentment. Taking these two Code provisions together, the clear implication is that a buyer cannot retain and, conversely, a seller has the right to reclaim goods sold in a cash transaction if the buyer's check is dishonored. The existence of the cash seller's right to reclaim is further supported, and limited, by Comment 3 to section 2-507: [quotation omitted] The reference in the last sentence of Comment 3 is to the limitation contained in 2-702(2) requiring a credit seller to reclaim goods within ten days of receipt. See note 1 supra. Based on this reference, courts have invariably held that a cash seller must make a demand for the return of the goods within ten days after the goods are received by the buyer. E.g., In re Samuels & Co., 526 F.2d 1238, 1245 (5th Cir.) (en banc), cert. denied 429 U.S. 834 (1976); In re Helms Veneer Corp., supra, at 846 * * * [footnote omitted].

See also Dugan, Cash Sellers Under Articles 2 and 9 of the UCC, 8 UCC L.J. 330, 345349 (1976). Szabo, which represents the majority view by reason of the Comment, went on to hold that the seller's right of reclamation is lost if demand is made more than ten days after delivery of the goods:
Appellee urges us to disregard the limitation contained in Comment 3 on the ground that it directly contradicts the language of the Code. Although ocial Code Comments do not have the force of law, they are helpful in explaining the Code provisions and their purpose is to promote uniformity in construction. Mass.Gen. Laws ch. 106, Comment to Title; Thompson v. United States, 408 F.2d 1075, 1084 n. 15 (8th Cir.1969). See generally Skilton, Some Comments on the Comments to the Uniform Commercial Code, 1966 Wisc.L.Rev. 597. It has been stated that the Ocial Comments are powerful dicta. In re Yale Express System, Inc., 370 F.2d 433, 437 (2d Cir.1966). Nevertheless, it is the Code provisions and not the Comments which control. We do not, however, accept appellee's argument that there is a direct conict between the cash sale provisions of the Code and Comment 3 to 2-507. As noted above, Comment 3 supports a reclamation right which is only implicit in 2-507(2) and 2-511(3), and limits that right by reference to another Code provision, 2-702(2), dealing with credit sales. Comment 3 does not contradict, but merely complements and explains the Code. We decline to disregard it. (630 F.2d at 34).

The Eighth Circuit, however, rejected Szabo in Burk v. Emmick, 637 F.2d 1172, 29 UCC Rep.Serv. (Callaghan) 1489 (8th Cir.1980):
We reject this reasoning. In our view, it would tend to coerce the cash seller
1150

PEB Commentary No. 1 who reasonably expects the buyer to tender payment at delivery to go through the cautious motions of a credit seller dealing with an economically unstable buyer. This we are not prepared to do . . .. (637 F.2d at 1175 n. 6). Our holding is quite limited. We determine that as between the seller and the buyer, where a cash seller reclaims goods sold to a breaching buyer, the only limitation imposed upon the seller's right is a reasonableness requirement . . .. (637 F.2d at 1176).

There is nothing in the language of 2-507(2) supporting the imposition of the ten day limit mentioned in Comment 3. At common law, there was no specic time limitation. Rather, an attempt to reclaim after excessive delay would be defeated by doctrines such as waiver, estoppel, or ratication of the buyer's property interest. See, e.g., Frech v. Lewis, 218 Pa. 141, 67 A. 45 (1907). Under 1-103, common law principles supplement Code provisions, unless displaced by the particular provisions. Proper implementation of this doctrine compels the conclusion that the codication of the cash sale concept implicit in 2-507(2), without any mention of a time limit, means that common law rules governing enforcement are still applicable. Indeed, the third sentence of Comment 3 is consistent with this interpretation in referring to waiver where a seller fails to follow up his rights. The cases which, even though they rely on Comment 3, impose a ten day limit, must be considered to have reached an improper result. There is no need to impose a specic time limitation for enforcement of a cash seller's right of reclamation. The common law rules defeating the right where there is delay resulting in prejudice to the buyer adequately cover instances where only the seller and buyer are involved: If the rights of third parties are implicated 2-403(1)(b) and (c) protect good faith purchasers. CONCLUSION There is no justication for barring the cash seller's right or remedy of reclamation before discovery of non-payment. There is no specic time limit for a cash seller to exercise the right of reclamation. The right may be exercised as long as there has not been an excessive delay causing inequitable prejudice to the buyer. Common law rules and precedents governing such circumstances are applicable. The last sentence of Ocial Comment 3 to 2-507 is deleted as inappropriate and replaced by the following:
. . . This subsection (2) codies the cash seller's right of reclamation which is in the nature of a lien. There is no specic time limit for a cash seller to exercise the right of reclamation. However, the right will be defeated by delay causing prejudice to the buyer, waiver, estoppel, or ratication of the buyer's right to retain possession. Common law rules and precedents governing such principles are applicable (Section 1-103). If third parties are involved, Section 2-403(1) protects good faith purchasers. See PEB Commentary No. 1, dated March 10, 1990.

1151

PEB COMMENTARY NO. 2 SECTION 9-301(4)

ISSUE Section 9-301(4) provides: A person who becomes a lien creditor while a security interest is perfected takes subject to the security interest only to the extent that it secures advances made before he becomes a lien creditor or within 45 days thereafter or made without knowledge of the lien or pursuant to a commitment entered into without knowledge of the lien. Does the phrase only to the extent that it secures advances limit the priority of the security interest to advances, as distinguished from, e.g., accruing interest, collection expenses, and similar ancillary rights (all herein called non-advances)? DISCUSSION An example to illustrate the issue is the question whether non-advances, e.g., interest on advances accruing either before or after the lien arises, or expenses of foreclosure of the security interest arising after the lien arises, are excluded from the priority of pre-lien advances under the security interest by the language quoted above. If 9-301(4) were read in an exclusionary fashion as suggested in the issue above, it would put on the priority of a security interest a limitation which does not have any pre-Code precedents in chattel security law or similar real estate mortgage law. Even if the language were to be read as excluding only interest and expenses incurred after the creditor's lien arose, the limitation is believed to be without precedent except for some situations in which accruing interest and expenses were considered to be inchoate as that concept developed in federal law concerned with rights of the United States against secured parties under the Federal Preference Act, R.S. 3166, now 31 USC 3713, and under the Federal Tax Lien Act, 26 USC 63216323. Section 9-301(4) was one of three sections (the others being 9-307(3) and 9-312(7)) adopted by the 1972 amendments to Article 9 to solve the much debated question of the priority of future advances against intermediate security interests or buyers of the collateral or creditors having nonconsensual liens on the collateral. See the 1972 General Comments of the Review Committee for Article 9, paragraphs E-39 to -45 (republished in West's Uniform Commercial Code, 1987 Ocial Text with Comments, pp. 910912), which neither by their heading nor by their text oered any suggestion that the priority considered related to anything other than the future advances themselves, as distinguished from non-advances. To the same eect, the Reasons for 1972 Change to 9-301(4) (Rights of Lien Creditors), 9-307(3) (Rights of Buyers) and 9-312(7) (Rights of Intervening Secured Parties) do not contain any suggestion that the sections undertake to aect the priorities of non-advances. The three sections are in pari materia, although they use somewhat dierent combinations of the same elements to reach varying results in three situations.
1152

PEB Commentary No. 2

Sections 9-301(4) and 9-307(3) provide nearly identical rules as to the priority of subsequent advances against lien creditors and buyers respectively. Section 9-307(3) reads: A buyer . . . takes free of a security interest to the extent that it secures future advances made after the secured party acquires knowledge of the purchase, or more than 45 days after the purchase, whichever rst occurs, unless made pursuant to a commitment entered into without knowledge of the purchase and before the expiration of the 45 day period. The only substantive dierence between this and 9-301(4), quoted at the beginning of the Commentary, is that in 9-307(3) the eect of knowledge of the intervening rights is to shorten the specied 45-day period during which advances may be made with the same priority as the original advance, while in 9-301(4) absence of knowledge is a factor which can extend beyond the 45 days the right to make post-lien advances with the same priority as the original advance. The language in 9-307(3) sets forth the rule for future advances without suggesting that it is exclusive and excludes any priority for non-advances, while 9-301(4) is so phrased with the word only that on its face it excludes any right to non-advances. It is believed that this phraseology in 9-301(4) was just an accident of draftmanship as the draftsmen concentrated on the problem discussed in the last paragraph of the Reasons for 1972 Change for 9-301(4), namely, the eect of the rule chosen on priority of the security interest as against the Federal Tax Lien under the Federal Tax Lien Act of 1966. CONCLUSION Section 9-301(4) should not be read as excluding or limiting interest on advances or expenses made in their collection and enforcement, or other nonadvances ancillary to advances having priority against the lien creditor. This issue was presented in Dick Warner Cargo Handling Corp. v. Aetna Business Credit, Inc., 746 F.2d 126, 39 UCC Rep.Serv. (Callaghan) 762 (2d Cir.1984), and the Court held in accordance with this conclusion. The Ocial Comment to 9-301 is amended by adding the following:
8. The word only in subsection (4) is limited in its eect to the lien creditor's subjection to the specied advances. It does not limit the lien creditor's subjection to whatever other rights the secured party may have by contract or law, e.g., the right to interest before or after the attachment of the judgment lien to the collateral or the right to foreclosure expenses or other collection expenses. See PEB Commentary No. 2, dated March 10, 1990.

1153

PEB COMMENTARY NO. 3 SECTIONS 9-306(2) AND 9-402(7)

ISSUE Is there a conict between UCC 9-306(2), which terminates a security interest upon any disposition of the collateral that has been authorized by the secured party, and the last sentence of UCC 9-402(7), which continues the eectiveness of a nancing statement with respect to collateral that has been transferred even though the secured party knows of and consents to the transfer? The issue can be described by the following hypothetical: Debtor (D) has granted to Secured Party (SP) a security interest in collateral consisting of equipment. The security interest is perfected by the ling of a nancing statement naming D as the debtor. D disposes of the collateral to Transferee (T) who assumes D's obligations under the security agreement. SP is aware of and consents to the disposition but only on the conditions that D remain liable on the secured indebtedness and that T make all payments and perform all obligations under the security agreement in a timely manner. DISCUSSION 1. Section 9-306(2) Section 9-306(2) (1972 Ocial Text) provides:
Except where this Article otherwise provides, a security interest continues in collateral notwithstanding sale, exchange or other disposition thereof unless the disposition was authorized by the secured party in the security agreement or otherwise, and also continues in any identiable proceeds including collections received by the debtor.

Section 9-306(2) treats only the issue of whether a security interest continues in collateral following disposition of the collateral. Assuming the security interest continues in the collateral after disposition, this Section does not deal with the issue of whether the secured party must take further action to continue the perfected status of its security interest in the collateral. Section 9-306(2) states the general rule that a security interest in collateral is not terminated upon a disposition of the collateral and can be enforced against the collateral in the hands of the transferee. See Ofcial Comment No. 3 to UCC 9-306(2). Section 9-306(2), however, sets forth an exception to this rule if the secured party has authorized the disposition of the collateral in the security agreement or otherwise. The intent underlying this exception is to permit a disposition of the collateral free and clear of the security interest when the secured party has authorized the disposition free and clear of its security interest in the security agreement or otherwise. In the case of such an authorized disposition, the general rule of survivability of the security interest set forth in 9-306(2) will not apply and the security interest will terminate upon the disposition. However, this exception to the rule
1154

PEB Commentary No. 3

of survivability only applies if the secured party has authorized the disposition, by agreement or otherwise, free and clear of the security interest. The exception will not apply if the secured party did not authorize the disposition of the collateral or if the secured party authorized the disposition subject to its security interest. This authorization issue presents a factual question. The questions of what facts will constitute an eective express or implied authorization for purposes of this Section and what standard of proof is applicable to this determination are not addressed in the Code but are instead left to other law. If the disposition of the collateral has been authorized by the secured party free and clear of the security interest, the security interest will terminate upon the disposition and there will be no need to determine whether the secured party must take further action to continue the perfected status of the security interest in the collateral following its disposition. On the other hand, if the security interest in the collateral survives the disposition, the secured party must then determine whether further action is necessary to continue the perfected status of its security interest following the disposition. This is a perfection issue which is not governed by 9-306(2). This perfection issue is governed by 9-402(7). 2. Section 9-402(7) The last sentence of 9-402(7) provides that a led nancing statement remains eective with respect to collateral transferred by the debtor even though the secured party knows of or consents to the transfer. This sentence, which was added in the 1972 Ocial Text, was intended to resolve an ambiguity in the 1962 Code as to whether a secured party is required to le an amended or new nancing statement when the collateral is transferred. Substantial policy arguments can be made on both sides of this issue. Those favoring a reling obligation when collateral is transferred argue that, absent reling in the name of the transferee, secured creditors searching in the name of the transferee could be misled since they would not discover a nancing statement led in the name of the transferor. Allowing a ling against the transferor to be eective against creditors of the transferee would thus promote hidden liens in violation of the public notice purposes of Article 9. Those who argue against a reling obligation as to collateral transferred by the debtor point to the enormous policing responsibility that a reling duty would impose on secured creditors of the transferor, most of whom have no continuing contact with the transferor after the secured transaction other than to receive installment payments on the secured indebtedness. A reling obligation linked to the secured creditor's notice or knowledge of the transfer would create dicult problems of proof and would foster litigation with all of its resultant costs and uncertainties. Secured creditors of the transferee can protect themselves against lings in the name of prior owners of the collateral by tracing ownership of the collateral and searching in the names of prior owners. This tracing obligation, it is argued, is not an unreasonable burden to place on creditors of the transferee since they would have this responsibility anyway in order to insure that their debtor (the transferee) has rights in the collateral sucient to grant a security interest.
1155

Appendix A

Balancing these competing policy concerns, the National Conference of Commissioners on Uniform State Laws and the American Law Institute, in adopting 9-402(7), opted in favor of the no reling rule as to collateral transferred by the debtor. Thus, the last sentence of 9-402(7) makes it clear that the secured party has no reling obligation even if the secured party knows that the collateral has been transferred or even authorized or consented to the transfer. Ocial Comment 8 to 9-402(7) explains the purpose of the last sentence in 9-402(7):
Subsection (7) also deals with a dierent problem, namely whether a new ling is necessary where the collateral has been transferred from one debtor to another. This question has been much debated both in pre-Code law and under the Code. This Article now answers the questions in the negative. Thus, any person searching the condition of the ownership of a debtor must make inquiry as to the debtor's source of title, and must search in the name of a former owner if circumstances seem to require it.

3. Harmonizing Sections 9-306(2) and 9-402(7) Read together, 9-306(2) and 9-402(7) lead to the following results when collateral is disposed of:
If the secured party does not authorize the disposition or if the secured party authorizes the disposition subject to the security interest, the security interest will continue in the collateral following the disposition ( 9-306(2)) and no new nancing statement or amendment to the existing nancing statement will be required in order to continue the perfected status of the security interest in the collateral following the disposition ( 9-402(7)). If the secured party, in the security agreement or otherwise, authorizes the disposition free and clear of the security interest, the security interest will terminate the disposition ( 9-306(2)) and there will be no need to be concerned with perfection issues under 9-402(7).

Returning to the hypothetical, this analysis yields the following results: D's disposition of the collateral to T will not terminate SP's security interest under 9-306(2) since SP did not authorize the disposition free and clear of its security interest. The disposition of the collateral was authorized by SP but subject to T's recognition of SP's security interest in the collateral. Thus, under 9-306(2), SP's security interest continues in the collateral following the disposition. Under 9-402(7), SP's led nancing statement remains eective following the disposition of the collateral by D to T even though SP was aware of and consented to the disposition. Therefore, SP need not le a new nancing statement in the names of D or T or take any other action to continue the perfected status of its security interest in the collateral. This Commentary does not imply that the secured creditor need not take ling action if required by other Sections of the Code (e.g., Sections 9-103(1), 9-103(3) or 9-401(3)) based upon a change in location of the collateral or a change in the debtor's location following the transfer of the collateral by the debtor. CONCLUSION There is no conict between 9-306(2) and the last sentence of 9-402(7). Section 9-306(2) deals with the eect of a disposition of the collateral upon a security interest in the collateral and sets forth a general rule of survivability which applies unless the secured party authorizes the disposition free and clear of the security interest. The last sentence of 9-402(7) only
1156

PEB Commentary No. 3

has operative eect if the security interest survives the disposition under 9-306(2). In this instance, the last sentence of 9-402(7) continues the perfected status of the security interest in the transferred collateral even though the secured party may have authorized or consented to the disposition. Cases reaching this conclusion as to the interplay between UCC 9-306(2) and 9-402(7) include In re Southern Properties, Inc., 44 B.R. 838, 40 UCC Rep.Serv. (Callaghan) 1089 (Bkcy.E.D.Va.1989); Loeb v. Franchise Distributors, Inc. (In re Franchise Systems, Inc.), 46 B.R. 158, 40 UCC Rep.Serv. (Callaghan) 689 (Bkcy.N.D.Ga.1985); and Matto's Inc. v. Olde Colonie Place (In re Matto's Inc.), 30 UCC Rep.Serv. (Callaghan) 1750 (Bkcy.E.D.Mich.1981). The second paragraph of Ocial Comment 3 to UCC 9-306 is supplemented as follows:
In many cases a purchaser or other transferee of collateral will take free of a security interest: in such cases the secured party's only right will be to proceeds. A transferee will acquire the collateral free and clear of a preexisting security interest only if the disposition of the collateral by the debtor was authorized by the secured party free and clear of the secured party's security interest. If the disposition was not authorized by the secured party, or was authorized by the secured party subject to the secured party's security interest, the transferee will not acquire the collateral free and clear of the security interest. The authorization may be contained in the security agreement or otherwise given. The right to proceeds, either under the rules of this section or under specic mention thereof in a security agreement or nancing statement does not in itself constitute an authorization of sale. PEB Commentary No. 3, dated March 10, 1990, analyzes the interplay between this Section and Section 9-402(7).

Ocial Comment 8 to UCC 9-402 is amended to add the following paragraph at the end of the Comment:
PEB Commentary No. 3, dated March 10, 1990, explains the interplay between this Section and Section 9-306(2). As explained in this Commentary, this Section is consistent with Section 9-306(2) since Section 9-306(2) deals with the continuation or termination of a security interest in collateral following a disposition of the collateral. The last sentence of Section 9-402(7), on the other hand, deals with the continued eectiveness of a led nancing statement to perfect any security interest that continues in the collateral following its disposition.

1157

PEB COMMENTARY NO. 4 SECTION 8-207(1)

ISSUE Section 8-207(1) provides that
(1) Prior to due presentment for registration of transfer of a certicated security in registered form, the issuer or indenture trustee may treat the registered owner as the person exclusively entitled to vote, to receive notications, and otherwise to exercise all the rights and powers of an owner.

This section has been part of the UCC since its inception, the only change made by the 1977 amendments being the addition of the word certicated. Under what circumstances will a distribution of money or other property to the registered owner of a certicated security provide the issuer with a defense against a claim to that distribution asserted by a pledgee who was a bona de purchaser and in possession of that security at the time of such distribution? DISCUSSION 1. The Statutory Scheme As between the parties, the rights of the owner of a registered certicated security are transferred to a purchaser when the security is delivered to the purchaser. 8-313(1)(a). The issuer is required to register that transfer when the security is presented to it with an appropriate request. 8401(1). Thus, between the time of delivery and presentment, the registered owner and the person ultimately entitled to the rights of ownership will be dierent parties. The objective of 8-207(1) is to protect the issuer by express authorization to treat the original registered owner of a security, during this gap period, as the person entitled to the rights of ownership, including the right to receive distributions with respect thereto. Such protection is clearly necessary, since, in the vast majority of cases, the issuer would have no knowledge that a transfer had been made or know the identity of the purchaser. Inherent in this scheme is that a distribution to the registered owner will relieve the issuer from any liability to the purchaser for the same distribution. Without that protection, no issuer could safely make any distribution without requiring the surrender, or exhibition, of the security by the distributeea patently impractical requirement. In the context of outright sales of securities, the rule of 8-207(1) does not constitute a serious problem. In such transactions, the period of incongruity between registered and actual ownership will be of limited duration, since the purchaser will normally present the security for registration of transfer as promptly as possible. The nature, amount, and record date of any imminent distributions can usually be ascertained and can be reected in the price or otherwise adjusted between the parties. In the context of pledges of securities, however, the pledgee, in most cases, takes delivery of the security, duly endorsed for transfer, but does
1158

PEB Commentary No. 4

not present it to the issuer for registration of transfer. Possession of the security by the pledgee eectively prevents the pledgor from transferring it to another purchaser and places the pledgee in the position where registration of transfer can be obtained in the event of the pledgor's default. When the loan is repaid, as most loans are, the securities, still registered in the pledgor's name, are returned to the pledgor. This procedure avoids two unnecessary registrations of transferpledgor to pledgee and, then, pledgee back to pledgor. Furthermore, while the loan is outstanding, the pledgor, who remains the registered owner, continues to receive reports, proxy materials, and periodic dividend or interest payments, directly from the issuer and without inconvenience to the pledgee. This is precisely the result normally intended by the parties to the pledge transaction. See 9-207(2)(c). Hence, even in the pledge context, the rule of 8-207(1), notwithstanding the existence of dual interests in the security, generally produces results that are both ecient and fair. 2. The Problem Section 8-207(1) does not dene or limit the phrase all the rights and powers of an owner. If that phrase is construed, as it logically might be, to include the right to receive all distributions, the issuer may, with impunity, distribute, to the registered owner, not only regular cash dividends and interest payments, but also extraordinary cash dividends, negotiable securities in connection with stock dividends, stock splits and spin-os and, indeed, cash in complete liquidation of stock or partial or complete redemption of debt or redeemable equity securities. Thus, the pledgee that fails to present its collateral for registration of transfer subjects itself to the continuing risk that the issuer will distribute cash and/or negotiable securities to the pledgor, which, if not turned over to the pledgee as the pledge agreement would normally require, will have the eect of substantially reducing or eliminating the value of the collateral in its possession. For example, the distribution of stock to the pledgor, in connection with a two-for-one split, would leave the pledgee with collateral worth only half its pre-split value, and the distribution of cash to the pledgor, as a nal liquidating dividend, would render the pledgee's collateral worthless. The pledgee, of course, is not without power to avoid these dire consequences. It could, routinely, present its collateral for registration of transfer in every pledge transaction, but only with the attendant extra expense, which would ultimately be borne by all borrowers. Alternatively, it can evaluate the risk in any particular transaction, taking into account such factors as the nancial strength and integrity of the pledgor, the identity of the issuers and the likelihood that any contemplated extraordinary distributions will receive advance public notice, the extent to which the pledged securities are diversied, and the magnitude of any collateral cushion. The fact remains, however, that part of the price paid for the protection aorded the issuer by 8-207(1) is the risk borne by the pledgee who does not register the transfer. 3. The Cases It is encouraging to note that only two reported cases have raised the
1159

Appendix A

question of the scope of issuer protection for distributions made to registered owners pursuant to 8-207(1). Because of the aberrational fact situations involved, neither case directly addressed the issue as stated. In New England Merchants Bank of Boston v. Old Colony Trust Co., 385 Mass. 24, 429 N.E.2d 1143, 32 UCC Rep.Serv. (Callaghan) 1592 (Mass. 1982), arming 11 Mass.App. 539, 417 N.E.2d 471, 30 UCC Rep.Serv. (Callaghan) 1661 (Mass.App.1981), the issuer, in paying a liquidating dividend, did not rely on 8-207(1), which permits, but does not require, an issuer to recognize the registered owner, without further proof, as the person entitled to receive distributions. Rather, with an abundance of prudence, it required surrender of the stock certicates as a condition of payment. The certicates that were surrendered had been issued to the registered owner, ve years earlier, to replace the original certicates which the owner had asserted were lost. Pursuant to 8-405(2), the issuer had obtained a lost securities indemnity bond. The claimant was the administrator of an intestate estate who had found the original certicates among the decedent's papers. Apparently, they had been delivered to the decedent, endorsed in blank, almost thirty years before, and no attempt had been made to have the transfer registered on the books of the issuer. Upon surrender of the certicates to the issuer, the claimant demanded payment of the liquidating dividend. In denying the claim, the court stated: (1) that payment to the registered owner, pursuant to 8-207(1) constitutes a defense against the possessor of the certicates; (2) that 8-207(1) makes no distinction between ordinary and liquidating dividends; and (3) that the plainti had not established that he was a bona de purchaser, implying that the result might have been dierent if he had so established. The question of bona de purchase is relevant to the case, but only under the provisions of 8-405(3), which deals with the rights of the holder of a security that has been reported lost and has previously been replaced. In Bank of Honolulu v. Hawaii Corp., 829 F.2d 813, 4 UCC Rep.Serv.2d (Callaghan) 837 (9th Cir.1987), reversing 59 B.R. 410, 42 UCC Rep.Serv. (Callaghan) 1736 (Bkcy.D.Haw.1986), the claimant, a pledgee bank that had received stock certicates as collateral for a loan to the issuer's president, was unquestionably a bona de purchaser. Subsequently, the issuer entered a Chapter X bankruptcy proceeding. The issuer's Trustee brought suit against the pledgor which was ultimately settled. As part of the settlement, the pledgor released the Trustee from all claims . . . or interests. When it later developed that there would be a distribution to stockholders, the bank led a Proof of Stock Interest, based on the pledged stock. The Trustee refused to honor the bank's Proof on the ground that 8-207(1) permitted the issuer to treat the pledgor, who remained the registered owner, as the person who could exercise all the rights and powers of an owner. In his view, these included the right to dispose of the stock, free of the pledgee's interest, in what was, essentially, a privately negotiated transaction. The trial court agreed. The Ninth Circuit reversed, ordering entry of judgment for the bank. In so holding, however, the court stated: (1) that payment, even pursuant to
1160

PEB Commentary No. 4

8-207(1), does not constitute a defense . . . going to the validity of the security, which, in the court's view, is required under 8-105(2)(c); (2) that 8-207 is meant to apply [only] in what might be called the normal case . . . the payment of dividends in the normal course of business; and (3) that negotiability is negated when the transferror retains rights which . . . will frustrate the exercise of rights by the transferee. While the results in both these cases are probably correct under their own peculiar facts, the gratuitous statements of the respective courts, supporting their holdings, are in conict with each other and tend to confuse, rather than clarify, the proper construction of the intent, scope, and limitations of 8-207(1). CONCLUSION In light of this confusion, and in an eort to promote a reasonable and uniform construction of 8-207(1), the Board oers the following guidelines: (1) A distribution to the registered owner of a security is protected under 8-207(1) only if it is distributable to the owners of all securities of the same issue. This rule would prevent an issuer from acquiring a security, free of claims, in a negotiated transaction with the registered owner without requiring surrender of the security. In such a transaction, which is, in eect, a purchase rather than a distribution by the issuer, requiring delivery of the security imposes no burden on the issuer that is not borne by any purchaser. It supports the result in the Hawaii case. (2) If the terms of a security require its surrender as a condition of payment or exchange, a distribution to the registered owner in payment or exchange is not protected under 8-207(1) unless the security is surrendered. The requirement of surrender is commonly included in the terms of debt securities, redeemable equity securities, and convertible securities. Since the outstanding security is rendered worthless by the redemption or exchange, it is clearly in the interest of all concerned to get it out of circulation. Even if surrender is not required by the terms of the security, issuers may, and, as a matter of prudence, frequently do, as did the issuer in the New England Merchants case, require surrender as a condition of payment of a liquidating dividend. (3) Distributions to all the registered owners of a security, the terms of which do not require the surrender thereof, are protected under 8-207(1), regardless of the regularity, amount, or nature of such distributions. This rule rejects the suggestion that only regular dividend and interest payments can be safely distributed to the registered owners. The issuer's lack of knowledge of unregistered transfers, which requires protection for regular payments to the registered owners, also demands similar protection for the distributions in stock dividends, stock splits, spin-os, and other extraordinary distributions, even though they may substantially impair the value of the outstanding securities. (4) A distribution to the registered owner that is protected under 8-207(1) constitutes a defense against a claim to such distribution by a person in possession of the security, even if such person is a bona de purchaser. The entire purpose of 8-207(1) would be vitiated if a distribution protected by
1161

Appendix A

it could not be successfully asserted against a claim by a person in possession of the security, who, in most cases, will be a bona de purchaser. This result can be justied by charging the transferee who elects not to register a transfer with knowledge of 8-207(1) and notice that any distributions protected under that section will be made directly to the registered owner. The Board believes that these guidelines strike a proper balance between the right of an issuer to rely solely on its registration records in making distributions and the ability of a pledgee to rely on its possession of a security to protect it against diminutions of value that cannot be reasonably anticipated. The Ocial Comment to 8-207 is supplemented by the addition of the following paragraph, immediately following the rst paragraph of Ocial Comment 1:
The issuer may, under this section, make distributions of money or securities to the registered owners of certicated securities without requiring further proof of ownership, provided that such distributions are distributable to the owners of all securities of the same issue and the terms of the security do not require its surrender as a condition of payment or exchange. Any such distribution shall constitute a defense against a claim for the same distribution by a person, even if that person is in possession of the security and is a bona de purchaser of the security. See PEB Commentary No. 4, dated March 10, 1990.

1162

PEB COMMENTARY NO. 5 SECTION 9-306(5)

ISSUE Section 9-306(5)(b) gives a purchaser of a conditional sales contract or other chattel paper (chattel paper nancer) a security interest in the goods covered by the chattel paper against the seller of the goods (and of the chattel paper) if the chattel paper nancer is unpaid and the goods are returned to or are repossessed by the seller or the secured party. If the chattel paper nancer had obtained priority in the chattel paper pursuant to 9-308 over a secured party with a security interest in the seller's goods (inventory nancer), does 9-306(5)(b) enable the chattel paper nancer to retain that priority without having to further perfect for protection under 9-306(5)(d) against the inventory nancer? DISCUSSION The issue will usually arise in the context of the following fact situation: (I) Secured Party #1 (inventory nancer) has a perfected security interest in all the inventory of a dealer in goods (Dealer); (II) Dealer sells some of its inventory to a buyer in the ordinary course of business (BIOCOB) pursuant to a conditional sales contract (chattel paper); and (III) Secured Party #2 (chattel paper nancer) purchases the chattel paper from Dealer and takes possession of the paper in the ordinary course of its business. Secured Party #1's security interest in the sold goods terminates under 9-307(1) when they are sold to BIOCOB. However, Secured Party #1's security interest continues in the chattel paper as proceeds. If the goods are thereafter returned to Dealer, 9-306(5)(a) provides that if the goods were collateral at the time of sale for an indebtedness of the seller which is still unpaid, Secured Party #1's security interest in the goods attaches again to the goods and continues as a perfected security interest. In eect, the returned goods are proceeds of the chattel paper. Section 9-306(5)(b) also gives Secured Party #2 a security interest in the same returned goods against Dealer and states that this security interest is prior to a security interest under [ 9-306(5)(a)] to the extent that the [chattel paper nancer] was entitled to priority under Section 9-308. This interplay between 9-306(5)(a) and (b) arises in the following two circumstances. First, when BIOCOB's obligation is terminated because the goods are returned to Dealer pursuant to an agreement with Dealer or because BIOCOB had a right to rescind the sale, e.g., revoke acceptance under 2608. See Ocial Comment 4 to 9-306(5). In that circumstance, the goods once again become part of Dealer's inventory and are subject to Secured Party #1's security interest. However, because Secured Party #2 has not been paid pursuant to the chattel paper, 9-306(5)(b) gives Secured Party #2, as an unpaid transferee of the chattel paper, a security interest in the goods against Dealer to secure the amount remaining unpaid under
1163

Appendix A

the chattel paper at the time BIOCOB's obligation was terminated.1 Second, when the goods are repossessed because BIOCOB has defaulted under the chattel paper and are returned to Dealer whereat Secured Party #2 then sells the goods pursuant to 9-504. In that circumstance, if the goods are purchased at the foreclosure sale either (a) by Dealer or (b) by Secured Party #2 who then conveys the goods to Dealer pursuant to an agreement by Dealer to repurchase the goods, 9-306(5) is applicable if Dealer does not then pay Secured Party #2 the purchase price.2 In both of these instances, the goods once again become part of Dealer's inventory and are subject to Secured Party #1's security interest. However, because Dealer has not paid Secured Party #2 the purchase price for the goods, 9-306(5)(b) gives Secured Party #2, as an unpaid transferee, a security interest in the goods against Dealer to secure Dealer's obligation to pay the purchase price, i.e. the successful bid price at the foreclosure sale3 or the amount due under the repurchase agreement,4 as the case may be. This security interest of Secured Party #2 in the goods against Dealer is separate and distinct from the security interest evidenced by the chattel paper itself in which BIOCOB is the debtor. It attaches to the goods when returned to Dealer, whether voluntarily or through revocation of acceptance or repossession, and upon Dealer acquiring rights in the collateral by reason of the (i) revocation of acceptance or (ii) agreement with BIOCOB or (iii) purchase of the goods at the foreclosure sale or (iv) repurchase agreement. 9-203(1)(c). In essence, Secured Party #2 has a security interest against Dealer in the returned goods as the proceeds of the secured transaction represented by the purchase of the chattel paper from the Dealer. In both instances, Secured Party #2 is the secured party and Dealer is the debtor. . . . When the underlying goods are returned or repos1 Dealer's sale of the chattel paper is usually accompanied by a warranty that the chattel paper is genuine, valid and enforceable according to its term. Inasmuch as BIOCOB's obligation has been terminated, Secured Party has lost the benet of the bargain it made in purchasing the chattel paper from Dealer, i.e., the right to receive all payments required thereunder. Dealer, who has reacquired the goods, either by agreement or because BIOCOB had the right to revoke acceptance, is, therefore, liable to Secured Party #2 for those remaining payments. 2 Frequently, there will be an agreement that Dealer need not pay the purchase price until it is able to re-sell the goods. 3 When the sale or disposition to enforce the security interest in the goods is made, the proceeds are applied to BIOCOB's indebtedness under the chattel paper and BIOCOB is entitled to any surplus and liable for any deciency. 9-504(1) and (2). The amount due from Dealer on the sale is usually the same as the amount due under

the chattel paper, but might be a dierent amount. Secured Party #2's security interest against Dealer terminates upon payment of that amount to Secured Party #2, but if that amount is less than that due under the chattel paper, BIOCOB remains liable to Secured Party #2 for that deciency. Instead of an agreement for Dealer to repurchase the goods, there could be an agreement to repurchase the chattel paper. That repurchase is not a sale or disposition under 9-504(5). Upon that repurchase, Dealer becomes the secured party. If Dealer then sells the goods under 9-504 and buys them at the sale, the same analysis applies. That is, the goods are once again part of Dealer's inventory and subject to Secured Party #1's security interest; but, if Dealer has not paid the repurchase price to Secured Party #2, 9-306(5)(b) likewise gives Secured Party #2, as an unpaid transferee, a security interest in the goods against Dealer to secure Dealer's obligation to pay that repurchase price.
4

1164

PEB Commentary No. 5

sessed, the chattel paper interest automatically shifts to the goods . . .. 2 Gilmore, Security Interests in Personal Property, 27.5. Under 9-306(5)(b), Secured Party #2's security interest in the returned goods against Dealer is
. . . prior to a security interest under paragraph (a) [i.e. that of Secured Party #1] to the extent that the transferee of the chattel paper [Secured Party #2] was entitled to priority under Section 9-308.

In the above circumstances, Secured Party #2 had priority in the chattel paper at the time it purchased the chattel paper for new value from Dealer over Secured Party #1's claim to the chattel paper as proceeds of the inventory. 9-308(b). Accordingly, 9-306(5)(b) gives Secured Party #2 priority over Secured Party #1 in the returned goods. This result is consistent with the policy of encouraging the purchase of chattel paper reected by 9-308. Furthermore, it is not unfair to Secured Party #1 because Secured Party #1 is entitled to receive the money paid to Dealer by Secured Party #2 upon purchase of the chattel paper as proceeds of its security interest in the goods sold to BIOCOB.5 The interpretative problem is presented by 9-306(5)(d):
A security interest of an unpaid transferee [Secured Party #2] asserted under paragraph (b) . . . must be perfected for protection against creditors of the transferor [Dealer] and purchasers of the returned or repossessed goods.

Does this negate 9-306(5)(b) and mean that Secured Party #2 does not have priority over Secured Party #1 in the returned goods under 9-306(5) (b) unless Secured Party #2's security interest in the goods is perfected against Dealer? Stated dierently, is Secured Party #1 a creditor of Dealer or a purchaser of the returned or repossessed goods within the purview of 9-306(5)(d)?6 Furthermore, assuming Secured Party #1 is such a creditor or purchaser, does the requirement that Secured Party #2's security interest be perfected for protection against Secured Party #1 mean that Secured Party #2 must acquire priority under 9-312? If Secured Party #1's position was prior in time under 9-312(5)(a), must Secured Party #2 somehow follow a procedure sucient to give it a purchase money super-priority over Secured Party #1? This priority issue will be signicant in the event Secured Party #1 and Secured Party #2 both claim the goods or the proceeds of any sale or disposition thereof by Dealer. J.I. Case v. Borg-Warner, 669 S.W.2d 543, 37 UCC Rep.Serv. (Callaghan) 1025 (Ky.App.1984), and Northwest Accept. Corp. v. Lynnwood Equipment, Inc., 1 UCC Rep.Serv.2d (Callaghan) 980, motion for reconsideration denied, 1 UCC Rep.Serv.2d (Callaghan) 171 (D.W.D.Wash.1986), both held that the chattel paper nancer had priority without having to take further action to perfect with respect to the inventory nancer. The courts held
If Secured Party #2 had purchased accounts instead of chattel paper, 9-306(5)(c) subordinates Secured Party #2 to Secured Party #1's rights in the returned goods. This Commentary does not undertake to explore this dierent treatment for purchasers of
5

accountsor the reasons for this dierence. A secured creditor is included within both the denitions of creditor in 1201(12) and purchaser in 1-201(32), (33), unless the context otherwise requires. 1165
6

Appendix A

that in the context of 9-306(5) the denitions of creditor and purchaser in 1-201 are not applicable to Secured Party #1. Since Secured Party #1 is neither a creditor nor purchaser as used in 9-306(5)(d), Secured Party #2 has priority under 9-306(5)(b). These decisions are consistent with the intent of 9-306(5)(b) and 9-308. See 2 Gilmore, Security Interests in Personal Property, 27.5; Smith, Annual Survey: Secured Transactions, 40 The Business Lawyer 1487, 15051508 (1985). Cf. the opposite treatment of a transferee of accounts under 9-306(5)(c). To conclude otherwise (i.e. that Secured Party #1 is a creditor or purchaser) would nullify the intent of 9-306(5)(b). Crocker Nat. Bank v. Clark, 724 F.2d 696, 37 UCC Rep.Serv. (Callaghan) 673 (8th Cir.1984), holding that the inventory nancer was a creditor is not consistent with this analysis. The drafting history to 9-306(5) demonstrates that the inventory nancer (Secured Party #1) is neither a creditor nor a purchaser within the purview of 9-306(5)(d). In the 1952 Ocial Draft of the UCC, 9306(5) read as follows:
(5) If collateral which has been sold is returned to the debtor, the following rules determine the priorities: (a) As between the debtor and a secured party to whom the indebtedness originally secured by the collateral has not been paid, the original security interest continues; (b) As between the debtor and an unpaid transferee of the chattel paper arising from the sale, the transferee shall have a security interest in the property returned, but such security interest must be perfected for protection against third parties; (c) The security interest of an unpaid transferee under (b) shall have priority over a security interest claimed under (a).

This section was redrafted to its present form pursuant to the 1956 Recommendations of the Editorial Board. The revision covered repossessions in addition to returns and added present subsection (c) which aords subordinate priority status to the purchaser of an account. The rule of former subsection (c) which aords rst priority to the chattel paper purchaser was carried over to present subsection (b). Present 9-306(5)(d) states the rule that both the chattel paper purchaser and the account purchaser must be perfected for protection against creditors of the transferor and purchasers of the returned or repossessed goods. The 1952 Draft, which had dealt only with the priority of the chattel paper purchaser, had set forth the same rule in then 9-306(5) (b):
As between the debtor and an unpaid transferee of the chattel paper arising from the sale, the transferee shall have a security interest in the property returned, but such security interest must be perfected for protection against third parties. (emphasis supplied)

It is evident from that 1952 Draft that third parties as used in subsection (b) did not include a security interest claimed under (a), because that interest was expressly covered in subsection (c). Rather, third parties could have referred only to creditors of the transferor and purchasers of the returned or repossessed goods, namely, the parties more particularly identied in the reformulation of the same rule now set forth in 9-306(5)(d). That is, third parties meant creditors of the transferor
1166

PEB Commentary No. 5

and purchasers of the returned or repossessed goods other than the inventory nancer. Accordingly, the meaning and intent of perfected for protection in 9-306(5)(d) is that by reason of the goods being in the possession of Dealer, Secured Party #2 must give constructive notice of its security interest in those goods by ling a nancing statement against Dealer in order to be perfected against those creditors and purchasers of Dealer (other than Secured Party #1) as to whom an unperfected security interest would otherwise be subordinate under 9-301. Secured Party #2 should le a signed nancing statement covering those returned goods either at the time it rst purchases the chattel paper or prior to returning the repossessed goods to Dealer. Note, however, that ling the nancing statement does not aect Secured Party #2's rights against Secured Party #1 under 9-306(5) and will not protect Secured Party #2 against the risk that the goods may be sold by Dealer to buyers in the ordinary course of business who will take free of that security interest. 2-403(2); 9-307(1); see the fth paragraph of Ocial Comment 4 to 9-306. If Secured Party #2 fails to perfect against Dealer, it will retain its priority against Secured Party #1 but may become subordinate to others under 9-301. This may result in a circular priority, the resolution of which is beyond the scope of this Commentary. See 2 Gilmore, Security Interests in Personal Property, 27.5. CONCLUSION Creditors and purchasers as used in 9-306(5)(d) do not include the original secured inventory nancer of the seller of goods under subsection (a). Accordingly, a purchaser of chattel paper generated by a sale of the goods by that seller, attaining priority over the inventory nancer under 9-308, retains that priority in the event the goods covered by that chattel paper are returned to the seller, without having to further perfect against that inventory nancer. The Ocial Comment to 9-306 is amended by adding the following:
5. Creditors and purchasers as used in paragraph (5)(d) do not include the original secured inventory nancer of the seller of goods under subsection (a). If a purchaser of chattel paper generated by a sale of the goods attains priority over the seller's inventory nancer under Section 9-308, the purchaser retains that priority in the event the goods covered by the chattel paper are returned to the seller, without having to further perfect against the inventory nancer. This priority issue will usually arise in the context of the original inventory nancer and the chattel paper purchaser both claiming the goods or the proceeds of any sale or disposition thereof by the seller. See PEB Commentary No. 5, dated March 10, 1990.

1167

PEB COMMENTARY NO. 6 SECTION 9-301(1)

ISSUE Section 9-301(1) provides (with an exception that is not relevant here) that a security interest is subordinate to members of various specied classes (herein called the protected classes) who acquired their interests while the security interest was unperfected, subject to conditions set forth for each specied class. When a security interest is subordinated under this rule in favor of a member of a protected class, does the security interest continue subordinated under the shelter principle to an assignee of that protected person, although the assignee does not t the specic requirements for a member of the protected class because he acquired his interest after the security interest was perfected? In other words, does the protected status of an assignor shelter the position of an assignee who by himself would not meet the standards for protection? DISCUSSION A right of ownership of personal property ordinarily consists in part of the right to transfer it to others in the same form and with the same attributes, e.g., freedom from competing ownership interests or defenses or security interests that are not valid against the transferring owner. This right is known as the shelter principle. Section 2-403(1) states the shelter principle: A purchaser of goods acquires all title which his transferor had . . .. As Ocial Comment 1 states: The basic principle of our law is generally continued and expanded under subsection (1). [emphasis added]. Since the principle existed before the Code, it is not dependent on its codication in 2-403(1). Examples of its use appear in four Articles of the Code: (a) Sections 3-201(1) and Ocial Comment 3, 3-305 and Ocial Comment, and 3-306 and Ocial Comment 1 illustrate the concept. These provisions set forth the ability of a holder in due course of a negotiable instrument to transfer the instrument free of the defenses and claims which the transferor's status as holder in due course has cut o. It is clear that the transferor's status as holder in due course and the value of his ownership of the instrument would be impaired if he could not transfer the instrument and confer the same status upon his transferee without the transferee qualifying on his own as a holder in due course (when the transfer was a gift or because the instrument had matured or because the transferee had knowledge of a defect). To protect the holder in due course fully, the law must protect the holder's transferee. (b) Similar shelter provisions are found in connection with equivalent negotiability rules in 8-301(1) and 8-302(4) and Ocial Comment 5 to the latter. (c) Similar shelter provisions are found in connection with equivalent
1168

PEB Commentary No. 6

negotiability rules in 7-504(1) and 7-502(1). (d) A similar shelter provision in respect to property rights other than those resting on negotiability is found in Article 9, 9-313(4)(b). Under specied circumstances this provision gives the holder of a security interest in a xture priority over the interest of an owner or an incumbrancer of the realty; but this rule is expressly subject to the condition that a real estate interest is not subordinated to the xture security interest if the real estate interest's predecessor in title was not subject to defeat by the xture security interest, thus applying the shelter principle. For variation of the shelter principle, see also 9-313(6), which shelters renancings of a superior interest from a subordinate interest which would otherwise have priority over the later renancing. The case of Aircraft Trading and Services, Inc. v. Brani, Inc., 819 F.2d 1227, 3 UCC Rep.Serv.2d (Callaghan) 1297 (2d Cir.1987), rst called attention to the absence of express shelter provisions in 9-301(1). Simplifying the facts, A sold an aircraft engine to B and took back a purchasemoney mortgage (security interest), which for a time A failed to record as required by federal law. B sold the engine to C, who searched the record and ascertained that there was no recorded mortgage. Thus A's mortgage was subordinate to C's interest, under 9-301(1)(c), which provides that an unperfected security interest is subordinate to a buyer like C to the extent that he gives value and receives delivery of the collateral without knowledge of the security interest and before it is perfected. Thereafter the mortgage was recorded, thus perfecting the security interest, and still later C sold the engine to D. (D had actual knowledge of the recording, but the Court's opinion did not rest on that fact.) The Court of Appeals held that since D did not acquire his interest while the security interest was unperfected, D's interest was subject to the security interest. The Court identied the shelter principle with 2-403(1), then rejected its application in reliance on 2-402(3), which reads: Nothing in this Article should be deemed to impair the rights of creditors of the seller (a) under the provisions of the Article on Secured Transactions (Article 9) . . .. This Commentary does not adhere to that interpretation. Application of the shelter principle of 2-403(1) in favor of a buyer from one who has obtained senior status under 9-301(1) does not impair the rights of creditors. The rights of the unperfected secured creditor have already been impaired by the operation of 9-301(1). The shelter principle should be applied to protect D. Otherwise the value of C's status, as one taking free of the security interest, is unjustiably impaired if he cannot confer that status upon his transferee. Section 2-402(3)(a) does not compel a dierent result. Article 2 does not apply the shelter principle, although the principle is stated in 2-403(1) as an introduction to rules stating when the purchaser can receive more than the transferor had. Once a protected party achieves such senior rights, 9-301(1) should not be construed to interfere with those rights and the shelter principle should be deemed applicable. The Code is a complex and interrelated statutory scheme. Bank of Honolulu v. Hawaii Corp., 829 F.2d 813, 815, 4 UCC Rep.Serv.2d (Callaghan) 837, 841 (9th Cir.1987). The Code should be interpreted to produce equivalent results in situations comparable to the
1169

Appendix A

four cited above. This broad approach is supported by 1-102 and its Ocial Comment 1. CONCLUSION Underlying principles of fairness require a broad reading and a broad application of the shelter concept, even when not expressly stated. The importance of shelter is too great in the Code's scheme to support a narrow reading of the Code. Section 9-301(1) should be interpreted and applied in this circumstance to incorporate the shelter principle so that a member of a protected class who prevails thereunder can transfer what he has, even though the security interest which was unperfected when the transferor acquired his rights has since been perfected. The shelter principle also should operate even though the transferee from the protected party has knowledge of the earlier subordinated security interest. The Ocial Comment to 9-301 is amended by adding the following: 9. There is no conict between the principle of 9-301(1) and the shelter principle, which is applied at several points in the statute, but is most explicitly stated in 2-403(1): A purchaser of goods acquires all title which his transferor had . . .. Although 9-301(1) fails to state the shelter principle expressly, that principle is applicable where a person who had met the conditions for prevailing over an unperfected security interest transfers his right to another person after the security interest is perfected. See PEB Commentary No. 6, dated March 10, 1990. The rules for subordination of unperfected security interests have a purposein common with similar rules in all ling and recording systemsto impose sanctions for not adhering to ling or recording requirements. Such rules are necessary to make the system eective and enforce the policy against secret liens. The shelter principle recognizes that when a person in a protected class transfers his right after the security interest has been perfected, the right will be diminished in value unless the sanction is continued. The sanction imposed by 9-301(1) is that members of protected classes take free of an unperfected security interest. That sanction should be continued to protect transferees from those members in order to fulll the purpose of the section.

1170

PEB COMMENTARY NO. 7 THE RELATIVE PRIORITIES OF SECURITY INTERESTS IN THE CASH PROCEEDS OF ACCOUNTS, CHATTEL PAPER, AND GENERAL INTANGIBLES
ISSUE Secured party A and secured party B each has a perfected security interest in the same account, chattel paper, or general intangible, with A having priority over B. If the account debtor makes payment to secured party B, directly or through the debtor, may A recover the payment from B? DISCUSSION The issue under discussion arises when two secured parties have a perfected security interest in an account, chattel paper, or general intangible and the secured party that does not have priority (B) receives a payment from the account debtor. The debtor, having received the payment from the account debtor, may remit it to B, or B may receive payment directly from the account debtor. See 9-502(2) (secured parties' right to notify account debtor to make payment to the secured party); 9-318(3) (account debtor may discharge obligation by paying assignee after receiving notication that right to receive payment has been assigned and that payment is to be made to assignee). Under these circumstances, may A, the secured party having priority in the account, chattel paper, or general intangible, recover the payment from B? A. Payment by Check Article 9 determines the relative priorities of security interests in accounts, chattel paper, and general intangibles. See 9-312(5) (general rule); 9-308 (special rule with respect to chattel paper). The Article also determines the relative priorities of security interests in payments made by the account debtor, which payments are the proceeds of the original collateral. See 9-312(6); 9-306(1). When the account debtor pays B by check, or when the debtor indorses and delivers to B a check drawn by the account debtor to the order of the debtor, B will be a holder of the check. If B takes the check under the circumstances described in 3-302(1), B will be a holder in due course. See 3-302(1) and (2). A's led nancing statement does not constitute notice to B of A's claim to the check and does not preclude B from being a holder in due course. See 3-305(1). Specically, B takes priority over A's earlier, perfected security interest in the check and is entitled to keep the funds received when the check is paid. See 9-309; Dallas Bank & Trust Co. v. Frigiking, Inc., 692 S.W.2d 163, 41 UCC Rep.Serv. (Callaghan) 1334 (Tex. Ct.App.1985); Thorp Commercial Corp. v. Northgate Industries, Inc., 490 F.Supp. 197, 20304, 29 UCC Rep.Serv. (Callaghan) 297, 306307 (D.Minn. 1980) (alternate holding), rev'd on other grounds, 654 F.2d 1245, 31 UCC Rep.Serv. (Callaghan) 801 (8th Cir.1981). Contra Bank of the West v.
1171

Appendix A

Commercial Credit Financial Services, Inc., 655 F.Supp. 807, 81920, 3 UCC Rep.Serv.2d (Callaghan) 240, 258259 (N.D.Cal.1987), rev'd on other grounds, 852 F.2d 1162, 6 UCC Rep.Serv.2d (Callaghan) 602 (9th Cir. 1988). Even if B is not a holder in due course, 9-308 may give priority to B's security interest in the check. But if B takes the check under circumstances that preclude B from being a holder in due course (e.g., if a notation on the check gives B reason to know that the check constitutes A's proceeds) and from taking priority under 9-308, then B would take the check subject to A's security interest. See 3-306(a). B. Payment in Cash The Code does not specically address the right of B to retain a cash payment from the account debtor. Accordingly, resort must be had to the principles of law and equity. See 1-103. Under those principles, when a person assigns the same claim to two persons and the assignee without priority (B) receives payment from the obligor, the assignee receiving payment owes a duty of restitution to the assignee having priority (A). But if B gave value for the assignment (as B must have, see 9-203(1)(b)) and obtained the payment in good faith and without knowledge or reason to know of the prior assignment, then B may retain the payment. See Restatement, Second, Contracts 342(b), Comment e & Illustration 3; see also Restatement of Restitution 126, Comment f & Illustration 8. Cf. 9-306 Comment 2(c) (recipients of cash proceeds paid from the debtor's checking account in the operation of the debtor's business take free of a security interest in the proceeds). In determining whether B had reason to know of A's security interest, courts should apply 9-309 by analogy. Otherwise, cash would be rendered less negotiable than a check. CONCLUSION Whether B will be entitled to keep a cash payment from an account debtor or will be under a duty of restitution to A depends on whether B received the payment in good faith and without knowledge or reason to know of A's security interest. Whether B will be entitled to keep a payment made by a check drawn by the account debtor depends on whether B is a holder in due course of the check or is entitled to priority under 9-308. A's led nancing statement should not constitute notice to B of A's security interest in either case. The Ocial Comment to 9-309 is amended by adding the following:
3. The operation of this section can be seen when two secured parties have a perfected security interest in an account, chattel paper, or general intangible and the secured party that does not have priority receives a payment by check directly or indirectly from the account debtor. If the recipient takes the check under circumstances that give the recipient the rights of a holder in due course (Section 3-302), then the recipient's security interest in the check will take priority over the competing security interest and the recipient will be entitled to keep the payment. See Commentary No. 7, dated March 10, 1990.

The Ocial Comment to 9-312 is amended by adding the following:

9. Under some circumstances, a secured party, who does not have priority in an account, chattel paper, or general intangible may be entitled to keep a
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PEB Commentary No. 7 cash payment received directly or indirectly from the account debtor. See PEB Commentary No. 7, dated March 10, 1990.

1173

COMMENTARY NO. 8 FINAL DRAFT (December 10, 1991) Permanent Editorial Board for the Uniform Commercial Code, 4025 Chestnut Street, Philadelphia, Pennsylvania 19104. 1991 by The American Law Institute and the National Conference of Commissioners on Uniform State Laws. All Rights Reserved COMMITTEES
PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE CHAIR Geoffrey C. Hazard, Jr., New Haven, Connecticut MEMBERS Boris Auerbach, Cincinnati, Ohio Marion W. Benfield, Jr., Winston-Salem, North Carolina William M. Burke, Los Angeles, California Ronald DeKoven, New York, New York William D. Hawkland, Baton Rouge, Louisiana Robert Haydock, Jr., Boston, Massachusetts Frederick H. Miller, Norman, Oklahoma William J. Pierce, Ann Arbor, Michigan Donald J. Rapson, Livingston, New Jersey Curtis R. Reitz, Philadelphia, Pennsylvania Carlyle C. Ring, Jr., Alexandria, Virginia EMERITUS MEMBERS William E. Hogan, New York, New York Homer Kripke, San Diego, California SECRETARY Paul A. Wolkin, Philadelphia, Pennsylvania COUNSELLOR EMERITUS Martin J. Aronstein, Philadelphia, Pennsylvania ABA LIAISON Charles W. Mooney, Jr., Philadelphia, Pennsylvania ABA SECTION OF BUSINESS LAW LIAISON Amelia H. Boss, Philadelphia, Pennsylvania PREFACE TO PEB COMMENTARY The Permanent Editorial Board (PEB) for the Uniform Commercial Code (UCC) acts under the authority of The American Law Institute and the National Conference of Commissioners on Uniform State Laws. In March, 1987, the PEB resolved to issue from time to time supplementary commentary on the UCC to be known as PEB Commentary. These PEB Commentaries seek to further the underlying policies of the UCC by aording guidance in interpreting and resolving issues raised by the UCC and/or the Ocial Comments. The Resolution states that:
A PEB Commentary should come within one or more of the following specic purposes, which should be made apparent at the inception of the Commentary: (1) to resolve an ambiguity in the

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PEB Commentary No. 8

UCC by restating more clearly what the PEB considers to be the legal rule; (2) to state a preferred resolution of an issue on which judicial opinion or scholarly writing diverges; (3) to elaborate on the application of the UCC where the statute and/or the Ocial Comment leaves doubt as to inclusion or exclusion of, or application to, particular circumstances or transactions; (4) consistent with UCC 1-102(2)(b), to apply the principles of the UCC to new or changed circumstances; (5) to clarify or elaborate upon the operation of the UCC as it relates to other statutes (such as the Bankruptcy Code and various federal and state consumer protection statutes) and general principles of law and equity pursuant to UCC 1-103; or (6) to otherwise improve the operation of the UCC.

The full Resolution appears in the 1990 Edition of the UCC.

1175

PEB COMMENTARY NO. 8 (AS AMENDED TO APPLY TO REVISED ARTICLE 9)* SECTION 9-330
ISSUE Section 9-330(a) provides a special priority rule for purchasers of chattel paper who give new value and take possession, or obtain control, of the chattel paper in the ordinary course of their business. Subsection (a) provides that such purchasers take priority over a security interest in the chattel paper which is claimed merely as proceeds of inventory subject to a security interest . . . This Commentary addresses an issue that may arise under 9-330(a): When is a security interest in chattel paper claimed merely as proceeds of inventory subject to a security interest so that the subsequent chattel paper nancer who meets the other requirements of 9-330(a) takes free of it? INTRODUCTORY DISCUSSION Most chattel paper is generated by dealers in automobiles, trucks, machinery, and other durable goods of substantial value. Such dealers frequently sell their chattel paper or use it as collateral for loans. Buyers of chattel paper usually take possession of the paper and collect from the debtors thereon themselves. Also, some lenders on chattel paper will take possession and handle collections. (Financers with a security interest in chattel paper covering smaller appliances, television sets, etc., frequently do not take possession of the paper.) Under the ordinary priority rules of the Code (rst to le or perfect has priority) the buyer of, or lender on, chattel paper would have to make a ling search before the transaction to determine whether a prior party has led a nancing statement covering chattel paper or inventory of which the chattel paper might be proceeds. (If a security interest in inventory is perfected by ling, there is also an automatically perfected proceeds security interest in chattel paper which is generated when inventory subject to the security interest is sold.) A ling search requirement before each trans*PEB Commentary No. 8 was originally issued in 1991, and covered two issues that arose under former UCC Section 9-308. Revised UCC Section 9-330 continues the basic provisions of former Section 9-308 with minor changes. One of the questions addressed in the original Commentarywhether a nancer of chattel paper that takes possession of it has a duty to make inquiry or search to determine whether there is an existing security interest in that chattel paper-is answered in the negative by Comment 6 to Revised UCC Section 9-330. 1176 The other question dealt with in the original Commentary-when does a secured party have an interest in chattel paper merely as proceeds-is not resolved in Revised UCC Section 9-330 or addressed in the Comments to that section. Accordingly, that discussion has been continued in this amended Commentary, modied to conform to the dierences between former UCC Section 9-308 and Revised UCC Section 9-330. Unless otherwise indicated, references in this amended Commentary to sections of Article 9 are references to Revised Article 9.

PEB Commentary No. 8

action would entail substantial delays and signicant expense even if the search revealed no prior led nancing statement. In the many cases in which there is a prior led nancing statement covering chattel paper or inventory, or both, the application of the general 9-322 priority rules would always give the rst ler priority. Such a system would make it difcult for any buyer or lender other than the rst led secured party to purchase or lend on the security of chattel paper and would make it particularly dicult for a dealer to deal as to chattel paper with anyone other than the inventory nancer. Prior lings would have to be limited to specic chattel paper or subordination agreements or releases would have to be secured from prior led inventory or chattel paper nancers each time items of chattel paper are transferred to a dierent nancer. When Article 9 was being drafted in the 1950s, some nancers of chattel paper left it with the dealer who had generated it and others took possession of the paper. The drafters of the Code did not want to disrupt those practices. Therefore, the problem presented to the drafters was how to structure priority rules so that both forms of nancing could continue efciently and safely. The Code drafters might have encouraged the practice of purchasing and taking possession of chattel paper by treating chattel paper like instruments and providing that a security interest in chattel paper could be perfected only by taking possession. That rule, however, would have denied perfected status to security interests in chattel paper left with the debtor and would have disrupted that widely used form of nancing. Requiring possession for perfection of chattel paper would also have meant that an inventory nancer's proceeds interest in chattel paper would be lost after 20 days unless the nancer took possession of the paper. On the other hand, as already noted, applying the ordinary Code priority rules to chattel paper would have imposed substantial impediments to the widespread business of buying and taking possession of chattel paper. The drafters, therefore, struck a compromise between the interests of non-possessory nancers of chattel paper and inventory nancers with a non-possessory proceeds interest in the paper on the one hand, and, on the other hand, competing chattel paper nancers who take possession of the paper. Section 9-330 continues that compromise and extends it to protect nancers who gain control of electronic chattel paper. (See 9-105 regarding control of electronic chattel paper.) Under that compromise a secured party can have a non-possessory security interest in chattel paper perfected through ling (including a proceeds interest therein) which will be good against subsequent non-possessory security interests and judgment creditors including the trustee in bankruptcy, but, under 9-330, that security interest will frequently be junior to a chattel paper purchaser who gives new value and takes possession, or obtains control, of the paper in the ordinary course of its business. (See also 9-322(c) regarding proceeds.) The above discussion has reviewed the basic reason for the adoption of the rules set out in 9-330. The discussion now turns to the specic issue arising under 9-330 which this Commentary addresses. ISSUE When is a security interest in chattel paper claimed merely as proceeds of
1177

Appendix A

inventory subject to a security interest so that a chattel paper nancer that gives new value and takes possession, or obtains control, of the paper in the ordinary course of its business has priority unless the chattel paper indicates that it has been assigned to an identied assignee other than the nancer? DISCUSSION Preliminarily, it should be noted that this issue may be of limited importance since, even if the security interest is more than a mere proceeds interest, the chattel paper nancer under 9-330 will take free of the interest unless it has knowledge that the purchase violates the rights of the secured party. The following discussion should be read with this caveat in mind. A brief description of two common types of inventory secured nancing will help put the discussion of the meaning of a mere proceeds interest in its business context. (a) The rst type, which will be called type A, is inventory nancing of automobiles and large items of equipment in which the nancing is primarily item by item (each item of inventory secures a precise amount loaned against that item even though there may be a cross-security provision), with a requirement that the associated inventory debt be paid o when the item is sold, or after a maximum period (usually 90 days subject to renewal), whichever rst occurs. (b) The second (type B) is a general oating loan secured by inventory and receivables (sometimes called an availability loan) under which the debtor is entitled to borrow from the secured party such amounts as the debtor may desire, subject to a maximum availability determined by a formula, e.g., 50% of cost of saleable inventory plus 80% of the amount of receivables not in default more than 30 days. This type of nancing is usually used in situations involving smaller items of inventory as to which it would be too burdensome to account on an individual basis and in which the receivables are accounts rather than chattel paper so that 9-330 issues do not arise. However, such nancing arrangements may sometimes involve larger, more expensive items of inventory which are frequently sold on credit generating chattel paper. For the reasons stated below, the Board believes that a type A inventory nancer will frequently have only a mere proceeds interest in chattel paper which is generated when items of inventory subject to its security interest are sold. On the other hand, as noted below, the Board believes that a type B nancer has more than a mere proceeds interest in any chattel paper generated on sale of the inventory. The type A inventory nancer having a proceeds claim to the chattel paper must do something more than rest on that proceeds claim in order to prevail against the person described in 9-330(a)(1), namely, a purchaser who in good faith and in the ordinary course of the purchaser's business . . . gives new value and takes possession of the chattel paper or obtains control of the chattel paper under Section 9-105. Such an inventory nancer takes the chattel paper out of the mere proceeds category only by giving value against it in some new transaction. Such a lender
1178

PEB Commentary No. 8

gives new value, as it commonly will, by purchasing the chattel paper (or, in some types of transactions, making a specic loan against it). Whether the type A inventory nancer will be willing to give value against the chattel paper instead of merely resting on its proceeds claim until payment will depend on the quality of the paper. That quality depends upon such factors as the credit worthiness of the buyer who is the principal obligor on the chattel paper, the amount of the buyer's down payment and hence the amount of the chattel paper debt as compared to the value of the collateral (the former inventory), and the terms under which the dealer (the former inventory debtor) is willing to assume full or limited recourse to support the buyer's obligation under the chattel paper. Not infrequently the nancer and the dealer will negotiate a package purchase of several items of chattel paper in which the total price is determined by the quality of the paper, the extent of the recourse, and so on. When the nancer buys, or lends against, chattel paper in the way just outlined, there is a new transaction by which the nancer has acquired an interest in the specic chattel paper which is more than a mere proceeds interest. If, however, the type A inventory nancer does not by some new transaction give value against specic chattel paper, the fact that the inventory debt is unpaid and that the security agreement specically claims the chattel paper proceeds as additional collateral does not give the nancer more than a mere proceeds interest. Further, while no doubt much inventory nancing is carried out with nominal prot to the nancer in anticipation that it will be given the opportunity to acquire the chattel paper, in the Board's opinion this anticipation of receiving the chattel paper does not take the case out of the mere proceeds phrase of the statute. As pointed out above, the Board believes that the type B nancer at all times has more than a mere proceeds interest in the chattel paper on hand whether or not at any specic time there is sucient inventory on hand to secure the amount of the loan outstanding at that time. The structure of the deal is such that the chattel paper is part of the primary collateral for the debt. That interest extends to any chattel paper subsequently generated by a sale of inventory whether or not at any particular time the existing inventory is adequate security for the debt actually outstanding. A number of reported cases under former Article 9 involved priority conicts between inventory nancers and purchasers of chattel paper who took possession, gave new value, and acted in the ordinary course of their business. In those cases, the courts applied the mere proceeds rules of former 9-308, and the chattel paper nancer always won.1 The courts have not always carefully reported the facts, but it is clear that in at least
1 See e.g. Aetna Finance Corp. v. Massey-Ferguson, Inc., 626 F. Supp. 482, 42 UCC Rep. Serv. (Callaghan) 1501 (S.D. Ind. 1985); Northwest Acceptance Corp. v. Lynnwood Equipment, Inc., 1 UCC Rep.Serv.2d (Callaghan) 980, 1710 (W.D. Wash. 1986); Rex Financial Corp. v. Great Western Bank & Trust, 23 Ariz. App. 286, 532 P.2d 558, 16 UCC Rep.Serv. (Callaghan) 1155 (Ariz. App.

1975); Commercial Credit Corp. v. National Credit Corp., 251 Ark. 541, 473 S.W.2d 876, 10 UCC Rep.Serv. (Callaghan) 232 (Ark. 1971); American State Bank v. Avco Financial Services of the United States, Inc., 71 Cal. App. 3d 774, 139 Cal.Rptr. 658, 22 UCC Rep.Serv. (Callaghan) 235 (Cal. App. 1977); Home Savings Ass'n v. General Electric Credit Corp., 101 Nev. 595, 708 P.2d 280, 42 1179

Appendix A

one of the cases, the security agreement did specically claim an interest in chattel paper and the court did not treat that fact as signicant.2 In most of the cases, the court did not carefully consider whether the chattel paper nancer had knowledge of the prior interest in the chattel paper, but in several cases the court either assumed that the chattel paper nancer had knowledge or the ndings of fact show that the chattel paper nancer did have knowledge.3 The results in all those cases are consistent with the position taken in this Commentary. CONCLUSION If a nancer loans or extends credit for the cost of specic items of inventory and expects to be paid upon the sale of the items, the nancer's security interest in chattel paper generated when the items are sold is a mere proceeds interest unless the nancer in a new transaction gives value against the specic paper. On the other hand, a lender who agrees to lend up to a specied percentage of the cost of inventory and of receivables has more than a mere proceeds interest in chattel paper which is a part of the receivables covered by the security agreement. In inventory nancing transactions which do not fall within the above two categories, whether the nancer has more than a mere proceeds interest in chattel paper generated when inventory subject to its secured interest is sold must be determined from an examination of all the facts of the case.
UCC Rep.Serv. (Callaghan) 1489 (Nev. 1985); Chrysler Credit Corp. v. Sharp, 56 Misc.2d 261, 288 N.Y.S.2d 525, 5 UCC Rep.Serv. (Callaghan) 226 (N.Y. Sup. Ct. 1968); Bank of Beulah v. Chase, 231 N.W.2d 738, 17 UCC Rep.Serv. (Callaghan) 259 (N.D. 1975); Associates Discount Corp. v. Old Freeport Bank, 421 Pa. 609, 220 A.2d 621, 3 UCC Rep.Serv. (Callaghan) 481 (Pa. 1966); Borg-Warner Acceptance Corp. v. C.I.T. Corp., 679 S.W.2d 140, 39 UCC Rep.Serv. (Callaghan) 1864 (Tex. Ct. App. 1984).
2 3

Home Savings Ass'n, supra note 1.

American State Bank, Rex Financial Corp., both supra note 1.

1180

COMMENTARY NO. 9 FINAL DRAFT (June 25, 1992) Permanent Editorial Board for the Uniform Commercial Code, 4025 Chestnut Street, Philadelphia, Pennsylvania 19104-3099. 1992 by The American Law Institute and the National Conference of Commissioners on Uniform State Laws. All Rights Reserved COMMITTEES
PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE CHAIR Geoffrey C. Hazard, Jr., New Haven, Connecticut MEMBERS Boris Auerbach, Cincinnati, Ohio Marion W. Benfield, Jr., Winston-Salem, North Carolina William M. Burke, Los Angeles, California Ronald DeKoven, New York, New York William D. Hawkland, Baton Rouge, Louisiana Robert Haydock, Jr., Boston, Massachusetts Frederick H. Miller, Norman, Oklahoma William J. Pierce, Ann Arbor, Michigan Donald J. Rapson, Livingston, New Jersey Curtis R. Reitz, Philadelphia, Pennsylvania Carlyle C. Ring, Jr., Vienna, Virginia EMERITUS MEMBERS William E. Hogan, Southbury, Connecticut Homer Kripke, San Diego, California SECRETARY Paul A. Wolkin, Philadelphia, Pennsylvania COUNSELLOR EMERITUS Martin J. Aronstein, Philadelphia, Pennsylvania ABA LIAISON Charles W. Mooney, Jr., Philadelphia, Pennsylvania ABA SECTION OF BUSINESS LAW LIAISON Amelia H. Boss, Philadelphia, Pennsylvania Preface to PEB Commentary The Permanent Editorial Board (PEB) for the Uniform Commercial Code (UCC) acts under the authority of The American Law Institute and the National Conference of Commissioners on Uniform State Laws. In March, 1987, the PEB resolved to issue from time to time supplementary commentary on the UCC to be known as PEB Commentary. These PEB Commentaries seek to further the underlying policies of the UCC by aording guidance in interpreting and resolving issues raised by the UCC and/or the Ocial Comments. The Resolution states that:
A PEB Commentary should come within one or more of the following specic purposes, which should be made apparent at the inception of the Commentary: (1) to resolve an ambiguity in the

1181

Appendix A
UCC by restating more clearly what the PEB considers to be the legal rule; (2) to state a preferred resolution of an issue on which judicial opinion or scholarly writing diverges; (3) to elaborate on the application of the UCC where the statute and/or the Ocial Comment leaves doubt as to inclusion or exclusion of, or application to, particular circumstances or transactions; (4) consistent with UCC 1-102(2)(b), to apply the principles of the UCC to new or changed circumstances; (5) to clarify or elaborate upon the operation of the UCC as it relates to other statutes (such as the Bankruptcy Code and various federal and state consumer protection statutes) and general principles of law and equity pursuant to UCC 1-103; or (6) to otherwise improve the operation of the UCC.

The full Resolution appears in the 1990 Edition of the UCC.

1182

PEB COMMENTARY NO. 9 SECTION 9-306(1)

ISSUE Section 9-306(1) provides: Proceeds includes whatever is received upon the sale, exchange, collection or other disposition of collateral or proceeds. Where a debtor has granted to a secured party a security interest in goods and the debtor later leases those goods as lessor, do the lease rentals constitute proceeds of the secured party's collateral? DISCUSSION Where a debtor has granted to a secured party a security interest in goods that the debtor later leases as lessor, the lease rentals would constitute proceeds of the secured party's collateral for the reason that the debtor's conveyance of a leasehold interest in the goods constitutes a disposition of the goods for purposes of 9-306(1). This would certainly be the case where the lease creates a security interest under 1-201(37). In that instance the lease is nothing more than a disguised sale of the goods, and the secured party would be entitled to a security interest in any chattel paper or payments on that chattel paper, all as proceeds resulting from that sales transaction. The following examples illustrate this conclusion: Example 1. Debtor grants to Secured Party a security interest in Debtor's drill press. Debtor sells the drill press to Buyer who pays for the drill press by issuing to Debtor Buyer's ve-year promissory note secured by a security interest in the drill press. The promissory note and security interest together constitute chattel paper under 9-105(1)(b), and, since the chattel paper was received by Debtor upon the sale of the drill press, the chattel paper constitutes proceeds of Secured Party's collateral. When payments are made by Buyer on the promissory note, those payments, arising upon the collection of proceeds, also constitute proceeds of Secured Party's collateral. Example 2. Debtor grants to Secured Party a security interest in Debtor's drill press. Debtor leases the drill press to Lessee for a xed term of ve years not subject to termination by Lessee. The drill press is predicted to have exhausted its useful life at the end of that ve-year term, and Lessee will then be entitled to purchase the drill press for the cash sum of $10. The lease constitutes chattel paper under 9-105(1)(b). Since the chattel paper was received by Debtor upon the granting to Lessee of a leasehold interest for the entire useful life of the drill press and Lessee can become the owner of the drill press at the end of the nonterminable lease term by paying a nominal consideration, the transaction will be viewed as creating a security interest under 1-201(37) and will be treated for Article 9 purposes as a disguised sale. Just as the chattel paper arising upon the sale of the drill press in Example 1 constituted proceeds of Secured Party's collateral, so does the chattel paper arising upon the granting of a security lease constitute proceeds of Secured
1183

Appendix A

Party's collateral in this example; the two transactions have precisely the same economic eect although labeled by the parties as a sale in Example 1 and a lease in this example. Similarly, when rental payments are made by Lessee on the security lease, those payments, arising upon the collection of proceeds, also constitute proceeds of Secured Party's collateral. In both Example 1 and Example 2 it is irrelevant to the payments to Debtor being treated as proceeds whether the sale or lease was authorized by Secured Party or whether the drill press constituted equipment or inventory in the hands of Debtor. This is because under 9-306(2) Secured Party's security interest will continue in any identiable proceeds including collections received by the debtor even when the disposition of the collateral was authorized by the Secured Party or where the collateral subject to the disposition was transferred to a buyer in the ordinary course as contemplated by 9-307(1). Lease rentals would also constitute proceeds of a secured party's collateral consisting of goods where the subsequent lease of those goods creates a true lease governed by Article 2A. Consider the following example: Example 3. Debtor grants to Secured Party a security interest in Debtor's drill press which then has a predicted useful life of ve years. Debtor leases the drill press to Lessee for a xed term, not subject to termination by Lessee, of two years with no purchase option. The lease would appear to be a true lease governed by Article 2A. See 1-201(37), 2A-102, and 2A-103(1)(j). Once again, the lease constitutes chattel paper under 9-105(1)(b). The chattel paper was received by Debtor upon the granting of a leasehold interest in the drill press for a non-terminable period of two years out of a predicted useful life of the drill press of ve years. Debtor has remaining to it a residual interest in the drill press, i.e., a right to the drill press arising only at the end of the two-year lease term. See 2A-103(1)(q) (dening lessor's residual interest). But an interest in the drill press constituting a right by Lessee to use the drill press for a two-year period out of the drill press's predicted ve-year useful life was conveyed by Debtor to Lessee. The granting of the leasehold interest constitutes a disposition of a portion of Debtor's interest in the drill press, and the chattel paper arising upon that disposition constitutes proceeds of Secured Party's collateral. When rental payments are made by Lessee on the true lease, those payments, arising upon the collection of proceeds, also constitute proceeds of Secured Party's collateral. The foregoing analysis in Example 3, by concluding that the granting of a true leasehold interest in goods constitutes a disposition of the goods for purposes of 9-306(1), is consistent with the common law rule that the granting of a real estate leasehold interest constitutes a disposition of a portion of the lessor's ownership interest in the leased estate. See, e.g., Hueschen v. Stalie, 98 N.M. 696, 652 P.2d 246 (1982) (real estate lease is a conveyance of an estate for a limited term with conditions); Powell, Law of Real Property, 221 (1990). It is also consistent with Article 9 cases which treat the totality of a debtor's interest in goods as comprising the debtor's leasehold interest as lessor plus the debtor's residual interest in the leased goods as owner, with the necessity of a secured party's security interest in
1184

PEB Commentary No. 9

the leasehold being perfected in one manner (e.g., possession or ling as to the chattel paper) and its security interest in the lessor's residual interest being perfected in another manner (e.g., ling as to the goods). See, e.g., In re Leasing Consultants, Inc., 486 F.2d 367, 13 UCC Rep.Serv. (Callaghan) 189 (2d Cir.1973). Furthermore, this analysis is consistent with Article 2A's denition of a lease being a transfer of a right to possession and use of the leased goods even without being a sale of the goods. See 2-106(1) and 2A-103(1)(j). Cf. Feldman v. Philadelphia Nat. Bank, 408 F.Supp. 24, 3738, 18 UCC Rep.Serv. (Callaghan) 776, 786788 (E.D.Pa.1976) (while the court referred to chattel paper as proceeds of a security interest in underlying goods, the reference may be viewed as dicta since the secured party had in any event taken possession of the chattel paper). Cases such as General Electric Credit Corp. v. Cleary Brothers Construction Co., Inc. (In re Cleary Brothers Construction Co., Inc.), 9 B.R. 40, 30 UCC Rep.Serv. (Callaghan) 1444 (Bkrtcy.S.D.Fla.1980), and In re A.E.I. Corp., 11 B.R. 97, 31 UCC Rep.Serv. (Callaghan) 1467 (Bkrtcy.E.D.Pa.1981), to the extent that they hold that a subsequent lease of goods or payments thereon cannot constitute proceeds of a secured party's pre-existing collateral consisting of the goods, are not consistent with this analysis. Lease rentals would constitute proceeds of a secured party's collateral consisting of goods even where the subsequent lease of the goods is for a term which is of a short duration in relation to the useful life of the goods. Where the goods have a limited useful life, any transfer of the use and possession of the goods in return for a consideration constitutes a disposition, however small, of the debtor's interest in the goods. If that consideration consists of chattel paper, that chattel paper and the payments thereon constitute proceeds of the secured party's collateral. For a case reaching an analogous conclusion in the context of a real estate mortgage, see Old Stone Bank v. Tycon I Building Limited Partnership, 946 F.2d 271 (4th Cir.1991) (forfeited earnest money deposit under a sales contract for mortgaged real estate constituted proceeds to which undersecured mortgagee is entitled under its mortgage since the deposit resulted from a disposition of valuable lock up rights to the collateral while the sales contract was in eect). The foregoing analysis is intended to clarify the treatment of rental payments as proceeds of a secured party's collateral consisting of goods subsequently leased. It is not intended to address transactions where the goods become subject to the secured party's security interest at a time when the goods are already under lease by the debtor as lessor. See 2A307; In re Leasing Consultants, Inc., 486 F.2d 367, 13 UCC Rep.Serv. (Callaghan) 189 (2d Cir.1973). Nor is it intended to address transactions where the goods, although subject to a secured party's pre-existing security interest, are not subsequently leased by the debtor as lessor. For example, the foregoing analysis is not intended to suggest that income generated from the debtor's own use and possession of goods should constitute proceeds of a secured party's pre-existing collateral consisting of the goods. Similarly, it is not intended to address other transactions where no disposition of the goods by security lease, determined by reference to 1-201(37), or true lease, governed by Article 2A, has taken place. Cf. In re S & J Holding Corp., 42 B.R. 249, 39 UCC Rep.Serv. (Callaghan) 668
1185

Appendix A

(Bkrtcy.S.D.Fla.1984) (payments for playing video games on game machines). Moreover, the foregoing analysis is not intended to suggest that, as a matter of federal bankruptcy law, a secured party is necessarily entitled to adequate protection compensation for the debtor's use of rental payments made under a post-petition lease by the debtor as lessor of goods in which a secured party held a perfected and unavoidable pre-petition security interest. Factors such as the term of the lease in relation to the useful life of the leased goods and the provision by the debtor of post-petition services associated with the post-petition lease of the goods may well aect the secured party's entitlement to such adequate protection compensation, without, however, aecting the status of the lease or the rental payments thereon as proceeds of the secured party's pre-existing collateral as a matter of state law. See 11 U.S.C. 361, 363(e), and 552(b); cf. General Electric Credit Corp. v. Cleary Brothers Construction Co., Inc. (In re Cleary Brothers Construction Co., Inc.), 9 B.R. 40, 30 UCC Rep.Serv. (Callaghan) 1444 (Bkrtcy.S.D.Fla.1980) (instead of holding that the secured party could not claim, as proceeds of its pre-petition security interest in a crane, the rentals under a post-petition lease of the crane for a 10-day period, the court could have reached the same result by concluding that, although the rentals were proceeds of the secured party's collateral, the secured party was adequately protected). CONCLUSION Where a debtor has granted to a secured party a security interest in goods and the debtor later leases those goods as lessor, the lease rentals will constitute proceeds of the secured party's collateral consisting of the goods. The Ocial Comment to 9-306 is amended by adding the following:
6. Where a debtor has granted to a secured party a security interest in goods and the debtor later leases those goods as lessor, the lease rentals constitute proceeds of the secured party's collateral consisting of the goods. See PEB Commentary No. 9, dated June 25, 1992.

1186

COMMENTARY NO. 10 (SECTION 1-203) FINAL DRAFT (February 10, 1994) Permanent Editorial Board for the Uniform Commercial Code, 4025 Chestnut Street, Philadelphia, Pennsylvania 19104-3099. 1994 by The American Law Institute and the National Conference of Commissioners on Uniform State Laws. All Rights Reserved COMMITTEES
PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE CHAIR * Geoffrey C. Hazard, Jr., New Haven, Connecticut MEMBERS Boris Auerbach, Cincinnati, Ohio Marion W. Benfield, Jr., Winston-Salem, North Carolina Gerald L. Bepko, Indianapolis, Indiana ** Amelia H. Boss, Philadelphia, Pennsylvania Lawrence J. Bugge, Madison, Wisconsin ** William M. Burke, Los Angeles, California Ronald DeKoven, New York, New York ** Frederick H. Miller, Norman, Oklahoma ** Donald J. Rapson, Livingston, New Jersey Curtis R. Reitz, Philadelphia, Pennsylvania ** Carlyle C. Ring, Jr., Alexandria, Virginia EMERITUS MEMBERS Robert Haydock, Jr., Boston, Massachusetts William E. Hogan, Southbury, Connecticut Homer Kripke, San Diego, California William J. Pierce, Ann Arbor, Michigan SECRETARY EMERITUS Paul A. Wolkin, Philadelphia, Pennsylvania COUNSELLOR EMERITUS Martin J. Aronstein, Philadelphia, Pennsylvania ABA LIAISON Linda C. Hayman, New York, New York ABA SECTION OF BUSINESS LAW LIAISON George A. Hisert, San Francisco, California *Also Chair of Executive Subcommittee. **Also Member of Executive Subcommittee. **Also Member of Executive Subcommittee. **Also Member of Executive Subcommittee. **Also Member of Executive Subcommittee. **Also Member of Executive Subcommittee. 1187

Appendix A
PREFACE TO PEB COMMENTARY The Permanent Editorial Board (PEB) for the Uniform Commercial Code (UCC) acts under the authority of The American Law Institute and the National Conference of Commissioners on Uniform State Laws. In March, 1987, the PEB resolved to issue from time to time supplementary commentary on the UCC to be known as PEB Commentary. These PEB Commentaries seek to further the underlying policies of the UCC by aording guidance in interpreting and resolving issues raised by the UCC and/or the Ocial Comments. The Resolution states that:
A PEB Commentary should come within one or more of the following specic purposes, which should be made apparent at the inception of the Commentary: (1) to resolve an ambiguity in the UCC by restating more clearly what the PEB considers to be the legal rule; (2) to state a preferred resolution of an issue on which judicial opinion or scholarly writing diverges; (3) to elaborate on the application of the UCC where the statute and/or the Ocial Comment leaves doubt as to inclusion or exclusion of, or application to, particular circumstances or transactions; (4) consistent with UCC 1-102(2)(b), to apply the principles of the UCC to new or changed circumstances; (5) to clarify or elaborate upon the operation of the UCC as it relates to other statutes (such as the Bankruptcy Code and various federal and state consumer protection statutes) and general principles of law and equity pursuant to UCC 1-103; or (6) to otherwise improve the operation of the UCC.

The full Resolution appears in the 1990 Edition of the UCC.

1188

PEB COMMENTARY NO. 10 SECTION 1-203

ISSUE Section 1-203 provides that Every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement.1 While this concept applies generally to every contract, it nds particular expression throughout the Code. For example, out of over 400 Code provisions, more than 50 sections make specic reference to good faith.2 The meaning of good faith varies with the context. Sometimes the context is as a standard of performance or enforcement; other times the context is that of good faith purchase.3 This Commentary deals only with good faith performance or enforcement of a right or duty under a contract that is within the Code. In the context in which the obligation of good faith functions as the standard of contract performance or enforcement, can the failure to meet this standard support a cause of action where no other basis for a cause of action exists? This Commentary examines this question in order to promote a uniform understanding of what it means to say that a general obligation of good faith is imposed on every contracting party. In so doing, several principles are discussed. DISCUSSION 1 Good Faith, Commercial Expectations, and the Concept of Agreement Section 1-201(19) denes good faith as honesty in fact in the conduct or transaction concerned.4 Commentators have said that this general requirement of good faith sets a subjective standard,5 while the particularized denitions elsewhere also create an additional objective standard of the
This does not mean that the obligation of good faith as dened in the Code will necessarily apply to all aspects of the same transaction. As written, the scope of 1-203 is co-extensive with the Code's coverage. For example, if a loan agreement that provides for an Article 9 security interest also contains nancial covenants which are not governed by the Code, 1-203 would apply to the former and the general law of contracts would apply to the latter. See, e.g., Restatement, Second, Contracts 205 (1981). 2 Farnsworth, Good Faith Performance and Commercial Reasonableness Under the Uniform Commercial Code, 30 U.Chi.L.Rev. 666, 667 (1963). 3 See, e.g., UCC 2-403 (good faith purchaser); 3-302 (holder in due course);
1

9-307 (buyer in the ordinary course of business). On the distinction between the doctrines of good faith performance and good faith purchase, see generally id. This sparse denition found in Article 1 is expanded elsewhere in the Code for purposes of particular Articles. See, e.g., 2-103(1)(b); 2A-103(2); 3-103(a)(4); 4-104(c); 4A-105(a)(6). This expanded denition is concerned with the fairness of conduct rather than the care with which an act is performed. UCC 3-103, Comment 4.
5 See Aronstein, Good Faith Performance of Security Agreements: The Liability of Corporate Managers, 120 U.Pa.L.Rev. 1, 31 (1971) (Good faith [as] dened in 1201(19) . . . [has] been historically construed as applying only to the actor's subjective state of mind.); Braucher, The 4

1189

Appendix A

observance of reasonable commercial standards of fair dealing. This Commentary applies with equal force to both standards of good faith. The principal author of the Code, Karl Llewellyn, recognized that parties develop expectations over time against the background of commercial practices and that if commercial law fails to account for those practices, it will cut against the parties' actual expectations. In an unpublished commentary on the Proposed Final Draft of the Uniform Revised Sales Act, Llewellyn had this to say about good faith:
No inconsistency of language and background exists merely because the words used mean something dierent to an outsider than they do to the merchants who used that language in the light of the commercial background against which they contracted. This is the necessary result of applying commercial standards and principles of good faith to the agreement . . .. Moreover, where the commercial background normally gives to a term in question some breadth of meaning so that it describes a range of acceptable tolerances rather than a sharp-edged single line of action, any attempted narrowing of this meaning by one party is so unusual as not likely to be expected or perceived by the other. Therefore, attention must be called to a desire to contract at material variance from the accepted commercial pattern of contract or use of language. Thus, this Act rejects any surprise variation from the fair and normal meaning of the agreement.6

Explaining the doctrine of good faith in such terms is thus a recognition that, as expressed in the Code, it serves as a directive to protect the reasonable expectations of the contracting parties. The general imperative that the reasonable expectations of the parties are the measure of the good faith of each suggests that good faith is a concept with conceptual content related to that of agreement. The Code denition of Agreement reads:
Agreement means the bargain of the parties in fact as found in their language or by implication from other circumstances including course of dealing or usage of trade or course of performance as provided in this Act (Sections 1-205 and 2-208).7

The agreement of the parties consists of more than their language alone. In elaborating on this theme, Comment 3 to 1-201 emphasizes that the word [agreement] is intended to include full recognition of usage of trade, course of dealing, course of performance and the surrounding circumstances
Legislative History of the Uniform Commercial Code, 58 Colum.L.Rev. 798, 812 (1958) (describing the test of good faith in 1-201(19) as a subjective test, sometimes known as the rule of the pure heart and empty head); Lawrence, The Prematurely Reported Demise of the Perfect Tender Rule, 35 U.Kan.L.Rev. 557, 571 (1987) (Good faith is a subjective term meaning honesty in fact in the contract or transaction concerned. ). 6 The Karl Llewellyn Papers, The University of Chicago Law Library, File J.X.2.K. 1, 9, reprinted in D. Patterson, Good Faith and Lender Liability 217 (1990). 1190 UCC 1-201(3). Furthermore, Comment 1 to 1-205 (Course of Dealing and Usage of Trade) reinforces this denition by stating:
This Act rejects both the lay-dictionary and the conveyancer's reading of a commercial agreement. Instead the meaning of the agreement of the parties is to be determined by the language used by them and by their action, read and interpreted in the light of commercial practices and other surrounding circumstances. The measure and background for interpretation are set by the commercial context, which may explain and supplement even the language of a formal or nal writing.
7

PEB Commentary No. 10

as eective parts thereof . . .. (emphasis added).8 Course of dealing is dened as follows:

A course of dealing is a sequence of previous conduct between the parties to a particular transaction which is fairly to be regarded as establishing a common basis of understanding for interpreting their expressions and other conduct.9

Usage of trade is dened as follows:

A usage of trade is any practice or method of dealing having such regularity of observance in a place, vocation or trade as to justify an expectation that it will be observed with respect to the transaction in question. The existence and scope of such a usage are to be proved as facts. If it is established that such a usage is embodied in a written trade code or similar writing the interpretation of the writing is for the court.10

Course of performance is dened as follows:

Where the contract for sale involves repeated occasions for performance by either party with knowledge of the nature of the performance and opportunity for objection to it by the other, any course of performance accepted or acquiesced in without objection shall be relevant to determine the meaning of the agreement.11

In addition to two denitional sections, 1-205 contains two additional methodological sections which direct how express terms, course of dealing, and usage of trade are to be synthesized:
(3) A course of dealing between parties and any usage of trade in the vocation or trade in which they are engaged or of which they are or should be aware give particular meaning to and supplement or qualify terms of an agreement. (4) The express terms of an agreement and an applicable course of dealing or usage of trade shall be construed wherever reasonable as consistent with each other; but when such construction is unreasonable express terms control both course of dealing and usage of trade and course of dealing controls usage of trade.12

At this juncture it is important to recognize that one acts in good faith

This Commentary recognizes the fact that course of performance is dened in Articles 2 and 2A and was originally not a part of the general denition of Agreement in Article 1. The concept is included here as an element of the agreement of the parties because there exists no plausible justication for excluding it. This view is strongly supported by Comments 1 and 2 to 2-208. Comment 2, in particular, emphasizes that a course of performance is always relevant to determine the meaning of the agreement. See also Westinghouse Credit Corp. v. Shelton, 645 F.2d 869, 31 UCC Rep.Serv. (Callaghan) 410 (10th Cir.1981) (course of performance may also be used for discerning the meaning of Agreement in Article 9). The Restatement, Second, of Contracts does not reect the Code's isolation of course of performance in Articles 2 and 2A. The Restatement provides that all four elementsexpress terms, course of dealing,
8

course of performance, and usage of trade are all elements of the meaning of contract. See Restatement, Second, Contracts 203. In fact, 202(4) states that any course of performance accepted or acquiesced in without objection is given great weight in the interpretation of the agreement. 9 UCC 1-205(1). 10 UCC 1-205(2). 11 UCC 2-208(1). This denition is duplicated in 2A-207(1). 12 UCC 1-205(3) (4). The connection between 1-205 and good faith is made explicit in the Comment to 1-203, wherein it is stated that the obligation of good faith is further implemented by Section 1-205 on course of dealing and usage of trade. The interpretational priorities set forth in 1-205 are, with the added inclusion of course of performance, duplicated in 2-208(2). That section states as follows:
The express terms of the agreement and any

1191

Appendix A

relative to the agreement of the parties. To decide the question whether a party has acted in good faith, a court must rst ascertain the substance of the parties' agreement. The performance and enforcement of agreements in a manner consistent with the reasonable expectations of the parties is in keeping with the broadest understanding of contract doctrine.13 The Code is consistent with this tradition of thought. However, the Code's concept of agreement broadens the sources for determining the meaning of the parties' agreement. The concept of agreement is not limited to the terms of the parties' writing: it includes a variety of elements, all of which must be synthesized. Under 1-205(4), the initial interpretive eort is to read all the terms as consistent with one another. Only when this is impossible does the interpreter then move to a lexical ordering of the terms, with express terms at the head of the list. Cases which make no attempt to reconcile the various terms before according priority to express terms in the construction of the parties' agreement must be considered to have proceeded improperly.14 The better application of 1-205(4), and the issues of interpretation which are central to it, is illustrated in cases like Nanakuli Paving & Rock Co. v. Shell Oil Co., 664 F.2d 772, 32 UCC Rep.Serv. (Callaghan) 1025 (9th Cir.1981) (upholding a nding that the written price term in an asphalt supply contract was qualied by a trade practice requiring suppliers to delay price increases for jobs on which buyers have already bid). Accordingly, in order to answer the question, Has a party performed or enforced a contractual right or duty in good faith?, the content of the parties' agreement must rst be determined.15
such course of performance, as well as any course of dealing and usage of trade, shall be construed whenever reasonable as consistent with each other; but when such construction is unreasonable, express terms shall control course of performance and course of performance shall control both course of dealing and usage of trade (Section 1-205). tions, it is recognizing that sometimes silence says more than words, and it is understanding its duty to the spirit of the bargain is higher than its duty to the technicalities of the language.

See also UCC 2A-207(2). 13 See 3 A. Corbin, Corbin on Contracts 570 (West Supp.1993).
If the purpose of contract law is to enforce the reasonable expectations of parties induced by promises, then at some point it becomes necessary for courts to look to the substance rather than to the form of the agreement, and to hold that substance controls over form. What courts are doing here, whether calling the process implication of promises, or interpreting the requirements of good faith, as the current fashion may be, is but a recognition that the parties occasionally have understandings or expectations that were so fundamental that they did not need to negotiate about those expectations. When the court implies a promise or holds that good faith requires a party not to violate those expecta-

Id. Reiter & Swan, Contracts and the Protection of Reasonable Expectations, in Studies in Contract Law 1, 11 (B. Reiter & J. Swan eds. 1980) ([T]hroughout the law of contract, a striving to protect reasonable expectations is visible . . ..). See, e.g., Southern Concrete Servs. v. Mableton Contractors, Inc., 407 F.Supp. 581, 19 UCC Rep.Serv. (Callaghan) 79 (N.D.Ga.1975), a'd mem., 569 F.2d 1154 (5th Cir.1978); Division of Triple T Serv. v. Mobil Oil Corp., 304 N.Y.S.2d 191, 6 UCC Rep.Serv. (Callaghan) 1011 (Sup.Ct.1969). For a non-Code decision which is consistent with this approach, see Southwest Savings and Loan Association v. Sunamp Systems, Inc., 838 P.2d 1314 (Ariz.App. 1992) (holding that inquiry does not stop with recognition that lender had general authority in written loan agreement to take
15 14

1192

PEB Commentary No. 10

2 UCC 1-203 Does Not Create an Independent Cause of Action The inherent aw in the view that 1-203 supports an independent cause of action is the belief that the obligation of good faith has an existence which is conceptually separate from the underlying agreement. As the above discussion demonstrates, however, this is an incorrect view of the duty. A party cannot simply act in good faith. One acts in good faith relative to the agreement of the parties. Thus the real question is What is the Agreement of the parties? 16 Put dierently, good faith merely directs attention to the parties reasonable expectations; it is not an independent source from which rights and duties evolve.17 The language of 1-203 itself makes this quite clear by providing that the obligation to perform or enforce in good faith extends only to the rights and duties resulting from the parties' contract. The term contract is, in turn, dened as the total legal obligation which results from the parties' agreement . . .. 18 Consequently, resort to principles of law or equity outside the Code are not appropriate to create rights, duties, and liabilities inconsistent with those stated in the Code.19 For example, a breach of a contract or duty within the Code arising from a failure to act in good faith does not give rise to a claim for punitive damages unless specically permitted.20 CONCLUSION Section 1-203 does not support a cause of action where no other basis for a cause of action exists. The concept of Agreement permeates the entirety of the Code. For example, 9-105(1)(l) incorporates the Article 1 concept of Agreement directly into Article 9. The agreement of the parties cannot be read o the face of a document, but must be discerned against the background of actual commercial practice. Not only does the Code recognize the reasonable practices and standards of the commercial community . . . [as] an apthe particular action, but inquiry extends to whether lender exercised that authority for a reason beyond the risks assumed by borrower in loan agreement, or beyond borrower's justied expectations, in the context of how a reasonable lender might act). 16 Patterson, supra, at 143. Good faith is sometimes the basis of an implied term to ll a gap or deal with an omitted case, e.g., the duty of cooperation frequently imposed on a party whose cooperation is essential and not unreasonably burdensome; or, the duty to give notice within a reasonable time of some important fact of which the other party would otherwise be unaware. See 2309(3) and Comment 8; 2 Farnsworth on Contracts 7.17, 7.17a (1990). A breach of such duties gives rise to a cause of action for breach of the contract of which the implied term becomes a part. Although such a cause of action arguably has the same practical content as a cause of action based upon a purported breach of 1-203, there is an important methodological dierence in that this Commentary requires, in the case of contracts within the Code, that the focus be upon the Agreement of the parties and their reasonable expectations. 17 Cases reaching this conclusion include Management Assistance, Inc. v. Computer Dimensions, Inc., 546 F.Supp. 666 (N.D.Ga.1982), a'd 747 F.2d 708 (11th Cir.1984), and Chandler v. Hunter, 340 So.2d 818, 21 UCC Rep.Serv. (Callaghan) 484 (Ala.Civ.App.1976). A contrary conclusion was reached in Reid v. Key Bank of Southern Maine, Inc., 821 F.2d 9, 3 UCC Rep.Serv.2d (Callaghan) 1665 (1st Cir.1987). 18 UCC 1-201(11) (emphasis supplied). 19 See UCC 1-103. 20 See UCC 1-106(1).

1193

Appendix A

propriate source of legal obligation,21 but it also rejects the premise that the language used [by the parties] has the meaning attributable to [it] by rules of construction existing in the law rather than the meaning which arises out of the commercial context in which it was used.22 The correct perspective on the meaning of good faith performance and enforcement is the Agreement of the parties. The critical question is, Has X acted in good faith with respect to the performance or enforcement of some right or duty under the terms of the Agreement? It is therefore wrong to conclude that as long as the agreement allows a party to do something, it is under all terms and conditions permissible. Such a conclusion overlooks completely the distinction between merely performing or enforcing a right or duty under an agreement on the one hand and, on the other hand, doing so in a way that recognizes that the agreement should be interpreted in a manner consistent with the reasonable expectations of the parties in the light of the commercial conditions existing in the context under scrutiny. The latter is the correct approach. Examples are: (1) Is it reasonable for a buyer in a particular locale or trade to expect that an express quantity term in a contract is not really a quantity term, but a mere projection to be adjusted according to market forces?23; (2) Does a party to a sales contract that permits discretionary termination have the right to expect that the decision whether to terminate will be made on the basis of sound business criteria? The Ocial Comment to 1-203 is amended by adding the following language at the end of the rst paragraph:
This section does not support an independent cause of action for failure to perform or enforce in good faith. Rather, this section means that a failure to perform or enforce, in good faith, a specic duty or obligation under the contract, constitutes a breach of that contract or makes unavailable, under the particular circumstances, a remedial right or power. This distinction makes it clear that the doctrine of good faith merely directs a court towards interpreting contracts within the commercial context in which they are created, performed, and enforced, and does not create a separate duty of fairness and reasonableness which can be independently breached. See PEB Commentary No. 10, dated February 10, 1994.
21 Kastely, Stock Equipment for the Bargain in Fact: Trade Usage, Express Terms, and Consistency Under Section 1-205 of the Uniform Commercial Code, 64 N.C.L.Rev. 777, 780 (1986). 22 23

UCC 2-202, Comment 1.

See Columbia Nitrogen Corp. v. Royster Co., 451 F.2d 3, 9 UCC Rep.Serv. (Callaghan) 977 (4th Cir.1971).

1194

COMMENTARY NO. 11 (SURETYSHIP ISSUES UNDER SECTIONS 3-116, 3-305, 3-415, 3-419, AND 3-605) FINAL DRAFT (February 10, 1994) Permanent Editorial Board for the Uniform Commercial Code, 4025 Chestnut Street, Philadelphia, Pennsylvania 19104-3099. 1994 by The American Law Institute and the National Conference of Commissioners on Uniform State Laws. All Rights Reserved COMMITTEES
PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE CHAIR * Geoffrey C. Hazard, Jr., New Haven, Connecticut MEMBERS Boris Auerbach, Cincinnati, Ohio Marion W. Benfield, Jr., Winston-Salem, North Carolina Gerald L. Bepko, Indianapolis, Indiana ** Amelia H. Boss, Philadelphia, Pennsylvania Lawrence J. Bugge, Madison, Wisconsin ** William M. Burke, Los Angeles, California Ronald DeKoven, New York, New York ** Frederick H. Miller, Norman, Oklahoma ** Donald J. Rapson, Livingston, New Jersey Curtis R. Reitz, Philadelphia, Pennsylvania ** Carlyle C. Ring, Jr., Alexandria, Virginia EMERITUS MEMBERS Robert Haydock, Jr., Boston, Massachusetts William E. Hogan, Southbury, Connecticut Homer Kripke, San Diego, California William J. Pierce, Ann Arbor, Michigan SECRETARY EMERITUS Paul A. Wolkin, Philadelphia, Pennsylvania COUNSELLOR EMERITUS Martin J. Aronstein, Philadelphia, Pennsylvania ABA LIAISON Linda C. Hayman, New York, New York ABA SECTION OF BUSINESS LAW LIAISON George A. Hisert, San Francisco, California *Also Chair of Executive Subcommittee **Also Member of Executive Subcommittee **Also Member of Executive Subcommittee **Also Member of Executive Subcommittee **Also Member of Executive Subcommittee **Also Member of Executive Subcommittee 1195

Appendix A
PREFACE TO PROPOSED PEB COMMENTARY The Permanent Editorial Board (PEB) for the Uniform Commercial Code (UCC) acts under the authority of The American Law Institute and the National Conference of Commissioners on Uniform State Laws. In March, 1987, the PEB resolved to issue from time to time supplementary commentary on the UCC to be known as PEB Commentary. These PEB Commentaries seek to further the underlying policies of the UCC by aording guidance in interpreting and resolving issues raised by the UCC and/or the Ocial Comments. The Resolution states that:
A PEB Commentary should come within one or more of the following specic purposes, which should be made apparent at the inception of the Commentary: (1) to resolve an ambiguity in the UCC by restating more clearly what the PEB considers to be the legal rule; (2) to state a preferred resolution of an issue on which judicial opinion or scholarly writing diverges; (3) to elaborate on the application of the UCC where the statute and/or the Ocial Comment leaves doubt as to inclusion or exclusion of, or application to, particular circumstances or transactions; (4) consistent with UCC 1-102(2)(b) to apply the principles of the UCC to new or changed circumstances; (5) to clarify or elaborate upon the operation of the UCC as it relates to other statutes (such as the Bankruptcy Code and various federal and state consumer protection statutes) and general principles of law and equity pursuant to UCC 1-103; or (6) to otherwise improve the operation of the UCC.

The full Resolution appears in the 1990 Edition of the UCC.

1196

PEB COMMENTARY NO. 11 (AS AMENDED TO APPLY TO REVISED ARTICLE 9)* SURETYSHIP ISSUES UNDER SECTIONS 3-116, 3-305, 3-415, 3-419, AND 3-605
INTRODUCTION The promulgation of revised Article 3 of the Uniform Commercial Code has given rise to a number of questions concerning the provisions in that Article governing the rights and duties of accommodation parties. This heightened level of interest results from many factors. In particular, the provisions in revised Article 3 concerning accommodation parties dier signicantly from those in former Article 3 in ways that are complex and not always obvious. Application of these rules often raises issues that were not pertinent under prior law. In addition, the promulgation in 1995 of the Restatement of Suretyship and Guaranty by The American Law Institute has generated greater interest in the rights and duties of sureties, including, of course, accommodation parties. As a result of this heightened interest, the suretyship rules in Article 3 have been the subject of a great deal of scrutiny, which has resulted in a recognition that the treatment of some suretyship issues in revised Article 3 should be claried. It is the purpose of this Commentary to answer several questions that have arisen concerning the rights and duties of accommodation parties. This Commentary concludes with a series of revisions and additions to the Comments to various sections in Article 3 that govern suretyship issues. ISSUE 1 If another person agrees to be liable for the obligation of the maker of a note, are the rights and duties of that person determined by the provisions of Article 3 governing accommodation parties, by the general law of suretyship, or both? DISCUSSION A person who agrees to be liable for the debt of another is clearly a surety. See Restatement of Suretyship and Guaranty 1. If the person eectuates the agreement by becoming a party (i.e., a co-maker or indorser) to the
*PEB Commentary No. 11, which addresses suretyship issues that arise under Article 3 of the Uniform Commercial Code, was originally issued in 1994. Issue 11 in the original Commentary dealt with the power of an accommodation party on an instrument that is secured by a security interest governed by Uniform Commercial Code Article 9 to waive the rights of that party that were provided for in Part 5 of former Article 9. Since the issuance of the original Commentary, former Article 9 has been replaced with Revised Article 9 and the Restatement of Suretyship and Guaranty, which was in the process of being drafted in 1994, has been promulgated by the American Law Institute. This amended Commentary updates the discussion of Issue 11 to reect Revised Article 9 and the promulgation of the Restatement of Suretyship and Guaranty. 1197

Appendix A

same instrument that creates the obligation, the surety is also an accommodation party. In such a case, the rules in 3-116, 3-305, 3-415, 3-419, and 3-605 concerning accommodation parties are applicable. Of course, these sections will not resolve all possible issues concerning the rights and duties of the surety. In the event that a situation is presented that is not resolved by those sections, the resolution may be provided by the general law of suretyship because, pursuant to 1-103, that law is applicable unless displaced by provisions of this Act. If the surety does not eectuate the obligation by becoming a party to the note, the surety is not an accommodation party. In that case, the surety's rights and duties are determined by the general law of suretyship. In unusual cases, two parties to an instrument may have a surety relationship that is not governed by Article 3 because the requirements of 3-419(a) are not fullled. For example, assume that the payee of an instrument would like to sell it, but the potential buyer will agree to buy the instrument only if, in the event that the instrument is dishonored, the buyer has recourse not only against the issuer and the payee but also against someone more creditworthy. Accordingly, the payee produces a creditworthy person who agrees to stand behind the payee's obligations with respect to the instrument. The transfer to the buyer is then made after both the payee and the creditworthy person indorse the instrument. The creditworthy person is a party to the instrument as an indorser and is an accommodation party for the issuer who is the accommodated party. The creditworthy person is also a surety with respect to the obligation of both the issuer and the payee as indorser. The creditworthy person, however, is not an accommodation party for the payee and the payee is not an accommodated party under 3-419(a) inasmuch as the instrument was not issued for value given for the benet of the payee. Therefore, the general law of suretyship, and not the provisions in Article 3 concerning accommodation parties, provides the rules that govern the suretyship relationship between the creditworthy person and the payee.1 ISSUE 2 What are the dierences between the rights of an accommodation party with respect to the accommodated party under revised Article 3 and former Article 3? DISCUSSION Under the general law of suretyship, as between the principal obligor and the secondary obligor, it is the principal obligor who ought to bear the cost of performance. Restatement of Suretyship and Guaranty 1. Suretyship law provides three mechanisms to eectuate that cost allocation. First, if the principal obligor is charged with notice of the secondary obligation, the principal obligor owes the secondary obligor a duty of performance; this duty of performance can be enforced by the secondary obligor through the mechanism commonly known as exoneration. Restatement of Suretyship and Guaranty 21. Second, a secondary obligor who performs may be
The revisions to Comment 3 to 3419 and Comment 6 to 3-605 reect this 1198
1

discussion. See Appendix, par. 3 and par. 10.

PEB Commentary No. 11

subrogated to the rights of the obligee against the principal obligor (regardless of whether the principal obligor was charged with notice of the secondary obligation). Restatement of Suretyship and Guaranty 27. Third, if the principal obligor is charged with notice of the secondary obligation, the principal obligor must reimburse a secondary obligor who performs the obligation. Restatement of Suretyship and Guaranty 22. If the principal obligor is not charged with notice of the secondary obligation, a secondary obligor who performs is nonetheless entitled to restitution from the principal obligor. Restatement of Suretyship and Guaranty 26. An accommodation party is always a surety. Former Article 3 explicitly provided in 3-415(5) that an accommodation party who paid the instrument was entitled to enforce the instrument against the accommodated party. This right essentially codied the surety's right of subrogation. Other rights of the accommodation party against the accommodated party were left to the general law of suretyship through 1-103. In 3-419(e), revised Article 3 also in eect sets forth subrogation rights of accommodation parties by providing that such parties are entitled to enforce the instrument against the accommodated party. That section also codies the accommodation party's right to be reimbursed by the accommodated party. Unlike the general law of suretyship, however, that right is not limited to situations in which the accommodated party was charged with notice of the accommodation party's obligation. Thus, it need not be determined whether the accommodated party is charged with notice of the accommodation party's obligation, and the right of restitution that is present in the general law of suretyship is superuous. Revised Article 3, like former Article 3, leaves the accommodated party's duty of performance and the accommodation party's concomitant right of exoneration to the general law of suretyship through 1-103.2 ISSUE 3 Is an accommodation party entitled to reimbursement if the accommodated party had a defense to its obligation that could have been raised by the accommodation party against the person entitled to enforce the instrument? DISCUSSION The juxtaposition of the accommodated party's duty to reimburse the accommodation party ( 3-419(e)) with the accommodated party's right to raise defenses ( 3-305(b)) raises important policy issues. If a duty to reimburse exists even when the accommodated party had a defense, that duty could be said to obviate the value of the defense. On the other hand, if no duty to reimburse exists in such circumstances, the cost of performance will be borne ultimately by the accommodation party rather than the accommodated party. There are a number of dierent contexts in which the situation may arise. Generally speaking, the accommodation party may raise as a defense to its obligation the defenses of the accommodated party to its obligation. See 3-305(d). There are three exceptions. The accommodated party's deThe revision to Comment 5 to 3-419 reects this discussion. See Appendix, par.
2

5.

1199

Appendix A

fenses of discharge in insolvency proceedings, infancy, and lack of legal capacity are not available to the accommodation party. If the accommodation party pays the instrument when the accommodated party had one of these defenses, the accommodated party has no duty to reimburse the accommodation party. The accommodation party has, in a sense, assumed the risk that such defenses will exist. Occasionally, an accommodation party will pay an instrument even though the accommodated party has a defense that is available to the accommodation party. In such cases, the existence of the duty to reimburse may depend on whether the accommodation party was aware of the defense at the time it paid the instrument. If the accommodation party was unaware of the defense, there is a duty to reimburse. Thus, there is an incentive for the accommodated party to make the accommodation party aware of any defenses it may have. If the accommodation party pays the instrument while aware of a defense of the accommodated party, however, reimbursement would ordinarily not be justied but might be justied in some circumstances. Resolution of this issue is left to the general law of suretyship through 1-103.3 ISSUE 4 Section 3-415(a) provides that an indorser's obligation to pay the instrument upon dishonor is owed, inter alia, to a subsequent indorser who pays the instrument. What if both the prior indorser and subsequent indorser are anomalous indorsers? DISCUSSION In the general law of suretyship, when there are two secondary obligors for the same underlying obligation, the relationship between those two secondary obligors may be that of co-suretyship or sub-suretyship. In a cosuretyship situation, the two secondary obligors are jointly and severally liable and, as between themselves, have a right of contribution against each other. In a sub-suretyship situation, on the other hand, the second secondary obligor is, in a sense, a surety for the obligation of the rst secondary obligor. Thus, as between the two secondary obligors, the rst obligor occupies the position of a principal obligor while the later one occupies the position of a secondary obligor. It is often dicult to determine whether the two secondary obligors are co-sureties or sub-sureties, especially in the context of negotiable instruments when the obligations of those parties may be created by a signature alone, unaccompanied by words of explanation. Article 3 treats successive anomalous indorsers as having joint and several liability on the instrument. See 3-116(a). If one of the anomalous indorsers pays the instrument, that indorser has a right to receive contribution from the other indorser. See 3-116(b). Accordingly, the general rule of 3-415(a), that a subsequent indorser who pays the instrument may recover the full amount of the instrument from a prior indorser, does not apply in such cases. Section 3-116(b) does not recognize a distinction
The addition of Comments 6 and 7 to 3-419 reect this discussion. See Appendix, 1200
3

par. 6.

PEB Commentary No. 11

between a co-surety and a sub-surety, but in providing for a right to contribution, 3-116(b) has the eect of treating anomalous indorsers as though they were co-sureties. Section 3-116(b), however, is subject to agreement of the aected parties. If the subsequent indorser can prove an agreement with the prior indorser giving the subsequent indorser rights as a sub-surety, that agreement changes the rule of 3-116(b). If the subsequent indorser pays the instrument and has rights under the agreement as a sub-surety, the subsequent indorser has a right of recourse against the prior indorser for the amount of the payment rather than only a right to contribution; if the prior indorser pays the instrument, there is no right of recourse against the subsequent indorser.4 ISSUE 5 What eect do words of guaranty have on the obligation of an indorser to a person entitled to enforce an instrument? DISCUSSION Under former 3-416, the obligation of an indorser who added the words payment guaranteed or collection guaranteed to the indorsement was dierent than that of an indorser who did not add those words. The addition of the words payment guaranteed (or their equivalent) meant that if the instrument was not paid when due the indorser would pay it without resort to any other party. Thus, an indorser who guaranteed payment could be said to have waived presentment, notice of dishonor, and protest, as well as all demand upon the maker or drawee. In contrast, the addition of the words collection guaranteed (or their equivalent) meant that the indorser was required to pay only after the holder reduced its claim against the maker or acceptor to judgment or it was shown that such a proceeding would be useless. Section 3-419(d) preserves the concept of a guaranty of collection, but no provision is made for a guaranty of payment. Moreover, the preferred treatment given to a guarantor of collection is only applicable when the words accompanying the indorsement indicate unambiguously that the party is guaranteeing collection rather than payment of the obligation of another party to the instrument. Thus, an indorser who adds the words payment guaranteed, or the like, to the indorsement has the same liability as an indorser who added no special words to the indorsement. Such an indorser may be entitled, inter alia, to notice of dishonor pursuant to 3-503.5 ISSUE 6 May a person entitled to enforce an instrument avoid discharge of an accommodation party pursuant to 3-605 by reserving rights against that party in conjunction with a release, extension, or other modication of the duty of the accommodated party?
The addition of Comment 5 to 3-415 reects this discussion. See Appendix, par. 2.
4

The revision to Comment 4 to 3-419 reects this discussion. See Appendix, par. 4. 1201

Appendix A

DISCUSSION Under former UCC 3-606(1)(a), a release, extension, or other modication of the accommodated party's duty accompanied by an express reservation of rights against the accommodation party would not discharge that party. This provision paralleled the general law of suretyship in many jurisdictions. Article 3 rejects the reservation of rights doctrine. The eects of a release, extension, or other modication of the accommodated party's duty cannot be changed by the incantation of a reservation of rights. Pursuant to 3-605(b), a release of the accommodated party does not discharge the accommodation party, so there is no need for the person entitled to enforce the instrument to take any action, such as a reservation of rights, to preserve recourse against the accommodation party. Pursuant to 3605(c)(d), an extension or modication of the accommodated party's duty discharges the accommodation party to the extent that the extension or modication would otherwise cause the accommodation party a loss. This discharge cannot be avoided by a reservation of rights by the person entitled to enforce the instrument.6 ISSUE 7 If a person entitled to enforce an instrument agrees to extend the due date of the accommodated party's performance and, pursuant to 3-605(c), the extension does not discharge the accommodation party, what is the eect of the extension on the obligation of the accommodation party? In particular, is the due date for the accommodation party's performance extended correspondingly? May the accommodation party perform on the original due date? DISCUSSION The person entitled to enforce the instrument will not be able to enforce the instrument against the accommodation party until the extended due date. If the accommodation party is an indorser, this is because an indorser is not liable until dishonor of the instrument, which, under these circumstances, cannot occur until it is unpaid on the extended due date. If the accommodation party is a co-maker, this is because, under 3-305(d), until the extended due date the accommodation party will be able to assert the accommodated party's defense that, pursuant to the extension agreement, performance is not yet due. The accommodation party may, however, perform on the original due date. The accommodation party is bound in accordance with the terms of its original engagement. The agreement between the accommodated party and the person entitled to enforce the instrument cannot bind the accommodation party to a change in its obligation without the accommodation party's consent. The eect on the recourse of the accommodation party against the accommodated party of performance by the accommodation party on the original due date is not addressed in 3-419 and is left to the
The revision to Comment 3 to 3-605 reects this discussion. See Appendix, par. 1202
6

7.

PEB Commentary No. 11

general law of suretyship. Even though the accommodation party has the option of paying the instrument on the original due date, the accommodation party is not precluded from asserting its rights to discharge under 3-605(c) if it does not exercise that option. The critical issue is whether the extension caused the accommodation party a loss by increasing the dierence between the accommodation party's cost of performing its obligation on the instrument and the amount recoverable from the accommodated party pursuant to 3419(e). The decision by the accommodation party not to exercise its option to pay on the original due date may, under the circumstances, be a factor to be considered in the determination of that issue.7 ISSUE 8 What if the person entitled to enforce the instrument agrees, in one transaction, to both an extension of time for the accommodated party's performance and another modication of the accommodation party's obligation? What if there is a dispute as to whether, as a result of these changes, the accommodation party has suered a loss? DISCUSSION This question highlights the diculties in properly allocating the burden of persuasion when the agreement between the person entitled to enforce the instrument and the accommodated party involves both an extension governed by 3-605(c) and a modication governed by 3-605(d). The accommodation party has the burden of demonstrating loss from an extension, but the person entitled to enforce the instrument has the burden of overcoming a presumption of loss from other modications. If neither party introduces evidence as to loss causation, the result is full discharge of the accommodation party because 3-605(d) applies. If the person entitled to enforce the instrument seeks to overcome the presumption of loss from the modication, it is entitled to a presumption that the extension alone caused no loss. Thus, the accommodation party will have to introduce evidence as to the eect of the extension, while the person entitled to enforce the instrument will have to introduce evidence as to the eect of the modication. On the basis of this evidence, the court will make an overall determination of the eect of the changes on the accommodation party's right of recourse against the accommodated party.8 ISSUE 9 How can 3-305(d), which provides that the accommodation party can raise defenses of the accommodated party, be reconciled with 3-605(b), which provides that a release of the accommodated party does not discharge the accommodation party? DISCUSSION While 3-305(d) provides that an accommodation party can raise most de7 The revision to Comment 4 to 3-605 reects this discussion. See Appendix, par. 8. 8 The revision to Comment 5 to 3-605 reects this discussion. See Appendix, par. 9.

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Appendix A

fenses of the accommodated party, that section must be read in conjunction with 3-605, which governs the eect on the obligation of the accommodation party of an act or omission of the person entitled to enforce the instrument. Section 3-605(b) provides that a release of the accommodated party does not discharge the accommodation party. Thus, while examined in isolation, 3-305(d) might seem to allow the accommodation party to raise, as a defense to its obligation, a release of the accommodated party granted by the person entitled to enforce the instrument, the applicability of that section to such a release must be considered in light of 3-605(b). If the release of the accommodated party is part of a settlement pursuant to which the person entitled to enforce the instrument accepts partial payment from an accommodated party who is nancially unable to pay the entire amount of the note, the transaction falls within the scope of 3-605(b) and the accommodation party cannot escape liability by asserting 3-305(d) essentially to nullify 3-605(b). If, on the other hand, the release of the accommodated party is part of an accord and satisfaction settling a dispute as to the obligation of the accommodated party, the accommodation party may utilize 3-305(d) to assert that release as a defense to its obligation because 3-605(b) is not intended to apply to settlement of disputed claims.9 ISSUE 10 What sort of language is sucient to waive discharge under 3-605? DISCUSSION Section 3-605(i) provides that a party is not discharged under that section if the instrument or a separate agreement of the party waives such discharge either specically or by general language indicating that parties waive defenses based on suretyship or impairment of collateral. Thus, no particular language or form of agreement is required, and the standards for enforcing such a term are the same as the standards for enforcing any other term in an instrument or agreement. There is no requirement of particularity in referring to the four grounds for discharge established by 3-605 so long as the language used indicates that suretyship defenses are waived. By allowing the use of general language, the rule recognizes that the use of lengthy provisions containing detailed waivers or even separate identication of each ground for discharge does not necessarily promote greater understanding of an instrument's terms. Yet, the requirement that the language indicate that defenses are being waived assures that a diligent indorser or accommodation party will, at the least, not be unjustly surprised when it is asserted that the terms of the instrument or agreement delete protections that would otherwise be available. In adopting this course, 3-605 is consistent with the general law of suretyship. See Restatement of Suretyship and Guaranty 48.10 ISSUE 11 As a result of 3-605(i), may an accommodation party waive whatever
9 The revision to Comment 5 to 3-305 reects this discussion. See Appendix, par. 1. 10 The revision to Comment 8 to 3-605 reects this discussion. See Appendix, par. 11.

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PEB Commentary No. 11

protections it may have pursuant to Part 6 of Article 9? DISCUSSION Section 3-605(e) provides that impairment of an interest in collateral for the obligation of the accommodated party may discharge the accommodation party. Section 3-605(g) denes impairment of an interest in collateral as including, inter alia, failure to comply with applicable law in disposing of collateral. In the case of personal property or xtures, applicable law includes, of course, Article 9. Thus, failure to comply with the rules in Part 6 of Article 9 concerning disposition of collateral for the accommodated party's obligation constitutes impairment of an interest in collateral. In addition, the accommodation party will qualify as an obligor and a secondary obligor with respect to that collateral. See 9-102(a)(59), (71). Obligors and, to a much greater extent, secondary obligors, are provided with substantial protections in Part 6 of Article 9. Section 9-602 provides that, with few exceptions, obligors may not waive these protections. Section 3-605(i), on the other hand, provides that an accommodation party may waive discharge under this section (including discharge for impairment of an interest in collateral pursuant to 3-605(e)). This does not mean that the accommodation party may waive all protections it may have concerning disposition of collateral; rather, it provides for the waiver of protections created by 3-605. To the extent that Article 9 also provides the accommodation party similar protections, waiver of those protections is governed by Article 9 as interpreted in each jurisdiction.11 APPENDIX 1. Comment 5 to 3-305 is amended by adding an unnumbered paragraph as follows:
Section 3-305(d) must be read in conjunction with Section 3-605, which provides rules (usually referred to as suretyship defenses) for determining when the obligation of an accommodation party is discharged, in whole or in part, because of some act or omission of a person entitled to enforce the instrument. To the extent a rule stated in Section 3-605 is inconsistent with Section 3-305(d), the Section 3-605 rule governs. For example, under Section 3-605(b), discharge under Section 3-604 of the accommodated party does not discharge the accommodation party. As explained in Comment 3 to Section 3-605, discharge of the accommodated party is normally part of a settlement under which the holder of a note accepts partial payment from an accommodated party who is nancially unable to pay the entire amount of the note. If the holder then brings an action against the accommodation party to recover the remaining unpaid amount of the note, the accommodation party cannot use Section 3-305(d) to nullify Section 3-605(b) by asserting the discharge of the accommodated party as a defense. On the other hand, suppose the accommodated party is a buyer of goods who issued the note to the seller who took the note for the buyer's obligation to pay for the goods. Suppose the buyer has a claim for breach of warranty with respect to the goods against the seller and the warranty claim may be asserted against the holder of the note. The warranty claim is a claim in recoupment. If the holder and the accommodated party reach a settlement under which the holder accepts payment less than the amount of the note in full satisfaction of the note and the warThe revision to Comment 8 to 3-605 reects this discussion. See Appendix, par.
11

11.

1205

Appendix A ranty claim, the accommodation party could defend an action on the note by the holder by asserting the accord and satisfaction under Section 3-305(d). There is no conict with Section 3-605(b) because that provision is not intended to apply to settlement of disputed claims. Other examples of the use of Section 3-305(d) in cases in which Section 3-605 applies are stated in Comment 4 to Section 3-605. See PEB Commentary No. 11, dated February 10, 1994.

2. A new Comment 5 to 3-415 is added as follows:

5. As stated in subsection (a), the obligation of an indorser to pay the amount due on the instrument is generally owed not only to a person entitled to enforce the instrument but also to a subsequent indorser who paid the instrument. But if the prior indorser and the subsequent indorser are both anomalous indorsers, this rule does not apply. In that case, Section 3-116 applies. Under Section 3-116(a), the anomalous indorsers are jointly and severally liable and if either pays the instrument the indorser who pays has a right of contribution against the other. Section 3-116(b). The right to contribution in Section 3-116(b) is subject to agreement of the aected parties. Suppose the subsequent indorser can prove an agreement with the prior indorser under which the prior indorser agreed to treat the subsequent indorser as a guarantor of the obligation of the prior indorser. Rights of the two indorsers between themselves would be governed by the agreement. Under suretyship law, the subsequent indorser under such an agreement is referred to as a subsurety. Under the agreement, if the subsequent indorser pays the instrument there is a right to reimbursement from the prior indorser; if the prior indorser pays the instrument, there is no right of recourse against the subsequent indorser. See PEB Commentary No. 11, dated February 10, 1994.

3. Comment 3 to 3-419 is amended by adding an unnumbered paragraph as follows:

An accommodation party is always a surety. A surety who is not a party to the instrument, however, is not an accommodation party. For example, if M issues a note payable to the order of P, and S signs a separate contract in which S agrees to pay P the amount of the instrument if it is dishonored, S is a surety but is not an accommodation party. In such a case, S's rights and duties are determined under the general law of suretyship. In unusual cases two parties to an instrument may have a surety relationship that is not governed by Article 3 because the requirements of Section 3-419(a) are not met. In those cases the general law of suretyship applies to the relationship. See PEB Commentary No. 11, dated February 10, 1994.

4. Comment 4 to 3-419 is amended by adding the following two sentences:

Words added to an anomalous indorsement indicating that payment of the instrument is guaranteed by the indorser do not change the liability of the indorser as stated in Section 3-415. This is a change from former Section 3-416(5). See PEB Commentary No. 11, supra.

5. Comment 5 to 3-419 is amended by deleting the struck-out words and adding the underlined words as follows:
5. Subsection (e) restates subsection (5) of present Section 3-415 like former Section 3-415(5), provides that an accommodation party that pays the instrument is entitled to enforce the instrument against the accommodated party. Since the accommodation party that pays the instrument is entitled to enforce the instrument against the accommodated party, the accommodation party also obtains rights to any security interest or other collateral that secures payment of the instrument. Subsection (e) also provides that an accommodation party that pays the instrument is entitled to reimbursement from the accommodated party. See PEB Commentary No. 11, supra.
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PEB Commentary No. 11

6. A new Comment 6 and a new Comment 7 to 3-419 are added as follows:

6. In occasional cases, the accommodation party might pay the instrument even though the accommodated party had a defense to its obligation that was available to the accommodation party under Section 3-305(d). In such cases, the accommodation party's right to reimbursement may conict with the accommodated party's right to raise its defense. For example, suppose the accommodation party pays the instrument without being aware of the defense. In that case the accommodation party should be entitled to reimbursement. Suppose the accommodation party paid the instrument with knowledge of the defense. In that case, to the extent of the defense, reimbursement ordinarily would not be justied, but under some circumstances reimbursement may be justied depending upon the facts of the case. The resolution of this conict is left to the general law of suretyship. Section 1-103. See PEB Commentary No. 11, supra. 7. Section 3-419, along with Section 3-116(a) and (b), Section 3-305(d) and Section 3-605, provides rules governing the rights of accommodation parties. In addition, except to the extent that it is displaced by provisions of this Article, the general law of suretyship also applies to the rights of accommodation parties. Section 1-103. See PEB Commentary No. 11, supra.

7. Comment 3 to 3-605 is amended by dividing it into two paragraphs, deleting the struck-out words, and adding the underlined words as follows:
3. Subsection (b) addresses the eect of discharge under Section 3-604 of the principal debtor. In the hypothetical case stated in Comment 1, release of Borrower by Bank does not release Accommodation Party. As a practical matter, Bank will not gratuitously release Borrower. Discharge of Borrower normally would be part of a settlement with Borrower if Borrower is insolvent or in nancial diculty. If Borrower is unable to pay all creditors, it may be prudent for Bank to take partial payment, but Borrower will normally insist on a release of the obligation. If Bank takes $3,000 and releases Borrower from the $10,000 debt, Accommodation Party is not injured. To the extent of the payment Accommodation Party's obligation to Bank is reduced. The release of Borrower by Bank does not aect the right of Accommodation Party to obtain reimbursement from Borrower or to enforce the note against Borrower if Accommodation Party pays Bank. Section 3-419(e). Subsection (b) is designed to allow a creditor to settle with the principal debtor without risk of losing rights against sureties. Settlement is in the interest of sureties as well as the creditor. Subsection (b), however, is not intended to apply to a settlement of a disputed claim which discharges the obligation. Subsection (b) changes the law stated in former Section 3-606 but the change relates largely to formalities rather than substance. Under former Section 3-606, Bank in the hypothetical case stated in Comment 1 could settle with and release Borrower without releasing Accommodation Party, but to accomplish that result Bank had to either obtain the consent of Accommodation Party or make an express reservation of rights against Accommodation Party at the time it released Borrower. The reservation of rights was made in the agreement between Bank and Borrower by which the release of Borrower was made. There was no requirement in former Section 3-606 that any notice be given to Accommodation Party. The reservation of rights doctrine is abolished in Section 3-605 with respect to rights on instruments eliminates the necessity that Bank formally reserve rights against Accommodation Party in order to retain rights of recourse against Accommodation Party. See PEB Commentary No. 11, dated February 10, 1994.

8. Comment 4 to 3-605 is amended by adding six unnumbered paragraphs as follows:

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Appendix A Under other provisions of Article 3, what is the eect of an extension agreement between the holder of a note and the maker who is an accommodated party? The question is illustrated by the following case: Case #1. A borrows money from Lender and issues a note payable on April 1, 1992. B signs the note for accommodation at the request of Lender. B signed the note either as co-maker or as an anomalous indorser. In either case Lender subsequently makes an agreement with A extending the due date of A's obligation to pay the note to July 1, 1992. In either case B did not agree to the extension. What is the eect of the extension agreement on B? Could Lender enforce the note against B if the note is not paid on April 1, 1992? A's obligation to Lender to pay the note on April 1, 1992 may be modied by the agreement of Lender. If B is an anomalous indorser Lender cannot enforce the note against B unless the note has been dishonored. Section 3-415(a). Under Section 3-502(a) (3) dishonor occurs if it is not paid on the day it becomes payable. Since the agreement between A and Lender extended the due date of A's obligation to July 1, 1992 there is no dishonor because A was not obligated to pay Lender on April 1, 1992. If B is a co-maker the analysis is somewhat dierent. Lender has no power to amend the terms of the note without the consent of both A and B. By an agreement with A, Lender can extend the due date of A's obligation to Lender to pay the note but B's obligation is to pay the note according to the terms of the note at the time of issue. Section 3-412. However, B's obligation to pay the note is subject to a defense because B is an accommodation party. B is not obliged to pay Lender if A is not obliged to pay Lender. Under Section 3-305(d), B as an accommodation party can assert against Lender any defense of A. A has a defense based on the extension agreement. Thus, the result is that Lender could not enforce the note against B until July 1, 1992. This result is consistent with the right of B if B is an anomalous indorser. As a practical matter an extension of the due date will normally occur when the accommodated party is unable to pay on the due date. The interest of the accommodation party normally is to defer payment to the holder rather than to pay right away and rely on an action against the accommodated party that may have little or no value. But in unusual cases the accommodation party may prefer to pay the holder on the original due date. In such cases, the accommodation party may do so. This is because the extension agreement between the accommodated party and the holder cannot bind the accommodation party to a change in its obligation without the accommodation party's consent. The eect on the recourse of the accommodation party against the accommodated party of performance by the accommodation party on the original due date is not addressed in 3-419 and is left to the general law of suretyship. Even though X has the option of paying the instrument on the original due date, X is not precluded from asserting its rights to discharge under Section 3-605(c) if it does not exercise that option. The critical issue is whether the extension caused X a loss by increasing the dierence between X's cost of performing its obligation on the instrument and the amount recoverable from Corporation pursuant to Section 3-419(e). The decision by X not to exercise its option to pay on the original due date may, under the circumstances, be a factor to be considered in the determination of that issue. See PEB Commentary No. 11, supra.

9. Comment 5 to 3-605 is amended by adding seven unnumbered paragraphs as follows:

The following is an illustration of the kind of case to which Section 3-605(d) would apply:
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PEB Commentary No. 11 Case #2. Corporation borrows money from Lender and issues a note payable to Lender. X signs the note as an accommodation party for Corporation. The loan agreement under which the note was issued states various events of default which allow Lender to accelerate the due date of the note. Among the events of default are breach of covenants not to incur debt beyond specied limits and not to engage in any line of business substantially dierent from that currently carried on by Corporation. Without consent of X, Lender agrees to modify the covenants to allow Corporation to enter into a new line of business that X considers to be risky, and to incur debt beyond the limits specied in the loan agreement to nance the new venture. This modication releases X unless Lender proves that the modication did not cause loss to X or that the loss caused by the modication was less than X's right of recourse. Sometimes there is both an extension of the due date and some other modication. In that case both subsections (c) and (d) apply. The following is an example: Case #3. Corporation was indebted to Lender on a note payable on April 1, 1992 and X signed the note as an accommodation party for Corporation. The interest rate on the note was 12 percent. Lender and Corporation agreed to a six-month extension of the due date of the note to October 1, 1992 and an increase in the interest rate to 14 percent after April 1, 1992. Corporation defaulted on October 1, 1992. Corporation paid no interest during the six-month extension period. Corporation is insolvent and has no assets from which unsecured creditors can be paid. Lender demanded payment from X. Assume X is an anomalous indorser. First consider Section 3-605(c) alone. If there had been no change in the interest rate, the fact that Lender gave an extension of six months to Corporation would not result in discharge unless X could prove loss with respect to the right of recourse because of the extension. If the nancial condition of Corporation on April 1, 1992 would not have allowed any recovery on the right of recourse, X can't show any loss as a result of the extension with respect to the amount due on the note on April 1, 1992. Since the note accrued interest during the six-month extension, is there a loss equal to the accrued interest? Since the interest rate was not raised, only Section 3-605(c) would apply and X probably could not prove any loss. The obligation of X includes interest on the note until the note is paid. To the extent payment was delayed X had the use of the money that X otherwise would have had to pay to Lender. X could have prevented the running of interest by paying the debt. Since X did not do so, X suered no loss as the result of the extension. If the interest rate was raised, Section 3-605(d) also must be considered. If X is an anomalous indorser, X's liability is to pay the note according to its terms at the time of indorsement. Section 3-415(a). Thus, X's obligation to pay interest is measured by the terms of the note (12%) rather than by the increased amount of 14 percent. The same analysis applies if X had been a comaker. Under Section 3-412 the liability of the issuer of a note is to pay the note according to its terms at the time it was issued. Either obligation could be changed by contract and that occurred with respect to Corporation when it agreed to the increase in the interest rate, but X did not join in that agreement and is not bound by it. Thus, the most that X can be required to pay is the amount due on the note plus interest at the rate of 12 percent. Does the modication discharge X under Section 3-605(d)? Any modication that increases the monetary obligation of X is material. An increase of the interest rate from 12 percent to 14 percent is certainly a material modication. There is a presumption that X is discharged because Section 3-605(d) creates a presumption that the modication caused a loss to X equal to the amount of
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Appendix A the right of recourse. Thus, Lender has the burden of proving absence of loss or a loss less than the amount of the right of recourse. Since Corporation paid no interest during the six-month period, the issue is like the issue presented under Section 3-605(c) which we have just discussed. The increase in the interest rate could not have aected the right of recourse because no interest was paid by Corporation. X is in the same position as X would have been in if there had been an extension without an increase in the interest rate. The analysis with respect to Section 3-605(c) and (d) would have been different if we change the assumptions. Suppose Corporation was not insolvent on April 1, 1992, that Corporation paid interest at the higher rate during the six-month period, and that Corporation was insolvent at the end of the sixmonth period. In this case it is possible that the extension and the additional burden placed on Corporation by the increased interest rate may have been detrimental to X. There are diculties in properly allocating burden of proof when the agreement between Lender and Corporation involves both an extension under Section 3-605(c) and a modication under Section 3-605(d). The agreement may have caused loss to X but it may be dicult to identify the extent to which the loss was caused by the extension or the other modication. If neither Lender nor X introduces evidence on the issue, the result is full discharge because Section 3-605(d) applies. Thus, Lender has the burden of overcoming the presumption in Section 3-605(d). In doing so, Lender should be entitled to a presumption that the extension of time by itself caused no loss. Section 3-605(c) is based on such a presumption and X should be required to introduce evidence on the eect of the extension on the right of recourse. Lender would have to introduce evidence on the eect of the increased interest rate. Thus both sides will have to introduce evidence. On the basis of this evidence the court will have to make a determination of the overall eect of the agreement on X's right of recourse. See PEB Commentary No. 11, supra.

10. The second paragraph of Comment 6 to 3-605 is amended to read as follows:

In some states a real property grantee who assumes the obligation of the grantor as maker of a note secured by the real property becomes by operation of law a principal debtor and the grantor becomes a surety. The meager case authority was split on whether former Section 3-606 applied to release the grantor if the holder released or extended the obligation of the grantee. Revised Article 3 takes no position on the eect of the release of the grantee in this case. Section 3-605(b) does not apply because the holder has not discharged the obligation of a party, a term dened in Section 3-103(a)(8) as party to an instrument. The assuming grantee is not a party to the instrument. The resolution of this question is governed by general principles of law, including the law of suretyship. See PEB Commentary No. 11, supra.

11. Comment 8 to 3-605 is amended by adding the underlined words as follows:

8. Subsection (i) is a continuation of former law which allowed suretyship defenses to be waived. As the subsection provides, a party is not discharged under this section if the instrument or a separate agreement of the party waives discharge either specically or by general language indicating that defenses based on suretyship and impairment of collateral are waived. No particular language or form of agreement is required, and the standards for enforcing such a term are the same as the standards for enforcing any other term in an instrument or agreement. Subsection (i), however, applies only to a discharge under this section. The right of an accommodation party to be discharged under Section 3-605(e) because of an impairment of collateral can be waived. But with respect to a
1210

PEB Commentary No. 11 note secured by personal property collateral, Article 9 also applies. If an accommodation party is a debtor under Section 9-105(1)(d) 9-102(a)(28), an obligor under Section 9-102(a)(59), or a secondary obligor under Section 9-102(a)(71), the accommodation party has rights under Article 9. Under Section 9-501(3)(b) 9-602, many rights of an Article 9 debtor or obligor under Part 6 of Article 9 under Section 9-504(3) and Section 9-505(1), which deal with disposition of collateral, cannot be waived except as provided in Article 9. These Article 9 rights are independent of rights under Section 3-605. Since Section 3-605(i) is specically limited to discharge under Section 3-605, a waiver of rights with respect to Section 3-605 has no eect on rights under Article 9. With respect to Article 9 rights, Section 9-501(3)(b) 9-602 controls. See PEB Commentary No. 11, supra.

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COMMENTARY NO. 12 (SECTION 9-302) FINAL DRAFT (February 10, 1994) Permanent Editorial Board for the Uniform Commercial Code, 4025 Chestnut Street, Philadelphia, Pennsylvania 19104-3099. 1994 by The American Law Institute and the National Conference of Commissioners on Uniform State Laws. All Rights Reserved COMMITTEES
PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE CHAIR * Geoffrey C. Hazard, Jr., New Haven, Connecticut MEMBERS Boris Auerbach, Cincinnati, Ohio Marion W. Benfield, Jr., Winston-Salem, North Carolina Gerald L. Bepko, Indianapolis, Indiana ** Amelia H. Boss, Philadelphia, Pennsylvania Lawrence J. Bugge, Madison, Wisconsin ** William M. Burke, Los Angeles, California Ronald DeKoven, New York, New York *Frederick H. Miller, Norman, Oklahoma ** Donald J. Rapson, Livingston, New Jersey Curtis R. Reitz, Philadelphia, Pennsylvania ** Carlyle C. Ring, Jr., Alexandria, Virginia EMERITUS MEMBERS Robert Haydock, Jr., Boston, Massachusetts William E. Hogan, Southbury, Connecticut Homer Kripke, San Diego, California William J. Pierce, Ann Arbor, Michigan SECRETARY EMERITUS Paul A. Wolkin, Philadelphia, Pennsylvania COUNSELLOR EMERITUS Martin J. Aronstein, Philadelphia, Pennsylvania ABA LIAISON Linda C. Hayman, New York, New York ABA SECTION OF BUSINESS LAW LIAISON George A. Hisert, San Francisco, California *Also Chair of Executive Subcommittee. **Also Member of Executive Subcommittee. **Also Member of Executive Subcommittee. 1212 tee. **Also Member of Executive Subcommittee. **Also Member of Executive Subcommittee. *Also Chair of Executive Subcommit-

PEB Commentary No. 12

PREFACE TO PEB COMMENTARY The Permanent Editorial Board (PEB) for the Uniform Commercial Code (UCC) acts under the authority of The American Law Institute and the National Conference of Commissioners on Uniform State Laws. In March, 1987, the PEB resolved to issue from time to time supplementary commentary on the UCC to be known as PEB Commentary. These PEB Commentaries seek to further the underlying policies of the UCC by aording guidance in interpreting and resolving issues raised by the UCC and/or the Ocial Comments. The Resolution states that:
A PEB Commentary should come within one or more of the following specic purposes, which should be made apparent at the inception of the Commentary: (1) to resolve an ambiguity in the UCC by restating more clearly what the PEB considers to be the legal rule; (2) to state a preferred resolution of an issue on which judicial opinion or scholarly writing diverges; (3) to elaborate on the application of the UCC where the statute and/or the Ocial Comment leaves doubt as to inclusion or exclusion of, or application to, particular circumstances or transactions; (4) consistent with UCC 1-102(2)(b), to apply the principles of the UCC to new or changed circumstances; (5) to clarify or elaborate upon the operation of the UCC as it relates to other statutes (such as the Bankruptcy Code and various federal and state consumer protection statutes) and general principles of law and equity pursuant to UCC 1-103; or (6) to otherwise improve the operation of the UCC.

The full Resolution appears in the 1990 Edition of the UCC.

1213

PEB COMMENTARY NO. 12 SECTION 9-302

ISSUE Section 9-302(3) provides that the ling requirements of Article 9 are not applicable to the perfection of a security interest in goods covered by a certicate of title statute. In that circumstance, perfection of a relevant security interest can be had only through compliance with the certicate of title statute. If the secured party perfects its security interest pursuant to such a statute and then assigns the security interest, must the assignee take some further action to reect that it has become the secured party in order to continue such perfection, for example, having the certicate of title endorsed or reissued to name itself as the secured party or lienholder? Or is 9-302(2), which provides that if a secured party assigns a perfected security interest, no ling under this Article is required in order to continue the perfected status of the security interest against creditors of and transferees from the original debtor, applicable in this instance so that the assignee need not take any further action? DISCUSSION Section 9-302(1) states the general rule that in order to perfect a security interest under Article 9, a nancing statement must be led, except for certain specied transactions. See Comment 1. Section 9-302(3) provides for an additional exception: The ling of a nancing statement otherwise required by this Article is not necessary or eective to perfect a security interest in property (emphasis supplied) that is subject to a ling system set up outside the UCC, including specically, the certicate of title statute of this state (subsection (b)) or a certicate of title statute of another jurisdiction under the law of which indication of a security interest on the certicate is required as a condition of perfection (subsection (2) of Section 9-103) (subsection (c)).1 Inasmuch as every jurisdiction that has enacted Article 9 has also enacted a certicate of title (or ownership) statute, the eect of these provisions is that perfection of Article 9 security interests in property covered by certicate of title laws must always be accomplished by compliance with those laws. In essence, 9-302(3) substitutes compliance with the requirements of the applicable certicate of title statute for ling a nancing statement under Article 9 as the means for perfecting a security inter1 Although some certicate of title statutes condition perfection on a physical notation being placed on the certicate and are clearly covered by 9-302(3)(c) and the conict provisions of 9-103(2), others, while contemplating notation, provide that perfection is achieved by delivery of designated documents to a state ocial and could, therefore, arguably fall outside of the

provisions of 9-302(3)(c) and 9-103(2). The Alabama Supreme Court in Lightfoot v. Harris Trust & Savings Bank, 357 So.2d 654, 23 UCC Rep.Serv. (Callaghan) 750 (Ala.1978), dismissed the argument and held that Article 9 applies to goods covered by a certicate of title issued under either kind of statute. This Commentary supports the position taken in Lightfoot.

1214

PEB Commentary No. 12

est in the aected property. (A major exception to this rule is that the ling provisions of Article 9 remain applicable where the collateral is inventory held for sale by a person who is in the business of selling goods of that kind, for example, an automobile dealer. Section 9-302(3)(b).) Section 9-302(2) states a corollary rule to 9-302(1)s general rule on perfection, which is that the perfected security interest can be assigned by the secured party to another person without the need for a further ling under Article 9 and that the security interest of the assignee continues to be perfected, without further action, against the creditors of and transferees from the original debtor. The security interest created in favor of the secured party is transferred by the assignment to the assignee;2 it is the same security interest and not a new security interest. Accordingly, neither a new nancing statement nor a statement of assignment is required to continue the perfection of the assignee's security interest in the property. Section 9-405 permits, but does not require, the assignee to le a statement of assignment against the original debtor. By not ling, the assignee may encounter certain risks with adverse business and legal consequences, and therefore, the assignee may opt to le a statement of assignment even though not required to do so. Some risks an assignee may encounter if the statement of assignment is not led are: the assignor might fraudulently or inadvertently release or terminate the security interest; the assignor might assign the security interest to an innocent third party who might then le a statement of assignment and become the secured party of record; or the assignor might go out of business or disappear and make it dicult or impossible for the assignee to be able to respond to inquiries from third parties concerning the status of the security interest. The decision whether to le or not le a statement of assignment is essentially a business decision for the assignee to make, taking into account these various risk factors, as well as the cost, administrative convenience, and the like. Inasmuch as the purpose of 9-302(3) and (4) is to substitute compliance with the perfection requirements of the applicable certicate of title statute for ling under Article 9, 9-302(4) makes it clear that it is only with regard to such perfection requirements that Article 9 is displaced by the certicate of title statute: in all other respects the security interest is subject to Article 9. Therefore, in order to determine whether 9-302(2) is
The assignment of that security interest, whether a grant of a security interest in the underlying security agreement (chattel paper) between the assignor-secured party and the original debtor, or a sale of that chattel paper ( 9-102(1)(b)), is a separate and distinct secured transaction and involves dierent considerations. The validity and perfection of the assignee's security interest against the creditors of and transferees from the assignor-secured party is governed entirely by Article 9 and a jurisdiction's certicate of title statute has no applicability. Perfection would be accomplished by the assignee either taking pos2

session of the chattel paper ( 9-305) or by ling a nancing statement against the assignor-secured party ( 9-304(1)). Comment 7 to 9-302 makes it clear that the rules set forth in 9-302(1) and (2) do not apply to the perfection of the assignee's interest in the security agreement when viewed in relation to the creditors of and transferees from the assignor-secured party. Section 9-302(2) only obviates the need to take further steps in order to continue perfection of the security interest in the underlying vehicle against the creditors of and transferees from the original debtor. 1215

Appendix A

applicable to security interests perfected under 9-302(3) and (4), it is rst necessary to ascertain whether the certicate of title statute applicable to the particular transaction contains provisions concerning an assignment of a security interest and, if so, whether such provisions relate to perfection. Even though all jurisdictions have enacted certicate of title statutes, there is a wide variation among those statutes. The Uniform Motor Vehicle Certicate of Title and Anti-Theft Act (the Uniform Act) has been enacted in 11 jurisdictions. 11 Uniform Laws Annotated 250 (1993 Supp.). In a jurisdiction that has enacted the Uniform Act, it is clear from the provisions thereof concerning the assignment of a security interest that such provisions do not aect the perfected status of the assigned security interest. Section 22(b) of the Uniform Act expressly provides that the assignee may, but need not to perfect the assignment, have the certicate of title endorsed or issued with the assignee named as lienholder, upon delivering to the Department [of Motor Vehicles] the certicate and an assignment by the lienholder named in the certicate in the form the Department prescribes. (Emphasis supplied.) In other jurisdictions, however, the certicate of title statute contains provisions concerning the assignment of a security interest, but the statute is not clear whether such provisions relate to perfection. In that circumstance, the guiding principle is that [t]he certicate of title statutes, when applied as lien perfection statutes, should be construed in harmony with the general U.C.C. scheme for perfection of security interests. In re Little-john, 519 F.2d 356, 358, 17 UCC Rep.Serv. (Callaghan) 254, 257 (10th Cir.1975). Accord, General Motors Acceptance Corp. v. Rupp, 951 F.2d 283, 16 UCC Rep.Serv.2d (Callaghan) 510 (10th Cir.1991); In re Circus Time, Inc., 641 F.2d 39, 30 UCC Rep.Serv. (Callaghan) 1475 (1st Cir.1981). In so construing the statutes, the courts have recognized that the primary purposes of the certicate of title statutes are to facilitate the identication of motor vehicles or boats, the ascertainment of their owners, and the prevention of theft or fraud in their transfer; to provide the state with a convenient and accessible record of title for tax purposes; and to lend stability to the business climate surrounding the sale of motor vehicles and like goods. As observed by the court in In re Circus Time, Inc.:
Absolute compliance with the requirements of the Certicate of Title Acts is not necessary to perfect a security interest in a vehicle. Courts have properly interpreted such acts in light of the perfection provisions of the Uniform Commercial Code, which recognize as eective to perfect a security interest any ling that substantially compl[ies] with the requirements of [the Code] . . . even though it contains minor errors which are not seriously misleading. U.C.C. 9-402(8); [other citations omitted] . . ..

641 F.2d at 42, 30 UCC Rep.Serv. at 1479. To the extent that 9-302(2) and the certicate of title statutes can be construed as consistent with each other, the Code's underlying purpose and policy of making uniform the law among the various jurisdictions ( 1-102(2)(c)) will, of course, be better served. See In re Hollis, 301 F.Supp. 1, 3 (D.Conn.1969) ([I]t is the duty of a court construing the [Certicate of Title] Act to create a uniform national interpretation.). The corollary of the foregoing principle is that a strict and literal construction of a certicate of title statute should be avoided if it produces
1216

PEB Commentary No. 12

a result that unnecessarily conicts with the Uniform Commercial Code. Additionally, courts have refused to apply a highly rened and technical interpretation to a certicate of title statute to defeat the perfection of a security interest. See In re Williams, 608 F.2d 1015 (5th Cir.1979) and Janney v. Bell, 111 F.2d 103 (4th Cir.1940). By way of analogy, the overwhelming majority of courts have upheld the rights of a buyer in ordinary course of business under 2-403 even though the buyer did not obtain certicate of title. See, e.g., Dugdale of Nebraska, Inc. v. First State Bank, 420 N.W.2d 273, 277, 6 UCC Rep.Serv.2d (Callaghan) 111, 11617 (Neb.1988) and Comment 7 to 2A-304, approving this line of cases; see also Associates Discount Corp. v. Rattan Chevrolet, Inc., 462 S.W.2d 546, 8 UCC Rep.Serv. (Callaghan) 117 (Tex.1970) and Sterling Acceptance Co. v. Grimes, 168 A.2d 600, 1 UCC Rep.Serv. (Callaghan) 487 (Pa.Super.1961), applying the same rationale to 9-307. This same rationale should be applied to the question of whether an assignee must do something under a certicate of title statute to continue the perfected status of an assigned security interest when the statute contains provisions on assignments but does not specically mandate any action by the assignee for perfection, or makes no or only isolated references to assignments, or is ambiguous as to what action an assignee must take and makes no mention of the consequence of the assignee's failure to take action with respect to the issue of perfection. A number of other jurisdictions have incorporated parts of 22 of the Uniform Act into their certicate of title statutes, but most of these states did not include the phrase but need not to perfect the assignment in their versions of 22. See, e.g., Code of Alabama 32-8-63. Even without the quoted phrase, it would be consistent with 9-302(2) to view these statutes as permitting but not requiring the assignment to be noted on the certicate of title. This would also be consistent with 9-405, which provides a permissive device for noting assignments in the public records. Those certicate of title statutes that do not specically require, as a condition of perfection, that an assignee have the certicate of title endorsed or reissued to name itself as lienholder, but instead contain phrases like: the title ocer shall le each assignment received, or upon receiving a certicate, or other words of similar import, may be construed consistently with 9-302(2) as being merely permissive on this issue and as not requiring further action in order to continue perfection. Section 9-302(2) can also be construed consistently with the certicate of title statutes in those jurisdictions where the latter is either silent as to assignments, e.g., Arizona Revised Statutes Annotated 28-325 (Liens and encumbrances), or where there is an isolated reference to an assignee but no mention of perfection. For example, New Jersey Statutes Annotated 39:10-9 states that the name and the business or residence address of the secured party or his assignee shall be noted on the certicate of ownership, but makes no reference to the assignee having to note its name on the certicate in place of a secured party whose name is already noted or taking any other action such as ling a notice or document with the Division of Motor Vehicles. In those circumstances, 9-302(3) and (4) do not have the eect of substituting the requirements of the certicate of title statute relating to perfection for ling under this Article, inasmuch as
1217

Appendix A

the certicate of title statute does not state, within the purview of those UCC provisions, any requirement that the assignment of the security interest be noted on the certicate of title. As a result, 9-302(2) remains applicable. Some jurisdictions have certicate of title statutes that are ambiguous about what an assignee must do or whether the assignee must act in a particular way, but do not, within the meaning of 9-302(2), relate such required action by the assignee to the continued perfection of the security interest. Pennsylvania is an example of a jurisdiction having such a statute. Section 1134(b) of Pennsylvania Consolidated Statutes Annotated, 75 Pa.C.S.A. 1134(b), is an assignment section in the certicate of title statute which provides that the assignee shall deliver to the department the certicate of title and an assignment by the lienholder . . .. The certicate of title statute does not specify either a time period within which such action is to be performed or the consequences of the assignee's failure to act with respect to perfection. Id. The only consequence specied in the statute for the assignee's failure to act is contained in 1134(a) which says, any person without notice of the assignment is protected in dealing with the lienholder as the holder of the security interest and the lienholder remains liable for any obligations as lienholder until the assignee is named as lienholder on the certicate. 75 Pa.C.S.A. 1134(a). That language is identical to that in 22(a) of the Uniform Act. Section 9-302(2) and these statutes may be construed consistently with each other as not requiring the security interest to become unperfected because of the assignee's failure to have its name noted on the certicate of title. In view of the express provision in 22(b) obviating the need for the assignee to take any action to perfect the assignment (see pages 34), the language in 22(a), viewed in that context, does not appear to relate to perfection. The language merely restates the other potential risks and adverse business and legal consequences discussed above that might result from the failure of the assignee to have its name noted on the certicate. (See page 3.) In summary, 9-302(2) and certicate of title statutes that do not specically address perfection in connection with the assignment of a security interest can be construed consistently. As a result, in accordance with the mandate of 9-302(4) that in all other respects the security interest is subject to Article 9, 9-302(2) remains applicable. In order to interpret and apply 9-302(2) in a manner that is harmonious with the various certicate of title statutes and to simplify, clarify, and modernize the law applicable to the assignment of security interests, no ling under this Article as used in 9-302(2) should be liberally and broadly construed to include no notation of a security interest on a certicate of title when not expressly required as a condition for perfection by the applicable certicate of title statute. See 1-102. This interpretation is consistent with the basic function of certicate of title statutes in that the continued notation of the security interest on the certicate gives notice to creditors of and transferees from the original debtor of the existence of the security interest in the property covered by the certicate of title. CONCLUSION If a security interest has been perfected under the applicable certicate of
1218

PEB Commentary No. 12

title statute and is thereafter assigned, and that statute does not expressly require the assignee to take some further action with respect to the certificate of title to reect that it has become the secured party in order to continue such perfection, 9-302(2) is applicable and the assignee is not required to place its name on the certicate of title in order to continue the perfected status of the security interest against creditors of and transferees from the original debtor. If the assignee, nevertheless, wishes to have the assignment noted on the certicate of title, its right to do so and the procedure therefor are governed by the applicable certicate of title statute. The Ocial Comment to 9-302 is amended by adding the following:
10. If a security interest has been perfected under the applicable certicate of title statute and is thereafter assigned, and that statute does not expressly require the assignee to take some further action with respect to the certicate of title to reect that it has become the secured party in order to continue such perfection, 9-302(2) is applicable and the assignee is not required to note its name on the certicate of title in order to continue the perfected status of the security interest against creditors of and transferees from the original debtor. See PEB Commentary No. 12, dated February 10, 1994.

1219

COMMENTARY NO. 13 (THE PLACE OF ARTICLE 4A IN A WORLD OF ELECTRONIC FUNDS TRANSFERS) FINAL DRAFT (February 16, 1994) Permanent Editorial Board for the Uniform Commercial Code, 4025 Chestnut Street, Philadelphia, Pennsylvania 19104-3099. 1994 by The American Law Institute and the National Conference of Commissioners on Uniform State Laws. All Rights Reserved COMMITTEES
PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE CHAIR * Geoffrey C. Hazard, Jr., New Haven, Connecticut MEMBERS Boris Auerbach, Cincinnati, Ohio Marion W. Benfield, Jr., Winston-Salem, North Carolina Gerald L. Bepko, Indianapolis, Indiana ** Amelia H. Boss, Philadelphia, Pennsylvania Lawrence J. Bugge, Madison, Wisconsin ** William M. Burke, Los Angeles, California Ronald DeKoven, New York, New York ** Frederick H. Miller, Norman, Oklahoma ** Donald J. Rapson, Livingston, New Jersey Curtis R. Reitz, Philadelphia, Pennsylvania ** Carlyle C. Ring, Jr., Alexandria, Virginia EMERITUS MEMBERS Robert Haydock, Jr., Boston, Massachusetts William E. Hogan, Southbury, Connecticut Homer Kripke, San Diego, California William J. Pierce, Ann Arbor, Michigan SECRETARY EMERITUS Paul A. Wolkin, Philadelphia, Pennsylvania COUNSELLOR EMERITUS Martin J. Aronstein, Philadelphia, Pennsylvania ABA LIAISON Linda C. Hayman, New York, New York ABA SECTION OF BUSINESS LAW LIAISON George A. Hisert, San Francisco, California *Also Chair of Executive Subcommittee. **Also Member of Executive Subcommittee. **Also Member of Executive Subcommittee. 1220 **Also Member of Executive Subcommittee. **Also Member of Executive Subcommittee. **Also Member of Executive Subcommittee.

PEB Commentary No. 13

PREFACE TO PEB COMMENTARY The Permanent Editorial Board (PEB) for the Uniform Commercial Code (UCC) acts under the authority of The American Law Institute and the National Conference of Commissioners on Uniform State Laws. In March, 1987, the PEB resolved to issue from time to time supplementary commentary on the UCC to be known as PEB Commentary. These PEB Commentaries seek to further the underlying policies of the UCC by aording guidance in interpreting and resolving issues raised by the UCC and/or the Ocial Comments. The Resolution states that:
A PEB Commentary should come within one or more of the following specic purposes, which should be made apparent at the inception of the Commentary: (1) to resolve an ambiguity in the UCC by restating more clearly what the PEB considers to be the legal rule; (2) to state a preferred resolution of an issue on which judicial opinion or scholarly writing diverges; (3) to elaborate on the application of the UCC where the statute and/or the Ocial Comment leaves doubt as to inclusion or exclusion of, or application to, particular circumstances or transactions; (4) consistent with UCC 1-102(2)(b), to apply the principles of the UCC to new or changed circumstances; (5) to clarify or elaborate upon the operation of the UCC as it relates to other statutes (such as the Bankruptcy Code and various federal and state consumer protection statutes) and general principles of law and equity pursuant to UCC 1-103; or (6) to otherwise improve the operation of the UCC.

The full Resolution appears in the 1990 Edition of the UCC.

1221

PEB COMMENTARY NO. 13 THE PLACE OF ARTICLE 4A IN A WORLD OF ELECTRONIC FUNDS TRANSFERS
ISSUE Article 4A of the UCC deals primarily with electronic funds transfers made through the banking system.1 Adopted by the ALI and the National Conference of Commissioners on Uniform State Laws in 1989, Article 4A has had a substantial measure of success. At this time it is law in all but a few states, has been incorporated into Regulation J of the Federal Reserve System2 and, through their incorporation of New York State law, has been written into the Rules of CHIPS3 and NACHA.4 For a transfer of funds to be governed by Article 4A, an instruction must be given to a bank (Bank I in this scenario) either to make payment to the person who is the ultimate recipient of the funds or to instruct some other bank (Bank II) to make the payment.5 If the instruction is that Bank I make payment to the ultimate recipient, the bank is dealing with its own depositor or someone who has a direct customer relationship with the bank. That relationship, while occasionally dealt with by Article 4A, is largely outside the coverage of the statute.6 Article 4A concentrates principally upon the relationship of one bank with another bank. Assuming that the instruction given to Bank I is that Bank I instruct Bank II to make the payment,7 Bank II can as easily be located abroad as in the United States. For this reason, it is desirable that Article 4A nd compatibility with such international law as exists in this area. The major international legal document dealing with the subject of electronic funds transfers is the Model Law on International Credit Transfers (Model Law) adopted in 1992 by the United Nations Commission on International Trade Law (UNCITRAL). It covers basically the same type of transaction as does Article 4A, although it requires the funds
While Article 4A was clearly drafted with electronic funds transfers in mind and while its present eect will be upon such transfers, it is not limited to electronic transfers and applies by its terms to all transfers among banks outside the checking system. This concept is elaborated upon in Comment 6 to 4A-104. 2 12 C.F.R. Part 210, Appendix B (1993). 3 New York Clearing House Interbank Payments Systems, CHIPS Rule 3. 4 National Automatic Clearing House Association, ACH Rule 1.7.
5 1

We need not deal with who gives the

instruction to Bank I. It might be a company or an individual originating a funds transfer; it might be another bank which is moving along an instruction that had been given to it. 6 Provisions of Article 4A that do deal with the relationship of beneciary's bank and beneciary are 4A-404 and 4A-405. 7 Bank II can, having received the instruction from Bank I, in turn instruct another bank to make the payment. In this way, a series of banks can be involved in one transfer of funds from the party originating the transfer (called the Originator) to the party ultimately receiving it (called the Beneciary).

1222

PEB Commentary No. 13

transferred to have an international component.8 No foreign State has, to date, adopted the Model Law as its own local law. Nevertheless, in examining international payments, this Commentary assumes that the United States is subject to Article 4A and that the remainder of the world, because of the lack of development in the law otherwise, has adopted the Model Law now oered to it by the United Nations.9 DISCUSSION We will hypothesize two funds transfers. One is sent by a New York bank to San Francisco (NY-SF) and the other to London (NY-L).10 We may correctly assume that a New York bank will have both business reason and technical capacity to send funds with equal ease to both San Francisco and London. Administratively, it will normally make little if any dierence to the bank whether the transfer goes east or west. For the two transfers to be subject to dierent legal regimes can, however, create problems. For example, if New York imposes a dierent level of responsibility upon the bank for completion of the funds transfer depending upon where it goes, the bank's fee structure might vary between the two. Similarly, if there are dierent requirements, depending upon the location of the receiving bank, of persons who must receive notices or duties as to correcting a transfer made in error, dierent expectations will be created for the bank's systems. The banking system was clear in its reactions to Article 4A and the Model Law through its drafting that it would nd it both dicult and expensive to administer electronic funds transfers subject to conicting legal systems. In its nal form, the Model Law is close to Article 4A both in its overall structure and in its details, but is not the same. A. Conicts of Laws The conicts of law provisions of Article 4A and the Model Law tell us what law will apply to these transfers. In this respect, the two statutes are essentially harmonious: 4A-507(a)(1) and an optional Article Y11 in the Model Law both prescribe that, for most issues, the law of the receiving bank will govern.12 Thus, Article 4A will generally govern for NY-SF, and
Model Law, Article 1(1) requires that any sending bank and its receiving bank (be) in dierent States. Henceforth, references to Article numbers will refer to the Model Law; references to sections beginning with 4A will refer to the UCC. 9 Full uniformity would of course occur if the United States adopted the Model Law. It is unlikely in the extreme that this will occur. See the Conclusion to this Commentary. 10 We need not deal with funds transfers made to New York from dierent sending banks. The UCC and the Model Law gener8

ally base their choice of law provisions on the law of the receiving bank. Thus, all funds transfers received in New York would be dealt with by New York law and there would be no problem of inconsistencies. See the discussion, infra, under A. Conicts of Laws. UNCITRAL was unable to agree whether a conicts of law article belonged in the Model Law and, consequently, created an optional provision. Details of both Article 4A and the Model Law introduce complexities. For example, both permit the parties to select 1223
12 11

Appendix A

the Model Law for NY-L.13 B. Working of the Two Laws Some examples will illustrate dierences between Article 4A and the Model Law: 1. Consumer Transactions Both Article 4A and the Model Law were written without a focus on consumer-related transactions and, therefore, without the particular protections that typically accompany laws written for the benet of consumers. In Article 4A, this is evidenced by an exclusion through 4A-108 of transactions covered by the federal Electronic Fund Transfer Act of 1978 (EFTA), which is tailored for the consumer funds transfer. In the Model Law, a footnote to Article 1 provides that the Law does not deal with issues related to the protection of consumers.14 This surface harmony leads, however, to problems. For example, the EFTA does not deal with the number of issues treated by Article 4A. It does not, for example, dene the time when the originator of a consumer funds transfer has made payment to the beneciary, a question answered by both Article 4A and the Model Law. If the NY-L and the NY-SF funds transfers were consumer in nature and this question arose, it would be answered for NY-L and not for NY-SF (since the latter would be governed by the EFTA).15
the applicable law. In an Article 4A transaction, the relationship between a beneciary (that is, the party who will ultimately receive the money being transferred) and its bank are governed pursuant to 4A507(a)(2) by the law of the jurisdiction where the bank is located. Article 4A also contains rules that will govern when the funds transfer is made through a funds-transfer system (see text infra, at Notes 2224), and that system has its own choice of law rules. This Commentary does not deal with such variations. One cannot exhaust the potential conicts problems that arise even within this simple structure. For example, when the originator of the funds transfer instructs its New York bank to send funds to San Francisco or to London, the relationship of originator and bank is governed by the law of the receiving bankNew York. A funds transfer may also pass through several jurisdictions and raise additional issues. For the NY-SF and the NY-L transfers, however, the rule is that the law of California and of England will, respectively, apply.
13

The Model Law does not present the sharp distinction between consumer and business transactions represented by the positioning of Article 4A and EFTA. The quoted language reects the philosophy behind the Model Lawthat its design is really for large, commercially oriented funds transfersand justies the positions taken on various issues. The Model Law on its face governs both consumer and commercial funds transfers and it was left to individual states to decide how their consumers would be treated. 15 Presumably a court would look to analogies in other laws to see how the question should be answered in the NY-SF context. Presumably, the closest law for this purpose would be Article 4A and the court would use the Article 4A solution. A limited number of consumer transactionsthose handled through the FedWire system and a few others such as unplanned telephone transfersare excluded from the EFTA by Federal Reserve Regulation E and returned to coverage under Article 4A. See 12 C.F.R. 205.3(b) (1992).

14

1224

PEB Commentary No. 13

2. Variation by Agreement Both Article 4A16 and the Model Law17 generally permit the parties to vary their statutory obligations by agreement except as may be specically prohibited. Areas of specic prohibition vary, however, between the two laws. For example, the obligation of a receiving bank that is also the beneciary's bank to pay the amount of an order that it has accepted to the beneciary may not be varied by agreement under 4A-404(c). It may be varied under Article 10 of the Model Law. If our New York bank were to enter into agreements with its receiving banks dening circumstances under which an accepted order should not thereupon be paid to the beneciary, the agreements would be eective for the NY-L transfer and not for the NY-SF transfer.18 3. Use of a Funds-Transfer System Most electronic funds transfers are executed through funds-transfer systems.19 Section 4A-206(a) provides that a funds-transfer system is the agent of the sender. Errors made by a funds-transfer system are, therefore, the errors of the bank that sent the funds through the system. (For this purpose, however, the FedWire system is excluded, and the Federal Reserve bank operating FedWire is deemed to be just another bank.) The Model Law is silent on this subject. Thus, if, in a NY-SF transfer, the New York bank gives a payment order of $100,000 to the CHIPS system and CHIPS mistakenly transmits $1,000,000, the error is that of the New York bank, which is considered to have sent $1,000,000.20 In a NY-L transfer, one cannot be certain. It appears, however, that the error is that of CHIPS.21
16 17 18

Section 4A-501(a). Article 4.

One might imagine a New York bank agreeing with certain of its correspondents that they would not pay money to certain named beneciaries without checking rst with New York. That such an agreement would be eective for foreign banks but not for American banks was not the subject of detailed discussion, but one might imagine that foreign spokesmen could have wanted to support greater freedom for their banking system than the United States believes should be tolerated. A funds-transfer system is dened under 4A-105(a)(5) as a wire transfer network, automated clearing house, or other communication system of a clearing house or other association of banks through which a payment order by a bank may be transmitted to the bank to which the order is ad19

dressed. Well-known domestic fundstransfer systems include the FedWire system of the Federal Reserve Banks, the CHIPS system of the New York Clearing House Association, and the systems of the National Automated Clearing House Association. Foreign systems include the Society of Worldwide Interbank Financial Telecommunication (SWIFT), the United Kingdom Clearing House Automated Payments System (CHAPS), and the Japanese BOJ-NET system. 20 See Comment 2 to 4A-206. 21 This sort of event and its consequences are typically covered in the rules of a funds-transfer system. As discussed above, both Article 4A, 4A-501, and the Model Law, Article 4, authorize agreements varying their provisions. Rules of a fundstransfer system would probably be considered agreements under the Model Law and are agreements specically under 4A-501. 1225

Appendix A

Under Article 4A,22 funds-transfer system rules are given legal eect and may bind even parties who are not members of the system. Under the Model Law, the eect of a systems rule upon nonparties is not prescribed and, therefore, will be determined according to the law of contracts.23 Generally, under American contract law, those who are not parties to a contract are not bound by its terms. If a funds-transfer system with its own rules is part of the two described funds transfers, the law applicable to the NY-L and the NY-SF transfers can be dierent. 4. Authentication Procedures For the protection of the banking system and bank customers, both Article 4A and the Model Law establish procedures for the authentication of messages. The two systems work in similar manners.24 Both protect a receiving bank if it properly authenticates a message, even if the message was sent without the sender's proper authority.25 Both also relieve the sender of responsibility if it can prove that the message was sent by someone outside the sender's inuence.26 The Model Law27 reimposes responsibility on the sender if the receiver can prove that the sender was responsible. Article 4A does not contain the reimposition responsibility, although this is implicit since the receiving bank will attempt to disclaim its liability by proving that the sender was responsible. The eect of agreements varying the terms of the law again varies between Article 4A and the Model Law. Article 4A holds that (subject to certain limited and restricted exceptions) the parties may not vary its statutory authentication rights and liabilities by agreement.28 The Model Law has no such prescription and the parties may alter their legal authentication relationships by agreement.29 Thus, if the New York bank in our hypothetical agrees with its customers for a result other than as provided by the statutes, it will be eective for the NY-L transfer, but not for the NY-SF transfer. 5. Acceptance and Rejection Under both Article 4A and the Model Law, a receiving bank is given the essentially unrestricted power to accept or reject an order sent to it. An order may be rejected by a notice sent to the sender.30 a. Receiving Banks Other Than the Beneciary's Bank If a bank (other than the beneciary's bank) does not send a rejection notice, the legal consequences vary between the two laws; on the other hand, they resolve themselves, as the following discussion illustrates, without undue tension between them.
22 23

Section 4A-501(b).

Report of UNCITRAL, U.N. Doc. A/46/17 (1991), par. 98. The relevant sections are 4A-201, 4A-202, and 4A-203 for Article 4A, and Article 5 for the Model Law.
25 26 24

Section 4A-202(b); Article 5(2). Section 4A-203(a)(2); Article 5(4).

Article 5(4). Section 4A-202(f). 29 Article 5(3) does provide that for the parties to agree that a sending bank will be bound by an authenticated message, the authentication must be reasonable. Section 4A-202(b) has a similar requirement. 30 Section 4A-210(a) and Model Law Articles 7 and 9.
28

27

1226

PEB Commentary No. 13

Under Article 4A, an order may be accepted by a bank other than the beneciary's bank only by that bank executing a new order in favor of the next bank in line.31 Failure to give a notice of rejection does not cause the bank to incur a penalty; neither does it result in acceptance. If the bank does not move, or execute, the order, it is not deemed to have accepted the order, and the order is automatically canceled by operation of law in ve days.32 If the receiving bank has received actual funds covering the order, it must return the funds and pay interest to the sending bank until cancellation.33 Under the Model Law, a receiving bank that executes a new order is deemed to have accepted the order sent to it as under Article 4A.34 An order that is neither executed nor rejected is deemedunlike the Article 4A approachto be accepted if funds covering the order have been paid to the receiving bank.35 The receiving bank then is obligated to issue a new order in accordance with the responsibilities put by the Model Law upon the acceptor of an order. Similar to Article 4A, the payment order ceases to have eect after ve days.36 If the transfer is not completed, however, the bank must return any payment received by it plus interest to the date of payment37 and does not suer any further liability for its failure to execute the accepted order. In the instant situation, still assuming that the San Francisco and the London banks are receiving banks that are not the beneciary's bank, if an order is neither accepted nor rejected and if funds have been advanced to that bank (that is, if the order is covered), there would not be any duty upon the San Francisco bank to accept (that is, to execute the order in favor of the next bank in line) and the funds paid would bear interest for ve days; for the NY-L transfer, the payment order would be accepted by the London bank, there would be a dutyalbeit for a brief timeto move the funds, the acceptance would cease after ve days, and the payment (the cover) would bear interest until returned. The nancial dierences do not appear consequential since the receiving bank has the use of the funds until they are returned. Under the general structure of both laws not to impose more than interest penalties for failure to reject, the receiving bank in London would not incur other penalties for failing to honor its responsibility to move the funds. b. The Beneciary's Bank as a Receiving Bank The ability of the beneciary's bank to accept or reject payment orders is handled with essential comparability under the two laws. Under Article 4A, there are three events that trigger such a bank's acceptance, including rules based upon the relationship between the bank and the beneciary,
Section 4A-209(a). Section 4A-211(d). 33 Section 4A-210(b) and 4A-402(c) and 4A-402(d). 34 Article 7(2)(c). 35 While there is also a ve-day cancellation provision, it is applicable only if the
32 31

order is neither accepted nor rejected and we are dealing here with a deemed acceptance. Article 7(2), 7(3), and 7(4).
36 37

Article 7(4).

Article 14(1). This diers from Article 4A, which requires interest only for the ve days. 1227

Appendix A

cover of the order to the bank, and the passage of time.38 The Model Law contains eight events signifying acceptance by the beneciary's bank.39 One does not anticipate signicant variations in practice between the two laws. 6. Time for Execution Although their approaches to the question of when a receiving bank must take action upon an accepted payment order dier in the two laws, they have an essential similarity. For example, both Article 4A40 and the Model Law41 basically require that an order be executed on the day it is received. The Model Law, however, permits the order to be sent on the next day. In the event that occurs, however, the receiver must execute for value as of the prior day (that is, must give the next bank in line interest for the day that execution was delayed). 7. Cancellation Both statutes provide the mechanism for a payment order to be canceled. Under Article 4A, if there is a security procedure between sender and receiver guarding the authenticity of the original order, the (that is, the same) procedure must be followed for cancellations.42 If the original order was not subject to a security procedure, the cancellation order need not be authenticated. Under the Model Law, it is necessary that every cancellation be subject to some security procedure, not necessarily the same one originally used and even if no security procedure was originally used.43 If the cancellation order is not authenticated, it is ineective. In addition, under the Model Law, it appears that every cancellation order must be authenticated. Under Article 4A, the cancellation must be authenticated only if there was an authentication procedure applicable to the original order. The Article 4A approach is applicable in the NY-SF transfer; the Model Law governs the NY-L transfer. 8. The Money-Back Guarantee As part of their underlying philosophy that the originator's funds will be transferred by the banking system, both Article 4A and the Model Law contain a so-called money-back guarantee. This provides that, if the total transfer of money is not completed, the originator (who, under the model we have been following, either gave an order to the New York bank or was someone who gave an order at an earlier stage in the total funds transfer that was transmitted by another bank to the New York bank) will obtain a refund plus accumulated interest and certain other charges.44 The provisions of the two laws are consistent in major respects. Neither permits variation by agreement. The Model Law, however, relieves receiving banks from the guarantee if they can demonstrate that they accepted the transfer
38 39

Section 4A-209(b). Article 9(1). 40 Section 4A-301(b). 41 Article 11(1). 1228

42 43 44

Section 4A-211(a). Article 12(4). Section 4A-402 and Model Law Article

14.

PEB Commentary No. 13

despite what had been perceived as a signicant risk.45 9. Underpayments and the Recovery of Overpayments Both laws contain essentially comparable provisions requiring sending banks who sent orders in amounts less than the amounts sent to them to send the dierences and to permit banks who sent excessive payments to recover the excess.46 10. Consequential Damages In general, the measure of damages provided by both laws for violations of their standards is the payment of interest for moneys held for the times beyond which the law allows. Occasionally, additional charges incident to the transfer will be included.47 Probably the single most controversial issue underlying the drafting of Article 4A was whether banks should have liability for consequential damages resulting from their negligence or failure to comply with the requirements of the statute. The banks argued that, given the traditionally low fees that they charged to transfer funds electronically, they could not at the same time subject themselves to the risk of immense and unquantiable consequential damage recoveries. Business users of electronic fundstransfer systems asserted that consequential damages were an appropriate result of the banks' transfer responsibilities. Consequential damages were ultimately eliminated from Article 4A.48 Consequential damages may, however, be imposed against a bank under the Model Law. In view of the intense opposition of some national banking systems and their representatives in the United Nations to this concept, however, they were reduced in scope to where they will be imposed only where a bank has acted (a) with the specic intent to cause loss, or (b) recklessly and with actual knowledge that loss would be likely to result.49 Thus, the NY-L transfer by a New York bank involves greater risk than does the NY-SF transfer. 11. Request for Assistance Article 13 of the Model Law requests a bank that receives a payment order to assist the originator and each prior bank and to seek the assisA prudent originator's bank may agree with the originator that the moneyback guarantee will not apply to a funds transfer if the bank accepted the transfer despite what it perceived as a signicant risk that the transfer might not be completed. The example frequently given for this situation is where the transfer is to pass through areas involved in armed conict. 46 Section 4A-303(a) and 4A-303(b), and Model Law Articles 15 and 16. 47 See 4A-303(b) and 4A-305(b). 48 This result was ultimately agreed to by the major business interests in exchange for the consent by the banks to the money45

back guarantee discussed in paragraph 8 above. Consequential damages were, however, authorized in favor of an ultimate beneciary of a funds transfer against its bank that refuses to pay it after being notied of the particular circumstances giving rise to such damages. Section 4A-404(a). Consequential damages may also be provided for by express written agreement with a receiving bank. Section 4A-305(c). Article 18. The terms used within the quotation marks have established meanings under United States tort law with the exception of actual knowledge that loss would be likely to result. 1229
49

Appendix A

tance of the next receiving bank in completing the banking procedures of the credit transfer. Article 4A has no equivalent. In the NY-L transfer, the New York bank is subject to the request; in the NY-SF transfer, it is not. There is no penalty for failing to abide by the request.50 The absence of penalty may suggest that a bank need have no concern about the requirement. On the other hand, the presence of a law does impose an obligation to comply. In addition, assuming that there are bank regulators enforcing compliance, the regulators in London could bring an action against the New York bank for specic performance of its obligation to assist under Article 13; United States regulators could not. CONCLUSION The Model Law was drafted for world-wide enactment. It is, however, unlikely in the extreme that it will be enacted in the United States in the foreseeable future.51 It was generally accepted by the foreign states in UNCITRAL that there would be no movement to repeal Article 4A in the United States and adopt the Model Law in its stead. The two laws basically live together in harmony, but to the extent there are dierences they must be recognized and, to the extent possible, avoided or adjusted by agreement. The PREFATORY NOTE to Article 4A is amended by adding the following paragraph at the end of the PREFATORY NOTE: International transfers.
The major international legal document dealing with the subject of electronic funds transfers is the Model Law on International Credit Transfers adopted in 1992 by the United Nations Commission on International Trade Law. It covers basically the same type of transaction as does Article 4A, although it requires the funds transferred to have an international component. The Model Law and Article 4A basically live together in harmony, but to the extent there are dierences they must be recognized and, to the extent possible, avoided or adjusted by agreement. See PEB Commentary No. 13, dated February 16, 1994.
50 Banks normally engage in this type of assistance even without statutory direction. 51 For further material on the subject of this Commentary, see Bhala, Rakesh K.,

Paying for the Deal, 42 Kan.L.Rev. No. 3 (1993), in which Professor Bhala uses microeconomic and banking concepts to evaluate the utility of both Article 4A and the UNCITRAL Model Law.

1230

COMMENTARY NO. 14 (SECTION 9-102(1)(B)) FINAL DRAFT (June 10, 1994) Permanent Editorial Board for the Uniform Commercial Code, 4025 Chestnut Street, Philadelphia, Pennsylvania 19104-3099. 1994 by The American Law Institute and the National Conference of Commissioners on Uniform State Laws. All Rights Reserved
PERMANENT EDITORIAL BOARD FOR THE UNIFORM COMMERCIAL CODE CHAIR * Geoffrey C. Hazard, Jr., Philadelphia, Pennsylvania MEMBERS Boris Auerbach, Cincinnati, Ohio Marion W. Benfield, Jr., Winston-Salem, North Carolina Gerald L. Bepko, Indianapolis, Indiana ** Amelia H. Boss, Philadelphia, Pennsylvania Lawrence J. Bugge, Madison, Wisconsin ** William M. Burke, Los Angeles, California Ronald DeKoven, New York, New York Frederick H. Miller, Norman, Oklahoma ** Donald J. Rapson, Livingston, New Jersey Curtis R. Reitz, Philadelphia, Pennsylvania ** Carlyle C. Ring, Jr., Alexandria, Virginia EMERITUS MEMBERS Robert Haydock, Jr., Boston, Massachusetts William E. Hogan, Southbury, Connecticut Homer Kripke, San Diego, California William J. Pierce, Ann Arbor, Michigan SECRETARY EMERITUS Paul A. Wolkin, Philadelphia, Pennsylvania COUNSELLOR EMERITUS Martin J. Aronstein, Philadelphia, Pennsylvania ABA LIAISON Linda C. Hayman, New York, New York ABA SECTION OF BUSINESS LAW LIAISON George A. Hisert, San Francisco, California PREFACE TO PEB COMMENTARY The Permanent Editorial Board (PEB) for the Uniform Commercial Code (UCC) acts under the authority of The American Law Institute and the National Conference of Com*Also Chair of Executive Subcommittee **Also Member of Executive Subcommittee **Also Member of Executive Subcommittee **Also Member of Executive Subcommittee **Also Member of Executive Subcommittee 1231

Appendix A
missioners on Uniform State Laws. In March, 1987, the PEB resolved to issue from time to time supplementary commentary on the UCC to be known as PEB Commentary. These PEB Commentaries seek to further the underlying policies of the UCC by aording guidance in interpreting and resolving issues raised by the UCC and/or the Ocial Comments. The Resolution states that:
A PEB Commentary should come within one or more of the following specic purposes, which should be made apparent at the inception of the Commentary: (1) to resolve an ambiguity in the UCC by restating more clearly what the PEB considers to be the legal rule; (2) to state a preferred resolution of an issue on which judicial opinion or scholarly writing diverges; (3) to elaborate on the application of the UCC where the statute and/or the Ocial Comment leaves doubt as to inclusion or exclusion of, or application to, particular circumstances or transactions; (4) consistent with UCC 1-102(2)(b), to apply the principles of the UCC to new or changed circumstances; (5) to clarify or elaborate upon the operation of the UCC as it relates to other statutes (such as the Bankruptcy Code and various federal and state consumer protection statutes) and general principles of law and equity pursuant to UCC 1-103; or (6) to otherwise improve the operation of the UCC.

The full Resolution appears in the 1990 Edition of the UCC.

1232

PEB COMMENTARY NO. 14 SECTION 9-102(1)(B)

ISSUE Does the application of Article 9 to the sale of accounts and chattel paper prevent the transfer of ownership of accounts or chattel paper? DISCUSSION Section 9-102(1)(b) provides, subject to certain exceptions,1 that Article 9 applies to any sale of accounts or chattel paper.2 Comment 2 to 9-102 explains that a sale of [accounts or chattel paper is] covered by subsection (1)(b) whether intended for security or not . . .. The buyer then is treated as a secured party, and his interest as a security interest.3 This Commentary examines whether that application means that ownership of receivables may not be transferred or that a buyer's interest in receivables is limited to one of security. It is a fundamental principle of law that an owner of property may transfer ownership to another person.4 Were a statute intended to take away that right, it would do so explicitly and such a signicant curtailment of rights would be supported by substantial reason. No such reason is expressed or implied in the Code or the Ocial Comments. Indeed, the sale of receivables long antedates adoption of the Code, and it cannot be supposed that either the drafters of the Code or the legislatures that enacted it intended to work so drastic a change in existing law without clearly saying so. Moreover, a close reading of the text of Article 9 and its Comments, particularly in the context of the pre-Code history, compels the conclusion that Article 9 does not prevent the transfer of ownership. Article 9 contemplates that sales of receivables may exist, and that the consequences of a sale dier from those of a transfer for security. For example, 9-502(2) recognizes a distinction in the consequences under Article 9 between sales of receivables and transactions secured by
See 9-104(f). For ease of reference, this Commentary refers to accounts and chattel paper collectively as receivables. 3 This drafting technique is implemented by conforming denitions. Section 1-201(37), for example, states that the term security interest includes any interest of a buyer of accounts or chattel paper which is subject to Article 9. Section 9-105(1)(m) provides that the term secured party includes a person to whom accounts or chattel paper have been sold. Section 9-105(1)(d) provides that the term debtor includes the seller of accounts or chattel paper. Section 9-105(1)(c) provides that the
2 1

term collateral includes accounts and chattel paper which have been sold. That such inclusion was simply a drafting technique was long ago freely acknowledged by Homer Kripke in paragraph 2 of his Practice Commentary to 9-502 of the New York UCC, Cons.Laws N.Y.Annot.Book 62, Part 3 (McKinney 1964): Subsection (2) of [ 9502] recognizes throughout the fact that this article [9] includes within its coverage not only true security transactions in which accounts are collateral, but also sales of accounts . . . which are included by articial denitions.
4

See, e.g., Comment 1 to 2-403. 1233

Appendix A

receivables. It provides that, [i]f the security agreement secures an indebtedness, the secured party must account to the debtor for any surplus . . .. But, if the underlying transaction was a sale of accounts or chattel paper, the debtor [as seller of the receivables] is entitled to any surplus [from collections of the sold receivables] . . . only if the security agreement so provides. (Emphasis added.) Section 9-504(2) has virtually identical language. Furthermore, Comment 4 to 9-502, after acknowledging that there may be a true sale of accounts or chattel paper, claries that [t]he determination whether a particular assignment constitutes a sale or a transfer for security is left to the courts.5 Why, then, was Article 9 made applicable to the sale of receivables? The introductory Comment and Comment 2 to 9-102 explain that Article 9 applies to both sales and security transfers of receivables to avoid the need to distinguish between such transfers for Article 9 purposes:
[C]ertain sales of accounts and chattel paper are brought within this Article [9] to avoid dicult problems of distinguishing between transactions intended for security and those not so intended.

* * *
2. * * * Commercial nancing on the basis of accounts and chattel paper is often so conducted that the distinction between a security transfer and a sale is blurred, and a sale of such property is therefore covered by subsection (1)(b) whether intended for security or not . . ..

The reason for subjecting both sales and secured transactions to Article 9 was to inform third parties of existing interests in a debtor's receivables and to provide protection for all types of assignments of receivables:
There was an obvious reason for the inclusion of sales: it was necessary to protect [transferees] not only [in] straight accounts receivable nancing but also [in] arrangements of the factoring type. [Emphasis added.] Article 9 merely follows the pre-Code accounts receivable statutes [covering sales of accounts and chattel paper as well as security transfers].6

This is not to say, however, that Article 9 has no impact upon a buyer's
This Commentary likewise does not discuss what factors a court should look to in determining whether a particular transfer of receivables constitutes a sale or a secured loan. It addresses only whether Article 9 negates sale treatment even though a court viewing those factors would, but for Article 9, determine that the transfer was a sale. For a discussion of factors that courts have found relevant in determining whether a given transfer of receivables constitutes a sale or a secured loan, see Steven L. Schwarcz, Structured Finance, A Guide to The Principles of Asset Securitization, at 2835 (2d ed. 1993). 6 1 Gilmore, Security Interests in Personal Property 8.7, at 275; 10.5, at 308 (Little Brown & Co. 1965). Indeed, 1201(37) of the 1952 Ocial Draft of the UCC 1234
5

referred to a nancing buyer of receivables and 9-102(1)(b) referred to a nancing sale of receivables. The word nancing was deleted from both sections in Supplement No. 1 to the 1952 Ocial Draft, January 1955, pursuant to the 1954 Recommendations of the Editorial Board, for the reason that the phrases nancing buyer and nancing sale were perceived as undened concepts and it was thought better to include all sales of receivables, subject to the exclusion provisions of 9-104. The exclusion in 9-104(f) was correspondingly broadened to exclude from Article 9 certain types of sales of receivables that, by their nature, have nothing to do with commercial nancing transactions. See Comment 6 to 9-104.

PEB Commentary No. 14

ownership rights regarding the purchased receivables. For example, a failure to perfect as required by Article 9 may leave the transferee's ownership of the receivables subject to the claims of third parties, such as the seller's lien creditors or trustee in bankruptcy.7 This perfection requirement, however, does not by its terms or by implication aect the transfer of ownership as between the seller and buyer.8 At least two Circuit Court opinions interpret the Code consistently with this Commentary. In Major's Furniture Mart v. Castle Credit Corp.,9 the Third Circuit considered whether a transfer of a company's receivables should be construed as a sale or a secured loan. By considering that question, the court started from the premise that a transaction that Article 9 calls a security interest could nonetheless be a sale. If the transaction was a sale, the transferee would be entitled to surplus collections of the receivables. If the transaction was only for security, then the transferor would be entitled to the surplus collections. The court followed Comment 4 to 9-502 and looked to non-UCC law to determine whether the transaction was a sale. In In re Contractors Equipment Supply Co.,10 the Ninth Circuit armed a lower court decision by looking to non-UCC law to determine that the transfer of receivables in question was a loan. The court stated that had there been a sale, the transferor would not be entitled to any surplus because [a] sale entails the passage of title.11 In Octagon Gas Systems, Inc. v. Rimmer,12 however, the Tenth Circuit, after stating that a purchased royalty interest in a natural gas system was
Section 9-301(1). Just as Article 9's perfection requirement may impact upon the rights of a buyer of receivables without negating that a sale has occurred, so too does the requirement of 9-502(2) that a buyer of receivables with a right of recourse against the seller must proceed in a commercially reasonable manner . . .. Section 9-502(2) does not, however, articulate an ownership principle but rather is an abbreviated codication of the rule that would be applicable in any event under common law and 1-103, whether the recourse right is characterized as one of suretyship or contract. Assuming perfection, the sold receivables are beyond the reach of the seller's creditors or purported transferees from the seller not earlier led or perfected. The buyer does not have to account in any way to the seller or its creditors, and the seller has no right of redemption or other legal or equitable interests in the receivables. These absolute ownership rights can exist in the buyer even if the purchase of the receivables is with recourse. See Comment 4 to 9-502. 8 Provisions of Article 9 that deal with matters other than perfection and priority
7

likewise are not intended to give a seller any legal or equitable interests in receivables that have been sold. For example, the debtor's right under 9-506 to redeem collateral prior to consummation of foreclosure by a secured party applies only where the transfer of the collateral was intended for security because it is only there that the debtor has retained rights that must be foreclosed. 9 Major's Furniture Mart v. Castle Credit Corp., 602 F.2d 538, 26 UCC Rep.Serv. (Callaghan) 1319 (3d Cir.1979). 10 In re Contractors Equipment Supply Co., 861 F.2d 241, 7 UCC Rep.Serv.2d (Callaghan) 583 (9th Cir.1988). 861 F.2d at 245, 7 UCC Rep.Serv.2d at 587 (referring to 9-502). Also see 861 F.2d at 245 n. 8, 7 UCC Rep.Serv.2d at 58788 n. 8: If the present case involved a true [sale], under basic contract law principles, the notication would have taken the account receivable out of the estate. Octagon Gas Systems, Inc. v. Rimmer, 995 F.2d 948, 20 UCC Rep.Serv.2d (Callaghan) 1330 (10th Cir.1993), cert. denied, U.S. , 114 S.Ct. 554, 126 L.Ed.2d 1235
12 11

Appendix A

an account, erroneously stated that [t]he impact of applying Article 9 to [the buyer's] account is that Article 9's treatment of accounts sold as collateral would place [the buyer's] account within the property of [the seller's] bankruptcy estate.13 The court reached this determination despite the transfer of the royalty interest purporting to be an outright sale of all the seller's interest. To the extent the court relied on Article 9 in reaching its determination, this Commentary adopts a contrary position. CONCLUSION Article 9's application to sales of receivables does not prevent the transfer of ownership. Ocial Comment 2 to 9-102 therefore is amended by adding the following paragraph:
Neither Section 9-102 nor any other provision of Article 9 is intended to prevent the transfer of ownership of accounts or chattel paper. The determination of whether a particular transfer of accounts or chattel paper constitutes a sale or a transfer for security purposes (such as in connection with a loan) is not governed by Article 9. Article 9 applies both to sales of accounts or chattel paper and loans secured by accounts or chattel paper primarily to incorporate Article 9's perfection rules. The use of terminology such as security interest to include the interest of a buyer of accounts or chattel paper, secured party to include a buyer of accounts or chattel paper, debtor to include a seller of accounts or chattel paper, and collateral to include accounts or chattel paper that have been sold is intended solely as a drafting technique to achieve this end and is not relevant to the sale or secured transaction determination. See PEB Commentary No. 14, dated June 10, 1994.
455 (1993). 13 995 F.2d at 955, 20 UCC Rep.Serv.2d at 1338.

1236

PEB COMMENTARY NO. 15 ELECTRONIC FILING UNDER ARTICLE 9

ISSUE Do data transmitted electronically to a ling oce, which provide all the information required under the applicable provision of Article 9, constitute a nancing statement or other ling under Article 9? DISCUSSION Under 9-402(1), a nancing statement is sucient if it gives the names of the debtor and secured party, is signed by the debtor, and gives the specied other information. Similar signing and writing requirements appear for amendments, continuation and termination statements, assignments, and other lings. Under 1-201(39), signed includes any symbol executed or adopted by a party with present intention to authenticate a writing. A writing includes any intentional reduction to tangible form. Section 1-201(46). Obviously a paper signed by the debtor meeting the other requirements of 9-402(1) qualies as a nancing statement. The UCC mandates that it is to be liberally construed and applied to . . . modernize the law governing commercial transactions [and] to permit the continued expansion of commercial practices. Section 1-102. This provision mandates that the provisions of the UCC be interpreted and applied in a manner that is consistent with and furthers the utilization of advances in technology and resultant changes in commercial practices. See, e.g., Goss v. Trinity Sav. & Loan Ass'n, 813 P.2d 492, 13 UCC Rep. Serv. 2d (Callaghan) 1138 (Okla. 1991) (intent of UCC is to aid in expansion of commercial practices; court, when faced with widespread commercial practice, should acknowledge it). Two of the stated purposes of the PEB Commentaries are to apply the principles of the UCC to new or changed circumstances and to otherwise improve the operation of the UCC. Applying the statutory mandate, this Commentary concludes that data transmitted electronically to a ling oce which provide all the information required under the applicable provision of Article 9 constitute a nancing statement or other ling under Article 9. No statutory change is required to accommodate electronic ling. This Commentary addresses only the issue of electronic ling under Article 9. Conclusions concerning the meaning of signed and writing in that context are not intended to suggest a meaning for those terms in other contexts, where relevant policies and factual considerations may dier. This Commentary also does not mandate that any state oer electronic ling or require any ling party to utilize that technique merely because it is oered. Prudent business practices to guard against fraud and forgery should be observed in the electronic environment just as they should be in the paper environment. With respect to electronic ling under Article 9, Iowa has been accepting electronically transmitted nancing statements and other lings since
1237

Appendix A

1992, and Kansas initiated an electronic ling system in 1995. Texas, the state with the largest annual volume of lings in the nation, has recently implemented an electronic ling system. The American National Standards Institute has already created a standard (ANSI standard X12 154) for the electronic transmission to ling oces of nancing statements and subsequent Article 9 lings. The Texas program is based on this standard. Nothing in Article 9 mandates a particular mode of transmission of a ling to the ling oce. Section 9-403 is written in media neutral language, providing that either [p]resentation for ling . . . or acceptance of the statement by the ling ocer constitutes ling . . .. Indeed, although Part 4 of Article 9 does not utilize the term send with respect to ling a nancing statement, it is instructive that the drafters dened that term as follows: in connection with any writing . . . [send] means to deposit in the mail or deliver for transmission by any other usual means of communication . . .. The receipt of any writing . . . within the time at which it would have arrived if properly sent has the eect of a proper sending. Section 1-201(38). This denition further illustrates the Code's policy of exibility, a desire to enable commercial practices to utilize future technological development, and a methodology of looking to practical results. Moreover, nothing in Article 9 appears to limit the ling ocer's use of any particular technology for the receipt, storage, or retrieval of lings, whether such use occurs pursuant to published rules or regulations or simply as a matter of administrative procedure, suggesting that ling ocers have the authority to adopt procedures and methodologies deemed by them to be reasonably suited to carrying out their legislatively mandated tasks. Finally, nothing in Article 9 mandates that a nancing statement or other ling be on paper or any other particular medium. Article 9 prescribes the suciency of a nancing statement ling not in terms of its form but in terms of its content, i.e., the presence or absence of the required data. Signing is not limited to the cursive writing of the letters of the party's name by means of a pen grasped in the hand.1 The focus of the denition is not on the technique but rather on the intent to authenticate. Ocial Comment 39 to 1-201 states: The inclusion of authentication in the denition of signed is to make clear that as the term is used in this Act a complete signature is not necessary. Authentication may be printed,
1 With respect to suciency of a typed or printed (i.e., non-manually written) name as a signature, see, e.g., In re Save-OnCarpets of Arizona, Inc., 545 F.2d 1239, 20 UCC Rep. Serv. (Callaghan) 1081 (9th Cir. 1976) (secured party's intent to authenticate manifested by typed corporate name and its credit manager's name typed in appropriate spaces and submission for ling). Cases such as In re Kane, 1 UCC Rep. Serv. (Callaghan) 582, 587 (E.D. Pa. 1962) (required an actual signature manually produced by a writing instrument in the hand of the signer in direct contact with the document being executed), and In re Carlstrom, 3 UCC Rep.

Serv. (Callaghan) 766, 772, 773 (D. Me. 1966) (stating that to incorporate 1-201(39) into 9-402 does considerable violence to the language and context of 9-402, and that 1-201(39) must be held to be inconsistent with the context of 9-402 and hence inapplicable) are disapproved. Other cases where a ling without a manual signature was held insucient are consistent with the analysis set forth in this Commentary because they are grounded not on the proposition that a manual signature is absolutely required but on the absence of evidence that the debtor had adopted some other symbol or otherwise intended to authenticate.

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PEB Commentary No. 15

stamped or written; it may be by initials or by thumbprint. It may be on any part of the document and in appropriate cases may be found in a billhead or letterhead. No catalog of possible authentications can be complete and the court must use common sense and commercial experience in passing upon these matters. The question always is whether the symbol was executed or adopted by the party with present intention to authenticate the writing. The statute and the Ocial Comment support the conclusions that (i) any symbol, including a typed or printed expression of the person's name, can constitute a signature; (ii) the person need not be the party who places it, physically or otherwise, on the nancing statement; and (iii) the adoption of the symbol by the signer need not occur at the instant of such placement but can occur theretofore or thereafter.2 In an electronically transmitted nancing statement or other ling, the signature requirement is satised by the signer's adoption of a symbol that is transmitted electronically to the ling oce. The symbol may be the signer's name, an asterisk, or any other symbol, provided that it is adopted by the signer. The symbol may be keyed or otherwise placed on the electronic form in the signature box (a eld agreed upon by the sender and the ling oce as the eld for authentication data, such as that approved for such use under the ANSI standard). For validity as a signature, there is no statutory requirement that the authentication data or symbol be transmitted to or received by the ling oce in any particular medium or form.3 The ultimate fact of legal signicance, the signer's intent to authenticate, can
For example, in Barber & Ross Co. v. Lifetime Doors, Inc., 810 F.2d 1276, 3 UCC Rep. Serv. 2d (Callaghan) 41 (4th Cir. 1987), cert. denied, 484 U.S. 823 (1987), the seller's pre-printed sales literature, given to the buyer prior to the making of an oral requirements agreement, was sucient to satisfy the statute of frauds requirement of a signed writing by virtue of the printed trademark on the literature. See also John Deere Co. v. First Interstate Bank of Arizona, N.A., 709 P.2d 890, 42 UCC Rep. Serv. (Callaghan) 1110 (Ariz. App. 1985) (corporate debtor's name signed by principal in his representative capacity sucient as debtor's signature although debtor did not come into existence until six days later). 3 In Barber-Greene Co. v. National City Bank of Minneapolis, 816 F.2d 1267, 3 UCC Rep. Serv. 2d (Callaghan) 1234 (8th Cir. 1987), the court held that the adoption need not be in writing. In that case, a nancing statement was signed by the debtor's typewritten name followed by a cursive writing of the debtor's name that had been manually performed by the secured party's manager. The jury was instructed that the debtor had signed the nancing statement by adoption if the debtor intended [it] to be
2

valid and expressed that intent by word or deed . . .. 816 F.2d at 1269, 3 UCC Rep. Serv. 2d at 1237. The jury found that the debtor had knowingly authorized the secured party to sign on its behalf and had, before the ling, adopted the signature with present intent to authenticate. Id. The appellate court reviewed the statutory denition of signed and the related Ocial Comment, and looked to the policy supportive of continued expansion of commercial practices. 816 F.2d at 127071, 3 UCC Rep. Serv. 2d at 1239. It rejected the argument that adoption required a writing, relying both on the common sense and commercial practice language in the Ocial Comment and on Benedict v. Lebowitz, 346 F.2d 120, 2 UCC Rep. Serv. (Callaghan) 747 (2d Cir. 1965) (creditor had not [manually] signed the nancing statement but court held that the act of typing in the name [in body of the statement, not in the signature block at the bottom] coupled with [the] subsequent act of ling the statement indicated creditor's intent to authenticate). 816 F.2d at 1271, 3 UCC Rep. Serv. 2d at 1240. Rejecting the assertion that a requirement of adoption in writing was intended by the draftsmen in order to eliminate issues of authentication or fraud, the court stated: But it is undis1239

Appendix A

be established by any evidence lawfully admissible in court. A common mode of establishing such intent to authenticate will likely be the presentation of language to that eect in a security agreement or other writing signed by the debtor. A prudent secured party, of course, will obtain and preserve evidence of the debtor's adoption of a particular data or symbol with the intent to authenticate. Writing includes any intentional reduction to tangible form. Even when the electronically transmitted ling data are not in tangible form before or during transmission, they are reducible to such form by the ling ocer. Data in fact reduced to such form constitute writings. Data transmitted electronically to the ling oce may be reduced to tangible form in a variety of ways; common forms include microlm, microche, magnetic tape, CD-ROM, other disks, other tapes, optical storage devices, and paper. All of these (and no attempt is here made to be exhaustive) are tangible and are writings. Courts have repeatedly demonstrated their ability and willingness, in many contexts, in and outside of the Uniform Commercial Code, to accommodate technological developments and resultant changes in business practices. For example, telegrams have long been accepted by the courts as writings sucient to satisfy the statute of frauds.4 See, e.g., Howley v. Whipple, 48 N.H. 487 (1869) (it makes no dierence whether [the agent] writes the oer or the acceptance in the presence of his principal and by his express direction, with a steel pen an inch long attached to an ordinary penholder, or whether his pen be a copper wire a thousand miles long). More recently, the statute of frauds was held to have been satised by a telegram transmitted pursuant to telephonic instructions to the telegraph operator. Hillstrom v. Gosnay, 188 Mont. 388, 614 P.2d 466 (1980). To the same eect in the case of a signed writing sent by teletype, see Joseph Denunzio Fruit Co. v. Crane, 79 F. Supp. 117 (S.D. Cal. 1948), mot. for new trial granted, 89 F. Supp. 962 (S.D. Cal. 1950), rev'd, 188 F.2d 569 (9th Cir. 1951), cert. denied, 342 U.S. 820 (1951), and cert. denied, 344 U.S. 829 (1952), and by mailgram, see Hessenthaler v. Farzin, 388 Pa. Super. 37, 564 A.2d 990 (1989) (mailgram is a signed writing within real estate statute of frauds; dictum in a footnote alludes favorably to e-mail, telexes, and faxes), and McMillan, Ltd. v. Warrior Drilling & Engineering Co., Inc., 512 So.2d 14, 4 UCC Rep. Serv. 2d (Callaghan) 1546 (Ala. 1986). In Apex Oil Co. v. Vanguard Oil & Service Co., Inc., 760 F.2d 417, 40 UCC Rep. Serv. (Callaghan) 1221 (2d Cir. 1985), a telex was held to constitute a writing satisfying the requirement of 2-201(2) of a writing conrming
puted in this case that the debtor was aware of the nancing statement, the debtor had read the statement, and by its word and deed had accepted the statement as authentic. From time to time, [debtor] requested and received from [secured party] releases of its security interest. A written adoption in this case was unnecessary. Id. 4 Article 9 does not state that a nancing statement must be in writing. It is only 1240 the signature requirement, an authentication requirement, that speaks in terms of a writing. The Article 9 requirement of a nancing statement serves a notice function which can be fullled electronically; the requirement is not based on possibilities of fraud. Statute of frauds cases are mentioned simply as illustrations of courts being able to deal with new technology in relation to a pre-existing statutory framework.

PEB Commentary No. 15

the existence of a contract. A telecopy or fax is a commonly used device for the electronic transmission of data. A fax may send data directly from one computer to another without the data having been on paper at the outset or being printed out on paper by the recipient; or the data might be on paper at one end and not the other; or the data might be on paper at both ends, giving the appearance of a reproduction.5 Accepting telecopies as writings within the meaning of 2-201, see International Products & Technologies, Inc. v. Iomega Corp., 1989 U.S. Dist. LEXIS 13589, 10 UCC Rep. Serv. 2d (Callaghan) 694 (E.D. Pa. 1989), a'd without op., 908 F.2d 962 (3d Cir. 1990); Bazak Int'l Corp. v. Mast Industries, Inc., 73 N.Y.2d 113, 538 N.Y.S.2d 503, 535 N.E.2d 633, 7 UCC Rep. Serv. 2d (Callaghan) 1380 (1989). Approximately a dozen states presently accept nancing statements transmitted to the ling oce by fax. CONCLUSION Data transmitted electronically to a ling oce, which provide all the information required under the applicable provision of Article 9, constitute a nancing statement or other ling under Article 9 and no statutory change is required to accommodate electronic ling under Article 9. Ocial Comment 1 to 9-402 is amended by the addition of the following language at the end: Nothing in Article 9 mandates a particular mode of transmission to the ling oce of the data required to be supplied for a nancing statement or other ling, mandates that a ling be on paper or any particular medium, or limits the ling ocer's use of any particular technology for the receipt, storage, or retrieval of lings. Accordingly, data transmitted electronically to the ling oce and reduced to tangible form constitute a nancing statement or other ling under Article 9 if they provide all the information required under the applicable provision of Article 9. See PEB Commentary No. 15, dated July 16, 1996.
Electronically transmitted data ordinarily do not purport to be copies of the data in a prior medium. Thus, cases and statu5

tory language concerning copies are not relevant to the issue dealt with in this Commentary.

1241

PEB COMMENTARY NO 16 SECTIONS 4A-502(D) AND 4A-503 July 1, 2009 Permanent Editorial Board for the Uniform Commercial Code 2009 by The American Law Institute and the National Conference of Commissioners on Uniform State Laws. All rights reserved.
PREFACE TO PEB COMMENTARY The Permanent Editorial Board (PEB) for the Uniform Commercial Code (UCC) acts under the authority of The American Law Institute and the Uniform Law Commission (also known as the National Conference of Commissioners on Uniform State Laws). In March 1987, the PEB resolved to issue from time to time supplementary commentary on the UCC to be known as PEB Commentary. These PEB Commentaries seek to further the underlying policies of the UCC by aording guidance in interpreting and resolving issues raised by the UCC and/or the Ocial Comments. The Resolution states that:
A PEB Commentary should come within one or more of the following specic purposes, which should be made apparent at the inception of the Commentary: (1) to resolve an ambiguity in the UCC by restating more clearly what the PEB considers to be the legal rule; (2) to state a preferred resolution of an issue on which judicial opinion or scholarly writing diverges; (3) to elaborate on the application of the UCC where the statute and/or the Ocial Comment leaves doubt as to inclusion or exclusion of, or application to, particular circumstances or transactions; (4) consistent with UCC 1-102(2)(b),* to apply the principles of the UCC to new or changed circumstances; (5) to clarify or elaborate upon the operation of the UCC as it relates to other statutes (such as the Bankruptcy Code and various federal and state consumer protection statutes) and general principles of law and equity pursuant to UCC 1-103;** or (6) to otherwise improve the operation of the UCC.

For more information about the PEB, visit www.ali.org or www.nccusl.org. *Current UCC 1-103(a)(2). **Current UCC 1-103(b).

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PEB COMMENTARY NO 16 SECTIONS 4A-502(D) AND 4A-503

INTRODUCTION A funds transfer is a series of payment orders starting with an originator's order to the originator's bank to cause a sum certain amount of money to be paid to a beneciary. The series of payment orders culminates with a beneciary bank crediting the account of a beneciary for that sum certain. U.C.C. 4A-104(a) (denition of funds transfer). The series of payment orders is a mechanism used to make a transfer of value through the debiting and crediting of bank accounts from the originator to the beneciary. The funds transfer often involves one or more intermediary banks that receive a payment order from the originator's bank or another bank. The receiving intermediary bank then issues its own payment order to another intermediary bank or the beneciary's bank. Several cases have raised the issue of whether a creditor of the beneciary may serve creditor process on an intermediary bank and thus capture the value transfer while it is in process. Article 4A provides that the creditor of the beneciary may not serve creditor process on any bank other than the beneciary's bank. U.C.C. 4A-502(d). Ocial Comment 4 to 4A-502 further explains the concept, and does so in relation to a creditor of either the beneciary or the originator:
A creditor of the originator can levy on the account of the originator in the originator's bank before the funds transfer is initiated . . . [but] cannot reach any other funds because no property of the originator is being transferred. A creditor of the beneciary cannot levy on property of the originator and until the funds transfer is completed by acceptance by the beneciary's bank of a payment order for the benet of the beneciary, the beneciary has no property interest in the funds transfer which the beneciary's creditor can reach (emphasis supplied).

Ocial Comment to 4A-503 further explains both 4A-502(d) and 4A-503 are designed to prevent interruption of a funds transfer after it has been set in motion and that, in particular, intermediary banks are protected. A funds transfer is a series of payment orders that create contractual obligations only as to the sender and receiver of each payment order. Those contractual obligations are not the property of either the originator or the beneciary. In a simple funds transfer, the originator instructs its bank, the originator's bank, to debit the originator's account and order the beneciary's bank to credit the beneciary. Those instructions are payment orders. U.C.C. 4A-103 (denition of payment order, beneciary, and beneciary's bank; 4A-104 (denition of funds transfer, originator, and originator's bank). See also Regulation J, 12 C.F.R. 210.26 (governing payment orders issued to or by a federal reserve bank). The originator is the sender of the payment order and the originator's bank is the receiving bank. U.C.C. 4A-103 (denitions of sender and receiv1243

Appendix A

ing bank). If the originator's bank accepts the originator's payment order, the originator owes an obligation to the originator's bank to pay the amount of the payment order. U.C.C. 4A-402(b). The originator's bank owes an obligation to the originator to execute the accepted payment order according to the instructions of the originator. U.C.C. 4A-302. In execution of the originator's payment order, the originator's bank may send its own payment order to the beneciary's bank, but more commonly it will send its payment order to an intermediary bank. U.C.C. 4A-104 (denition of intermediary bank). The originator's bank is the sender of its payment order and the intermediary bank is the receiving bank of that second payment order. Upon acceptance of that second payment order, the intermediary bank owes an obligation to the originator's bank, not the originator, to execute its own payment order that replicates the originator's bank's payment order (emphasis supplied). U.C.C. 4A-302 (obligation in execution owed by receiving bank to its sender). The originator's bank, not the originator, owes payment of the originator bank's payment order to the intermediary bank. U.C.C. 4A-402(b) (sender owes obligation to pay the amount of an accepted payment order to its receiving bank). In the event the originator is not able to pay the amount of its payment order to the originator's bank, but the originator's bank's payment order has been accepted by the intermediary bank, the originator's bank still owes a payment obligation to the intermediary bank. The intermediary bank has no right of recovery against the originator, but only has a right of recovery against the originator's bank (its sender) for payment of the payment order. Further, the intermediary bank will then issue its own payment order to the beneciary's bank for the beneciary's bank to credit the account of the beneciary when the beneciary's bank accepts that payment order. Accordingly, the intermediary bank owes an obligation to pay for that order to the beneciary bank, not the beneciary. U.C.C. 4A-402(b). Upon the beneciary bank's acceptance of the payment order, it is the beneciary's bank that owes an obligation to pay the beneciary, usually by crediting an account of the beneciary. U.C.C. 4A-404. See also Regulation J 210.28, 210.29, 210.30, 210.31, and 210.32. In summation, under the Article 4A structure, the issuance and acceptance of payment orders create rights and obligations only as between the sender of the payment order and its receiving bank (e.g., between originator and originator's bank as to the originator's payment order), between the originator's bank and an intermediary bank as to the originator's bank's payment order, between the intermediary bank and the beneciary bank as to the intermediary bank's payment order, and nally as between the beneciary bank that has accepted a payment order and the beneciary. Accepted and executed payment orders thus create contractual obligations that result in a series of credits and debits to bank accounts. They do not involve a transfer of property of the originator to the beneciary. A receiving bank owes its contractual obligation to its sender to execute the payment order and the sender owes its contractual obligation to pay the amount of the payment order to its receiving bank. The intermediary bank has no contractual obligation to the originator or to the beneciary, and
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PEB Commentary No 16

neither the originator nor the beneciary has any contractual obligation to or rights owing from the intermediary bank. Thus, credits in an intermediary bank are credits in favor of the originator's bank, and are not property of either the originator or the beneciary (emphasis supplied). DISCUSSION In a series of cases applying Admiralty Rule B regarding attachment, the federal courts in New York have held that the intermediary bank in a funds transfer is holding property of the originator or beneciary and have thus allowed creditor process on an intermediary bank in an eort to collect a debt owed by either the originator or the beneciary (as the case may be).1 See, e.g., Winter Storm Shipping, Ltd. v. TPI, 310 F.3d 263 (2d Cir. 2002), cert. denied, 539 U.S. 927 (2003); Aqua Stoli Shipping Ltd. v. Gardner Smith Pty Ltd., 460 F.3d 434 (2d Cir. 2006); Consub Delaware LLC v. Schahin Engenharia Limitada and Standard Chartered Bank, 534 F.3d 104 (2d Cir. 2008); Navalmar (U.K.) Ltd. v. Welspun Gujarat Stahl Rohren, Ltd., 485 F. Supp. 2d 399 (S.D.N.Y. 2007); Compania Sudamericana de Vapores S.A. v. Sinochem Tianjin Co., 2007 WL 1002265 (S.D.N.Y. 2007); but see Seamar Shipping Corp. v. Kremikovtzi Trade Ltd., 461 F. Supp. 2d 222 (S.D.N.Y. 2006). These decisions stem from the opinion of the court in Winter Storm that the value held by the intermediary bank is property of the originator. Under Article 4A, which is also adopted federal law in Regulation J for funds transfers through a federal reserve bank, the originator does not have any claim against the intermediary bank for return of the value in the event the funds transfer is not completed. Rather, the only party with a claim against the intermediary bank is the sender to that bank, which is typically the originator's bank. In an uncompleted funds transfer, it is the originator's bank that must refund the value to the originator. U.C.C. 4A-402(d). The intermediary bank owes its refund obligation to its sender, the originator's bank, not to the originator. The originator's bank must refund to the originator even if it cannot recover from the intermediary bank.2 The beneciary likewise has no claim to any payment from the intermediary bank. The beneciary's only claim to the funds is against its bank, the beneciary bank, and then only when the beneciary bank has accepted the payment order. U.C.C. 4A-404. The intermediary bank thus holds no property of either the originator or the beneciary. Since
Federal Rules of Civil Procedure, Supplemental Rules for Certain Admiralty and Maritime Claims, Admiralty Rule B(1)(a) permits attachment of the defendant's tangible or intangible personal property in the hands of named garnishees and thus allows garnishment of such property held by a bank. 2 A simple example illustrates how these courts conated privity-based contract claims between two parties to create property rights in a third party. Assume A owes B an obligation, B owes C an obligation, and
1

C owes D an obligation. Under garnishment law, D cannot garnish A to satisfy the obligation C owes D. A holds no property of C (A owes B). Now substitute the Article 4A terms to this simple example. A is the intermediary bank who has received payment of a payment order issued by B, the originator's bank, and C is the originator. D is the garnishing creditor. The court in Winter Storm and its progeny have in essence allowed D (the originator's creditor) to garnish A (the intermediary bank) to collect on the debt C (the originator) owes to D. 1245

Appendix A

Admiralty Rule B does not dene what is property of a party, normally courts look to other law on that issue. Other law is sucient to dene the parties' rights in a funds transfer. Article 4A is uniform law, enacted in every state in the United States, and Regulation J, which adopts in large part Article 4A's provisions, is uniform in applying to all funds transfers through the federal reserve system. Both dene uniformly the rights of parties in a funds transfer. The Consub court reasoned that leaving the functional usefulness of Rule B attachments to the vagaries of the laws of 50 states would create a measure of anarchy, but did not take into account that Article 4A is uniform law in all U.S. jurisdictions and is adopted federal law.3 Neither did the court explain how Rule B provides any basis for determining whether anyone had any
The courts following Winter Storm have not followed the applicable law directly on point regarding property rights, but have also not followed applicable precedent predating Article 4A. The court in Reibor International Limited v. Cargo Carriers (Kacz-Co.) Ltd., 759 F.2d 262 (2d Cir. 1985), considered whether the CHIPS credit involved was property subject to attachment under the Admiralty Rules. The court said that federal law generally governs questions as to the validity of Rule B attachments, but the Admiralty Rules themselves oered little guidance and so the court agreed with the district court that state law more directly in point should be turned to. This is entirely consistent with respect to other contexts where federal law relies on state law to determine whether property is involved, such as in bankruptcy. See, e.g., Butner v. United States, 440 U.S. 48 (1979). Also the Court in Grain Traders, Inc. v. Citibank, N.A., 160 F.3d 97 (2d Cir. 1998), recognized the applicability of U.C.C. Article 4A when it held that law prevents an originator of a funds transfer from suing an intermediary bank. Id. at 102. Grain Traders remains good law in the Second Circuit and its logic applies to suits by beneciaries as well. Further, looking for a federal precedent concerning the susceptibility of funds involved in an EFT to attachment under Admiralty Rule B, Winter Storm turned to United States v. Daccarett, 6 F.3d 37 (2d Cir. 1993), a forfeiture case involving the drug tracking and money laundering activities of a Colombian drug cartel. 310 F.3d at 27677 (The case is instructive in the admiralty eld because the attachments of funds in Daccarett were accomplished pursuant to the Admiralty Rules, incorporated by reference into the forfeiture stat1246
3

ute.) Reasoning from Daccaretts holding that an EFT while it takes the form of a bank credit at an intermediary bank is clearly a seizable res under the forfeiture statutes, id. at 276 (quoting Daccarett, 6 F.3d at 55), Winter Storm concluded that the inclusive language of [Rule B] and the EFT analysis in Daccarett combine to fashion a rule in this Circuit that EFT funds in the hands of an intermediary bank may be attached pursuant to [Rule B]. 310 F.3d at 276. Consub endorsed Winter Storms reliance on Daccarett, with minimal independent analysis. See 543 F.3d at 11011. It should be noted that Rule B remains unchanged for all relevant intents and purposes since Winter Storm was decided in 2002 even though, eective December 1, 2006, the rules embodying the practice of maritime attachment in civil forfeiture actions and other in rem proceedings have been renamed the Supplemental Rules for Admiralty or Maritime Claims and Asset Forfeiture Actions (the Supplemental Rules). The revised Supplemental Rules added, inter alia, the reference to Asset Forfeiture Actions, and Rule G, governing forfeiture actions in rem arising from a federal statute, to bring together the central procedures that govern civil forfeiture actions. Supplemental Rule G, Advisory Committee's Note. The point is that Daccarett never decided whether either an originator or a beneciary of the funds transfer had a property interest in the amount involved in a funds transfer received by an intermediary bank. It did not need to do so because in a forfeiture case funds can be seized even if they do not constitute property of the defendant. The Daccarett court, as appropriate in a forfeiture case, identied the amount of the funds as traceable to an illicit activity and therefore subject to attachment under 21 U.S.C. 881(a). This is a critical dier-

PEB Commentary No 16

property rights in the value held at the intermediary bank.4

ence. Moreover, as a remedy quasi in rem, the validity of a Rule B attachment depends entirely on the determination that the res at issue is property of the judgment debtor at the moment it is attached. See J. Lauritzen A/S v. Dashwood Shipping, Ltd., 65 F.3d 139, 141 (9th Cir. 1995) (Rule B attachment characterized as quasi in rem jurisdiction because jurisdiction is derived solely from the attachment of the property of the defendant). Forfeiture, on the other hand, is a remedy in rem, based as it is on the legal ction that property used in violation of law [is] itself the wrongdoer that must be held to account for the harms it [has] caused. United States v. 92 Buena Vista Avenue, 507 U.S. 111, 125 (1993). This is a critical distinction between actions proceeding under Supplemental Rule Cnow Rule Gand those brought under Rule B; it is not a distinction[] without a dierence, as Winter Storm found. 310 F.3d at 278. Accordingly, unless there is superseding federal law, such as a drug forfeiture law or a regulation of the Treasury Department's Oce of Foreign Assets Control (OFAC), Article 4A must be honored. Rule B is not such a superseding law. 4 The Consub court believed that the Winter Storm rule was not shown to be unworkable. Note that U.C.C. Article 4A is substantially premised on the ability to net obligations because of the large sums involved. U.C.C. 4A-403. If a particular creditor can seize funds and frustrate that plan, the resultant systemic risk may provide the demonstration that the Winter Storm approach and its progeny are unworkable. Even absent that scenario, the Winter Storm approach is proving to be practically unworkable. The result of the Winter Storm approach has been a staggering number of maritime writs that New York banks are required to process on a daily basis. For example, from October 1, 2008 to January 31, 2009, maritime plaintis led 962 lawsuits seeking to attach more than $1.35 billion. These lawsuits constituted 33 percent of all lawsuits led in the Southern District of New York during that period, and the resulting maritime writs only add to the burden of 800 to 900 prior writs already served daily on the District's banks. The numbers have tapered o only slightly during the past months; from February 1, 2009 to April 30, 2009, maritime plaintis led 498 lawsuits seeking to attach a total of $720 million. The explosion of maritime writs served on the banks has been logistically overwhelming. Of even more signicance, however, this explosion of writs creates an additional threat to the U.S. dollar as the world's primary reserve currency and New York's standing as a center of international banking and nance. Confronted with this situation, companies around the world may well consider restructuring their transactions to provide for payments in euros, sterling, yen, or some other currency to avoid using U.S. dollars cleared through intermediary banks in the United States, or clear transactions through one of the proliferating o-shore dollar clearing networks. Because the only contact with the United States in most of these transactions is the use of an intermediary bank in the United States to clear U.S. dollars, the U.S. litigation apparatus can be avoided entirely by the relatively simple expedient of using a dierent currency. As a result, Winter Storm and its progeny have had a far greater, and damaging, potential impact on U.S. and foreign banks located in New York than might have been anticipated. An additional signicant problem for banks is that the only practical way in which they can accommodate post-Winter Storm attachments is by frequent amendments to their software lters used to identify transactions involving entities and other persons whose nancial transactions are blocked under OFAC regulations. OFAC administers U.S. economic sanctions programs arising under the Trading with the Enemy Act, 50 U.S.C. app. 5, the International Emergency Economic Powers Act, 50 U.S.C. 1701 to 1706, and other statutes. OFAC regularly issues bulletins that add or delete entities or persons from its lists, and banks must update their screening software to reect these changes. This year, OFAC has updated its lists 19 times through May 6, 2009 (83 business days). By contrast, new maritime attachment orders were led nearly every business day. The process of constantly amending the software lters to deal with this ood of maritime attachments has greatly increased the burden on the banks, requiring them to take down their OFAC lters almost

1247

Appendix A

CONCLUSION In uniform law under Article 4A and under Regulation J, neither the originator nor the beneciary of a funds transfer has any property claim to the value held by an intermediary bank in a funds transfer. Thus, neither a creditor of an originator nor the creditor of a beneciary may successfully issue creditor process5 to an intermediary bank as the intermediary bank is not holding property of either the originator or the beneciary. To the extent that the cases cited earlier indicate to the contrary, that reasoning is disapproved and should not be followed.
every day, vastly increasing the chance that the OFAC database will be corrupted by the manipulation, and substantially increasing the number of hits, including numerous false positives that these lters now generate, creating real risks of ineciency and error. In addition, permitting a beneciary's creditor to attach a funds-transfer credit, ordinarily held only momentarily in New York, would exacerbate the considerable due-process concerns inherent in restraining a funds transfer. The defendants in maritime cases invariably are foreign corporations with few or no contacts with the United States. In many of the cases the defendant does not appear to have signicant contacts, if any, with New York. Indeed, for a maritime defendant's property to be prima facie subject to a Rule B attachment, the plainti is required to attest, pursuant to Rule B(1)(b), that the defendant could not be found within the District. See STX Panocean (UK) Co., Ltd. v. Glory Wealth Shipping Pte Ltd., 560 F.3d 127, 13031 (2d Cir. 2009). Moreover, the funds transfers at issue are often meant to eect payment from a third party's non-U.S. account to the defendant's non-U.S. account, or vice versa. The New York garnishee banks in most cases are involved as intermediary banks only because the payment was denominated in U.S. dollars. Creditor process means levy, attachment, garnishment, notice of lien, sequestration, or similar process issued by or on behalf of a creditor or other claimant with respect to an account. As to account, see authorized account dened in U.C.C. 4A105(a)(1).
5

1248

APPENDIX B 1972 Ocial Text Showing Changes Made in former Text of Article 9, Secured Transactions, and of Related Sections and Reasons for Changes General Comment on the Approach of the Review Committee for Article 9* Article 9 of the Uniform Commercial Code was the rst integration of the badly fragmented eld of chattel security. It was, therefore, the most innovative of the articles of the Code, and many persons have indicated their belief that it is the Code's most valuable article. Nevertheless, the fact that it was a rst integration of complex problems led to some imperfection of the drafting. The Reporters have reported to the Committee many instances in which the drafting could be improved for clarity or to answer questions that can be posed that are not now clearly answered. Yet the outstanding result of Article 9 in practice has been that it has been gratifyingly successful; that no errors with serious consequences have been disclosed; and that the demands for change have been in relatively narrow areas. The Committee has therefore felt that it is not its responsibility, consistent with the terms of creation of the Permanent Editorial Board, to seek perfection where the Code appears to be working satisfactorily without signicant problems in practice, for to do so would run the risk of opening up still further problems. The Committee has in mind that at a minimum the changes nally adopted by it, the Permanent Editorial Board and the sponsoring organizations will take several years to enact in the 51 jurisdictions which have now adopted the Code, and that it would be a great mistake to introduce serious non-uniformity into any fundamental aspect of operations under Article 9. The Code must remain uniform in its day-to-day impact and operation even if there should be a signicant period which may elapse before the Committee's ultimate proposals are adopted in all enacting jurisdictions. Thus the proposed changes must be compatible in operation with the existing Code, and the Committee has eschewed amendment merely for the sake of theoretical improvement where there was no pressing problem illustrated by non-uniform amendment or by substantial demand for change.
*The Review Committee for Article 9 prepared the following document to aid understanding of its recommendations. The discussion is by topics rather than by section as in the Reasons for Change and in the Comments. This document has not been approved by the Permanent Editorial Board for the Uniform Commercial Code or by the Council of the American Law Institute. This document is in the form approved at the last meeting of the Committee in October, 1970. Where the Permanent Editorial Board recommended changes in the statutory text which are inconsistent with the Committee's discussion, that fact is noted in footnotes. 1249

Appendix B

The proposed changes have been limited to Article 9 except in a few instances where an individual section of Article 1, 2 or 5 had to be changed to correspond with the changes in Article 9. The Review Committee has not sought herein to follow the Permanent Editorial Board's past practice of commenting individually on non-uniform amendments, but has proposed a revision in depth of Article 9 to take into account the amendments and also criticisms that might lead to nonuniform amendments. To the extent that the Committee has not incorporated amendments in its proposals in exact words or in substance, they should be deemed disapproved as merely stylistic or mere matters of detail, or because the problem was handled in some other fashion, or because the Committee disagreed as a matter of policy. There will be Reasons for Change and revised Comments to the sections changed. In addition, because the proposed changes in any given section may be related to several dierent problems, and the solution to one problem involves changes in more than one section, there is set forth below a Description of Proposed Changes from the 1962 Text, with Reasons Therefor, arranged by topic.1 The topics discussed are the following: A. Fixtures B. Crops and Farm Products C. Timber D. Oil, Gas and Minerals E. Intangibles, Proceeds and Priorities F. Conict of Laws
The Committee has had a dicult judgmental task in determining the length and the amount of detail in this Statement. To outline the problems considered in full detail with discussion of arguments pro and con and other possible solutions would have expanded this Statement to the length of a treatise. The Committee has sought to nd an appropriate middle ground in succinct statements of the diculties of the existing Code and the intended operation of suggested solutions. These should be understandable to persons basically familiar with the concepts of Article 9. There is an extensive literature in which the reader can nd most of the problems discussed in more detail. It would not be possible in this Statement to cite all of the worthwhile discussions, but mention may be made of Gilmore, Security Interests in Personal Property (2 volumes, 1965); Coogan, Hogan and Vagts, Secured Transactions under the Uniform Commercial Code (2 volumes, 1963); Hawkland, A Transactional Guide to the Uniform Commercial Code (ALI-ABA Joint Committee on Continuing Legal Education, 2 volumes, 1964, (hereinafter referred to as 1250
1

ALI-ABA Joint Committee)); Spivack, Secured Transactions (ALI-ABA Joint Committee, 1960); Davenport and Henson, Secured Transactionsii, (ALI-ABA Joint Committee, 1966); and Uniform Commercial Code Handbook, (American Bar Ass'n, 1964). There have been published transcripts of three discussions in which various members of the Committee, Reporters, Consultants and other specialists have discussed in depth some of the problems here considered: A Practical Approach to Article 9 of the Uniform Commercial Code, 19 Bus.Law. 20 (1963); Advanced ALI-ABA Course of Study on Banking and Secured Transactions Under The Uniform Commercial Code (ALIABA Joint Committee, 1968); Problems of Lenders, Borrowers and Sellers Under the Uniform Commercial Code (1968). The extensive and valuable discussions of some of these problems in periodic legal literature may be located through the usual indices and also through Ezer, Uniform Commercial Code Bibliography and Supplements (ALIABA Joint Committee, 1966, 1967 and 1969).

1972 Amendments

G. Motor Vehicles and Related Problems of Perfection H. Matters of Scope I. Filing J. Default A. Fixtures A-1. Section 9-313 deals with the problem that certain goods which are the subject of chattel nancing become so axed or otherwise so related to real estate that they become part of the real estate, and the chattel interests would be subordinate to real estate interests except as protected by the priorities regulated by the section. Such goods are called xtures. Some xtures also retain their chattel nature in that a chattel nancing with respect to them may exist and may continue to be recognized. But this concept does not apply if the goods are integrally incorporated into the real estate. A-2. Existing Section 9-313 states that the rules of the Section do not apply to goods incorporated in the structure in the manner of lumber, etc. This formulation of the problem would lead to the conclusion that these goods integrally incorporated into real estate are not xtures. In contrast, the Committee's proposal denes xture to include any goods which become so related to particular real estate that an interest in them arises under real estate law and therefore, goods integrally incorporated into the real estate are clearly xtures. This usage, in the Committee's opinion, conforms more clearly to pre-Code usage in most states than does the existing Section 9-313, and therefore permits a less confusing reference to pre-Code cases. There is no practical dierence, however, because the Committee's proposal, like the existing Section 9-313, provides in substance that no security interest exists under Article 9 in ordinary building materials incorporated into an improvement on land. A-3. Thus both the existing section and the Committee proposal recognize three categories of goods: (1) those which retain their chattel character entirely and are not part of the real estate; (2) ordinary building materials which have become an integral part of the real estate and cannot retain their chattel character for purposes of nance; and (3) the intermediate class which has become real estate for certain purposes, but as to which chattel nancing may be preserved. This third and intermediate class is the primary subject of Section 9-313. The demarcation between these classications is not delineated by this section. A-4. Goods may be technically ordinary building materials, e.g., window glass, but if they are incorporated into a structure which as a whole has not become an integral part of the real estate, the rules applicable to the ordinary building materials follow the rules applicable to the structure itself. The outstanding examples presenting this kind of problem are the modern mobile homes and the modern prefabricated steel buildings usable as warehouses, garages, factories, etc. In the case of the mobile homes, most of them are erected on leased land and the right of the debtor under a mobile home purchase contract to remove the goods as lessee will make clear that his secured party ordinarily has a similar right. See proposed paragraph (5)(b) of Section 9-313. In cases where mobile homes or prefab1251

Appendix B

ricated steel buildings are erected by a person having an ownership interest in the land, the question into which category the buildings fall is one determined by local law. In general, the governing local law will not be that applicable in determining whether goods have become real property between landlord and tenant, or between mortgagor and mortgagee, or between grantor and grantee, but rather that applicable in a three-party situation, determining whether chattel nancing can survive as against parties who acquire rights through the axation of the goods to the real estate. A-5. The assertion that no security interest exists in ordinary building materials is only for the operation of the priority provisions of this section. It is without prejudice to any rights which the secured party may have against the debtor himself if he incorporated the goods into real estate or against any party guilty of wrongful incorporation thereof in violation of the secured party's rights. A-6. In considering xture priority problems, there will always rst be a preliminary question whether real estate interests per se have an interest in the goods as part of real estate. If not, it is immaterial, so far as concerns real estate parties, as such, whether a chattel security interest is perfected or unperfected. In no event does a real estate party acquire an interest in a pure chattel just because a security interest therein is unperfected. If on the other hand real estate law gives real estate parties an interest in the goods, a conict arises and this section states the priorities. A-7. The general principle of priority announced in the proposed Section 9-313 is set forth in paragraph (4)(b). It is basically that a xture ling gives to the xture security interest priority as against other real estate interests according to the usual priority rule of conveyancing, that is, the rst to le or record prevails. An apparent limitation to this principle set forth in paragraph (4)(b), namely that the secured party must have had priority over any interest of a predecessor in title of the conicting encumbrancer or owner, is not really a limitation, but is an expression of the usual rule that a person must be entitled to transfer what he has. Thus, if the xture security interest is subordinate to a mortgage, it is subordinate to an interest of an assignee of the mortgage even though the assignment is a later recorded instrument. Similarly if the xture security interest is subordinate to the rights of an owner, it is subordinate to a subsequent grantee of the owner and likewise subordinate to a subsequent mortgagee of the owner. A-8. A qualication of the rule based on priority of ling or recording is paragraph (4)(d), where rules of priority in ling or recording are preserved, but there is no requirement that as against a judgment lienor of the real estate, the prior ling of the xture security interest must be in the real estate records. The Committee thought that the xture security interest if perfected rst should prevail even though not led or recorded in real estate records, because a judgment creditor is not2 a reliance creditor who would have searched records. Thus, even a prior ling in the chatIt has since been pointed out that in Pennsylvania, because of the use of the 1252
2

confession of judgment to obtain a real estate lien, the judgment creditor may be a

1972 Amendments

tel records should protect the priority of a xture security interest against a subsequent judgment lien. It is hoped that this rule will also have the eect of preserving a xture security interest against invalidation by a trustee in bankruptcy. That would, of course, be the result under Section 60a of the Bankruptcy Act if the time of perfection of the xture security interest were measured by the judgment creditor test applicable to personal property. It would not be the result if the time of perfection were measured by the purchaser test applicable to real estate. It is hoped that since the xture security interest arises against the goods in their capacity as chattels, the bankruptcy courts will apply the judgment creditor test. But the eectiveness of the Committee's drafting to achieve its purpose cannot be known certainly until the courts adjudicate the question or until it is settled by amendment to Section 60a of the Bankruptcy Act. The phrase lien by legal or equitable proceedings is taken from Section 70c of the Bankruptcy Act, and is intended to encompass all of the three ways in which judgment liens are there described. It has been suggested that a xture security interest perfected against lien creditors but subordinate to other real estate interests might be vulnerable to attack under Section 70e of the Bankruptcy Act. The interpretation involved is in dispute among bankruptcy scholars. In any event, those concerned with the question can avoid the issue by not taking advantage of the proposed statutory sanction of a ling in other than the real estate records. It was also suggested that paragraph (4)(d) should provide for a 10-day grace period like those in Sections 9-301(2) and 9-312(4). But the Committee thought the practical need for such a provision was slight and did not justify the resulting complexities. A-9. A special exception to the usual rule of priority based on time is the one of paragraph (4)(c) in favor of holders of security interests in factory and oce machines, and in certain replacement domestic appliances, as discussed below. This is not as broad an exception as it might seem. To repeat, a xture conict is reached only if the goods are held as a matter of local law to have become part of the real estate. If so, the rule of paragraph (4)(c) operates only if the xture security interest is perfected before the goods become xtures. Having been perfected, it would of course have priority over subsequent real estate interests under the rule of paragraph (4)(b). Since it would in almost all cases be a purchase money security interest, it would also have priority over other real estate interests under the purchase-money priority of paragraph (4)(a), to be discussed in paragraph A-11. The rule is stated separately because the permitted perfection is by any method permitted by the article, and not exclusively by xture ling in the real estate records. This rule is made necessary by the confusions of the law as to whether certain machinery and appliances become xtures. As an additional point, in the case of machinery, the separate statement
reliance creditor. 1253

Appendix B

of this rule makes clear that it is not overridden by the construction mortgage priority of subsection (6), as would have been true if reliance had been solely on the purchase money priority. The Committee considers that factory and oce machines are not always nanced as part of a construction mortgage, and that it is reasonable to expect the mortgagee to be alert to conicting chattel nancing of these machines. A-10. As to appliances, the rule stated is limited to readily removable replacements, not original installations of appliances. To facilitate nancing of original appliances in new dwellings as part of the real estate nancing of the dwellings, no special priority is given to chattel nancing of the appliances. The section leaves to other law of the state the question whether original installations are xtures to which the protection accorded by this section to construction mortgages would be applicable. Likewise, it is recognized that (when not supplied by tenants) appliances in commercial apartment buildings are intended as permanent improvements, and no special rule is stated for appliances in that case. The special priority rule here stated in favor of chattel nancing is limited to situations where the installation of appliances may not be intended to be permanent, i.e., replacement appliances in apartment units that are likely to be owneroccupiedthose with not more than four family units.3 The principal eect of the rule is to make clear that a secured party nancing occasional replacements of domestic appliances in dwellings, duplexes or similar units need not concern himself with real estate descriptions or records but may perfect by ordinary chattel ling; indeed, a purchase-money replacement in the buyer's own dwelling will be consumer goods, and perfection without ling will be possible. (The priority against the construction mortgage has no application to replacement appliances.) A-11. The principal exception to the rule of priority based on time of ling or recording is a priority given in paragraph (4)(a) to purchase money security interests in xtures as against prior recorded real estate interests, provided that the purchase money security interest is led as a xture ling in the real estate records before the goods become xtures or within 10 days thereafter. This priority corresponds to one given in Section 9-312(4), and the 10 days of grace represents a reduction of the purchase money priority as against prior interests in the real estate under the present Section 9-313, where the purchase money priority exists even though the security interest is never led. It should be emphasized that this purchase money priority with the 10day grace period for ling is limited to rights against prior real estate interests. There is no such priority with the 10-day grace period as against subsequent real estate interests. The xture security interest can defeat subsequent real estate interests only if it is led rst and prevails under the usual conveyancing rule recognized in paragraph (4)(b). A-12. The purchase money priority presents a dicult problem in relation
The Permanent Editorial Board revised the Committee's draft to limit this rule, so far as it concerns replacement appliances, to consumer goods, i.e., those used 1254
3

for the buyer's personal or family purposes. The reference to buildings of four units or less was eliminated.

1972 Amendments

to construction mortgages. The latter will ordinarily have been recorded even before the commencement of delivery of materials to the job, and therefor will be prior as against the xture security interests. Present Section 9-313(4) seeks to work this out by treating each advance under a construction mortgage as a separate subsequent loan, but then gets into diculties of language as to the times of actual advance and the times of commitment. The Committee's proposal is far more favorable to real estate interests, because it provides that the purchase money priority does not apply as against construction mortgages. The latter will ordinarily be recorded before the ling of the xture security interest, and therefore will have priority over the latter under the basic rule of paragraph (4)(b), and subsection (6) expressly states this subordination. It is the Committee's intention that the priority of a construction mortgage shall apply only during the construction period leading to the completion of the improvement; and that as to additions to the building made long after completion of the improvement, the construction priority will not apply simply because the additions are nanced by the real estate mortgagee under an open end clause of his construction mortgage. In such case, the applicable principles will be those of paragraphs (4)(a) and (4)(b). The Committee has further provided that a renancing of a construction mortgage has the same priority as the mortgage itself. The phrase an obligation incurred for the construction of an improvement is intended to cover both optional advances and advances pursuant to commitment, and to include advances for incidental expenses such as nancing and title costs.4 A-13. The term xture ling has been introduced and dened. It helps to emphasize a point that was intended but not clearly set forth in the existing Codethat when a ling is intended to give the priority advantages herein discussed against real estate interests, the ling must be for record in the real estate records and indexed therein, so that it will be found in a real estate search (except as stated in paragraphs A-8 to A-10). A-14. The prior uniform provisions seemed to make it possible for a xture supplier to retain a security interest against a contractor, to the possible surprise and deception of real estate interests. Proposed Section 9-313(4) (a) and (b) preclude such retention by a xture supplier by denying priority to the security interest unless the debtor has an interest of record in the real estate. A-15. The status of xtures installed by tenants (as well as such persons as licensees and holders of easements) is unclear under the present Code. The Committee's proposal in paragraph (5)(b) is that if the debtor (tenant or other interest mentioned) has the right to remove the xture as against a real estate interest, the secured party has priority over that real estate interest. A-16. The Committee proposes a change in Section 9-302(1)(d) so that there will be no exception of xtures from the rule that a purchase money security interest in consumer goods is perfected without ling, and thus good against lien creditors and the trustee in bankruptcy. See paragraph
The Permanent Editorial Board changed the text of Section 9-313(1)(c) to
4

make clear that the term construction mortgage may cover land acquisition costs. 1255

Appendix B

A-8. The xture security interest would no longer have to be led in all cases, but only in cases (for goods other than replacement appliances) in which priority against real estate parties is desired. A-17. In summary, eort has been made by a fresh approach to provide substantive rules that should satisfy the legitimate interests of all parties. In the Committee's opinion, there remains a necessity to preserve the possibility of purchase money xture nancing notwithstanding the existence of mortgages on the real property. Real estate lending is typically longterm, and is usually done by institutional investors who can aord to take a long view of the matter rather than concentrating on the results of any particular case. It is apparent that a rule which permits and encourages purchase money xture nancing, which in contrast is typically short term, will result in the modernization and improvement of real estate rather than in its deterioration and will on balance benet long-term real estate lenders. Because of the short-term character of the chattel nancing, it will rarely produce any conict in fact with the real estate lender. The contrary rule would chill the availability of short-term credit for modernization of real estate by installation of new xtures and in the long run could not help real estate lenders. The reported diculty in locating relevant xture security interests applicable to particular parcels of real estate has been cured by new provisions as to real estate description in xture lings, the indexing thereof, and other related provisions in Part 4 of Article 9. The weightiest objection to present Section 9-313 was to the possibility that xtures constituting material portions of the value of a building might come into the building subject to xture security interests which might have priority over the rights of a construction mortgagee. The proposed treatment reverses the position of the existing Code and accords priority to the construction mortgagee. The draft does not go as far as some of the non-uniform amendments, which would subject xture ling to the burden of obtaining full legal descriptions of real estate and would deny xture security interests priority against existing real estate parties who had not consented thereto, thus negating the purchase money concept. The Committee's changes move very substantially toward the views which gave rise to such amendments, but do not go all the way. B. Crops and Farm Products B-1. In contrast with dissatisfaction with the Code's classication of timber, discussed in Section C, no diculty seems to have arisen with respect to the recognition in Section 2-107 and in the denition of goods in Section 9-105(1) that growing crops are goods and therefore chattels. This still leaves a possibility that real estate parties such as mortgagees or grantees may have some interest in them. Section 2-107(3) recognizes that a contract for sale of growing crops may have to be recorded in realty records for protection of the buyer against real estate rights, and the Committee has found no indication that this provision declaratory of the preCode law has caused any diculty. Thus no change is proposed.
1256

1972 Amendments

B-2. The assumption that crops are chattels was carried through in preCode law by the treatment of crop mortgages as chattel mortgages. In some states description of the land was required, not for the purpose of placing the crop mortgages into the real estate records, but primarily for identication. B-3. The Code carries through this treatment. It treats an encumbrance of growing crops as a Code security interest for which a nancing statement is required for perfection. A description of the land in the security agreement is required in Section 9-203(1)(a) and a requirement of description of the land in the nancing statement is set forth in Section 9-402(1) and (3). Alternatives (2) and (3) of Section 9-401(1) add to the usual rule that a ling for farm products be at the residence of the debtor an additional rule that there be a ling on growing crops in the county where the land is situated, but these provisions do not indicate that the ling in the latter county should be in the real estate records. This is clear from two circumstances: The name of the applicable oce is left blank in these two Alternatives of Section 9-401(1) rather than being specied (as is true for xtures) as the oce where a mortgage on the real estate concerned would be led or recorded. Also, Alternative (1) for Section 9-401(1) contemplates ling for crops only in the oce of the Secretary of State, and this could not be intended as a real estate ling. B-4. Several states have departed from the Ocial Text by making it clear that the ling of a crop mortgage should be treated as a real estate ling and there is logic to this. But the Ocial Text seems to have worked satisfactorily without extensive criticism in other states, and the Committee has determined not to make so extensive a change in theory and practice as to require crop mortgages to be led or recorded in the real estate records. To have made the change would have required the real estate on which crops are growing to be described with a particularity suitable for real estate records, as set forth in proposed Section 9-402(5). But practice in crop mortgages has never been to require particularity in describing land on which crops are growing, and a substantial change in practice would have been required. B-5. There may nevertheless be rights of real property mortgagees or grantees in growing crops if Code security interests in the crops have not been properly led, comparable to the rights referred to in Section 2-107(3). The Committee has not thought it possible in the Uniform Code to deal with the diversity of existing state law on the interrelation of chattel security interests in growing crops and real estate interests. B-6. Existing Section 9-204(4)(a) provides that no security interest in crops attaches under an after-acquired property clause to crops which become such more than one year after the security agreement, unless the agreement involves certain real estate transactions. The obvious purpose of this provision was to protect a necessitous farmer from encumbering his crops for many years in the future. The provision does not work because there is no corresponding limit on the scope of a nancing statement covering crops, and under the Code's notice-ling rules the priority position of a security arrangement covering successive crops would be as eectively protected by the ling of a rst nancing statement whether the granting
1257

Appendix B

clause as to successive crops was in one security agreement with an afteracquired property clause or in a succession of security agreements. On the other hand the section does require an annual security agreement for crops even when the encumbrance on crops is agreed to as part of a longterm nancing covering farm machinery and other assets. The provision thus appears to be meaningless in operation except to cause unnecessary paperwork, but it does introduce some element of uncertainty as to its purpose. The Committee proposes to eliminate it. See also the next paragraph. B-7. The priority provision of Section 9-312(2) seems related to the same thinking as discussed in the preceding paragraph, and was intended perhaps to permit enabling crop nancing, notwithstanding the existence of prior crop nancing. However, subsection (2) is severely limited by a provision that the priority granted to current enabling nancing applies only as against earlier interests which are six months or more in default. In the absence of any demand therefor, it would be inappropriate to attempt to create a revolutionary change in crop nancing with a broad enabling priority to nance current crops. Such an attempt would probably be ineectual in any event because lenders on machinery and real estate who claim crops could readily provide that it would be an event of default for the debtor to nance under the proposed enabling priority. The Committee has determined therefore to leave subsection (2) unchanged, even while recognizing that it is of little practical eect. B-8. Several states have indicated their dissatisfaction with existing Section 9-302(1)(c), which provides a non-ling rule for purchase money security interests in farm equipment having a purchase price of $2500 or less, by reducing the amount. Authors on farm problems have suggested that the section is disadvantageous rather than advantageous to a farmer, because it in eect makes his farm machinery useless as collateral in view of prospective lenders' fear that there may be unled perfected security interests. The $2500 amount cannot be dismissed by lenders as immaterial, because substantial aggregates of collateral could have been nanced by separate purchase money transactions each of which was no greater than $2500. The Committee proposes that Section 9-302(1)(c) be eliminated. This makes unnecessary the reference to farm equipment in Section 9-307(2), which deals with the rights of certain buyers against perfected but unled security interests. B-9. A comparable problem exists with respect to the provision of Section 9-307(1) which makes inapplicable to farm products the usual rule of that section protecting a buyer in ordinary course of trade who buys goods from a person engaged in selling goods of that kind and permitting him to take free of any security interest created by his seller. The existing section reects pre-Code practice in distinguishing between a farmer's inventory and inventory of any other kind of businessman, but it must be seriously questioned whether the pre-Code practice is still sound under modern conditions. Feelings run strong on this issue, as evidenced by the fact that the New Mexico legislature amended other sections of the Code to make sure that waiver would not nullify the rule excluding farm products from Section 9-307(1), as had been held in Clovis National Bank v. Thomas, 425
1258

1972 Amendments

P.2d 776 (N.M.1967). The federal government, an important farm lender, likewise insists on the preservation of its security interest on farm products as against buyers or auctioneers, in reliance on a federal rule independent of the state rule embodied in Section 9-307(1). See U.S. v. McCleskey Mills, Inc., 409 F.2d 1216 (5th Cir.1969). On the other hand, strong representations have been made to the Committee by food processers and by authors who have written on farm problems under the Code that the inapplicability of Section 9-307(1) to farm products is anomalous and unfair. Georgia has amended the section to protect auctioneers of livestock. Recognizing that the Committee's recommendation is unlikely to induce the removal of the exception for farm products from Section 9-307(1) in all enacting jurisdictions, the Committee nevertheless recommends it as an optional amendment.5 The Committee considered various possibilities, such as distinguishing between the rst buyer and sub-buyers or between a buyer of an entire annual crop and multiple buyers of milk, eggs and the like. But no solution was found. Dierences of opinion on basic policy seem to be so sharp that they are unlikely to be resolved by an appeal to the goal of uniformity. B-10. There has been criticism of the unreality of the present Code's requiring ling against farmers at the residence. This concept is most unsatisfactory for the reality of the modern corporate farm. The Committee proposes a new Section 9-401(6) to the eect that the residence of an organization is its place of business if it has one, or its chief executive oce if it has more than one place of business. The rule is thus very similar in result to the rule as to the location of a debtor in proposed Section 9-103(3), although the latter rule starts as a matter of form with the assumption that the debtor has a place of business, with resort to residence as an exception, while the rule in Section 9-401(6) starts with residence, with the place of business as an exception for the corporate case. See paragraphs F-11 and F-12. C. Timber C-1. In contrast with its treatment of growing crops as chattels (paragraphs B-1 to 4 of this Statement), the present Code treats timber as real estate until cut. Section 2-107; note the omission of timber from the denition of goods in Section 9-105(1). This treatment has proved to be unsatisfactory, and many of the important timber-cutting states have changed it to provide that timber to be cut under a conveyance or contract for sale is goods. One reason for this is to facilitate loans by banks on timber to be cut without complying with restrictions relating to real estate mortgages. C-2. The Committee has decided to recommend adoption of this view. See proposed changes in Section 2-107 and the denition of goods in Section 9-105(1). The assertion in Section 9-204(2) that the debtor has no rights in timber until it is cut is proposed to be deleted together with the remainder of that subsection. See paragraph E-18 of this Statement.
The Permanent Editorial Board deleted the committee's optional recommendation. For states that are determined to change the present policy, it is recom5

mended that this be done by deleting the words in Section 9-307(1): other than a person buying farm products from a person engaged in farming operations. 1259

Appendix B

C-3. Corresponding changes have been made in Section 9-401(1) and in Section 9-402(1) and (3) to recognize a Code ling as to timber before it is cut, to require that ling to be in the real estate records of the county wherein is the land on which the timber is growing, and a new provision (Section 9-403(7)) requires the indexing thereof in real estate records. These requirements conform to the requirements for xture ling (paragraph A-10 of this Statement). In contrast to growing crops (paragraph B-3 of this Statement), the Committee considers that standing timber has been traditionally a part of the real estate and it could not be assumed that it would normally be cut at any specic time of maturity. Therefore, the ling of security interests thereon has to be in real estate records. This ling will conform to the practice of recording timber deeds in real estate records. D. Oil, Gas and Minerals D-1. In general, the existing Code treats oil, gas and minerals as part of the real estate until they have been extracted from the land. See Section 2-107 and the denition of goods in Section 9-105(1). There is no provision for ling a security interest against minerals to be eective prior to their extraction from the land, because the Code does not recognize such a security interest and therefore there is no provision for a description of the land in a nancing statement covering minerals. In contrast, the Code requires a description of the land in a security agreement covering minerals to be extracted (Section 9-203(1)(b)). Though this has caused no particular diculty, it is incongruous and the Committee proposes to delete it. D-2. Various requests have been made that the Committee clarify the question whether well-drilling equipment is on the one hand xtures or on the other hand mobile equipment of the kind referred to in Section 9-103. The Committee has sought to avoid encumbering the Code with details in response to inquiries of this nature. It seems fairly clear that well casings and related material that are removable are neither xtures nor mobile equipment. D-3. The most signicant problems in reference to minerals relate to the split ownership characteristic of oil and gas drilling and the practice of selling the product at wellhead, with the proceeds of the resulting receivable being distributed pursuant to a division order and the proceeds being sometimes repledged to the holder of the oil and gas mortgage. Since the holders of fractional interests in a well or of production payments with respect thereto may be investors living anywhere, the problem of search to determine whether they have encumbered the receivables under the chief place of business rule of present Section 9-103(1) or location rule of proposed Section 9-103(3) is a cumbersome one. It is proposed that all lings with respect to these receivables be authorized and required in the county where the well is, thus conforming to much pre-Code practice which assumed that everything related to sales at wellhead should be led (if at all) in the real estate records in the county where the well is located. See proposed Sections 9-103(5) and 9-401(1). The term at wellhead is intended to encompass all arrangements
1260

1972 Amendments

intended to cover sale of the product when it issues from the ground and is measured, without technical distinctions as to whether title passes at the Christmas tree or the far side of a gathering tank or some other point. At minehead is a comparable concept. It is essential to note that this special rule is applicable only to security interests created by persons who have interests in the production from the well which attach when the mineral is extracted, not to buyers of the production who may have an underlying security interest on their inventory which may happen to attach to the mineral as inventory or at the wellhead or minehead when that is where the buyer acquires rights therein. D-4. A related problem is whether, where the form of contract of sale at wellhead results in the minerals being sold by the persons who had the fractional interests, the purchaser of the product is protected from any encumbrances of the product, pursuant to Section 9-307(1) protecting buyers in ordinary course of business. The Committee has proposed in Section 1-201(9) to clarify the fact that buyers of minerals at wellhead or minehead are buyers in ordinary course of business because all persons who regularly sell the product under those circumstances are deemed to be engaged in selling goods of that kind, even though realistically the sellers may merely be investors. E. Intangibles, Proceeds and Priorities The Code has six classications of intangibles, of which three are semiintangibles embodied in pieces of paper, namely, documents, instruments and chattel paper (all dened in Section 9-105). There are also three classications of completely intangible rights, namely, accounts, contract rights and general intangibles (all dened in Section 9-106). Proposals as to Semi-Intangibles E-1. As to the classications of semi-intangibles, experience has been generally satisfactory and few specic changes are proposed by the Committee. E-2. A new rule is proposed in Section 9-103(4) as to the jurisdiction in which to le a nancing statement relating to chattel paper, thus curing an omission in the present Code. See paragraphs F-1415 of this Statement. E-3. Another problem is the classication of money, which is frequently proceeds of original collateral and in some types of nancing is itself original collateral. In the absence of an express specication, it could be argued that money is a general intangible, which would permit ling for a security interest therein. While this result would be so obviously unsound that it is doubted that a court would reach that result under the existing Code, it has been thought wise to provide expressly in Section 9-106 that the term general intangibles does not include money. E-4. Sections 9-304(1) and 9-305 have been amended to state specically that money may be pledged. E-5. Section 9-304(1) makes clear that as to negotiable instruments, a nonpossessory perfection of a security interest is not permitted except for
1261

Appendix B

temporary periods without either ling or possession under Sections 9-304(4) and (5). No doubt the failure of Section 9-304(1) to refer to temporary perfection for 10 days under the proceeds provisions of Sections 9-306(2) and (3) is a mere inadvertence of the present Code which the Committee proposes to correct, since this temporary perfection is also clearly contemplated. However, the present Section 9306(2) and (3) go further and seemingly would permit perfection by ling continued indenitely as to negotiable instruments which constitute proceeds of original collateral in which a security interest had been perfected by a led nancing statement which also claimed proceeds. The Committee considers this to be an error of the present Code and proposes to rectify it by providing in Section 9-306(3) that a security interest in proceeds does not persist beyond 10 days unless the security interest could have been directly led against the proceeds as independent collateral. See also paragraphs E-2223 of this Statement for other applications of this proposal. E-6. The foregoing discussion should not apply to negotiable instruments which are essentially cash payment, i.e., money and checks. The proceeds security interest should apply to these cash proceeds so long as they are identiable, and the proposed revision of Section 9-306(3) so provides. E-7. The Committee considers that another anomaly exists between Sections 9-308 and 9-309. Under the present Code, a purchaser of negotiable instruments prevails against a conicting proceeds claim thereto only if the purchaser is a holder in due course, which means that he cannot have notice of the conicting claim to the instrument as proceeds of prior collateral. In contrast, the purchaser of chattel paper may under the second sentence of Section 9-308 defeat a claim to the chattel paper as proceeds of prior collateral even though the purchaser of the chattel paper knows that the specic paper is subject to the proceeds security interest. Thus, the holder of a negotiable note which is not part of chattel paper is governed by less favorable rules than the holder of an equally negotiable note which is part of chattel paper, or than the holder of non-negotiable chattel paper. The Committee has sought to remedy this by rewriting Section 9-308 so that the rights therein conferred on holders of chattel paper and non-negotiable instruments also apply to holders of negotiable instruments. Thus, holders of negotiable instruments which are proceeds may be protected under Section 9-309 if they are holders in due course, and if they do not qualify as holders in due course, they may nevertheless have the rights provided in clause (b) of Section 9-308. Section 9-308 has also been reorganized for clarity. Proposals as to Intangibles E-8. As to pure intangibles, i.e., intangibles not embodied in a piece of paper, the Committee considered the question whether three categories are necessary. The Committee concluded that the category contract rights is not necessary and proposes to eliminate the denition thereof from Section 9-106 and the references thereto in other sections. The Committee proposes to broaden the term accounts to include rights which under the present Code would be contract rights since there had not yet been complete performance by the person to whom the monetary obligation is owing.
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The elimination of the term contract rights avoids the risk of inadvertent error where a nancing statement is led as to accounts and the designation turns out to be inapplicable because performance has not been completed, so that the collateral is at the stage of contract rights. E-9. This elimination also avoids proceeds problems and possible resulting priority questions where collateral was originally a contract right and after performance it became an account. As a conforming change the Committee proposes to eliminate the statement in Section 9-306(1) that an account is proceeds of a contract right. E-10. The only place in the 1962 Code where the concept of contract right was used to contrast with the concept of account was in Section 9-318(2). The Committee proposes to rewrite this subsection to draw the distinction between a right to money not yet completed by performance and a right so completed, without having to preserve the term contract right just for this purpose. E-11. As to the substantive standard of Section 9-318(2) respecting the power of the debtor and assignor to modify a contract before performance to the prejudice of the assignee, the Committee has given consideration to the non-uniform New York amendment which limited the rights of the original parties so to do to cases where the assignee was not materially prejudiced. The Permanent Editorial Board in its Report No. 2 took the position that this New York change merely articulates a condition already included in the requirement of good faith contained in the Ocial Text. The Committee has considered Professor Gilmore's view that the change goes beyond articulation of the meaning implied in the term good faith (2 Gilmore, Security Interests in Personal Property, 111721 (1965)) and his view disapproving the New York change on substantive grounds. The Committee adheres to the views expressed by the Permanent Editorial Board that the term good faith so limits the extent of the permissible change as not to make desirable adoption of the New York amendment. E-12. The elimination of the term contract right requires the re-editing of the 1966 change approved by the Permanent Editorial Board in Section 9-106. The purpose of this change was to choose a single classication of intangibles for ship charters and all related rights. The classication chosen was contract rights. With the elimination of this term, Section 9-106 has to be re-written to place all these rights in the category accounts. E-13. The term account debtor is dened in Section 9-105(1)(a) as a person who is obligated not merely on an account but also on chattel paper, general intangibles (and under the present Code, contract rights). Present Section 9-318(3) speaks of account debtors and, therefore, would apply to the debtors under all of these types of intangibles, but its scope in protecting an account debtor who pays without notice that his obligation has been assigned is limited by the phrase that the account has been assigned. The Committee proposes changes in Section 9-318(3) to aord the intended protection to all account debtors without limitation by the term account. E-14. The Committee considered the suggestion that there is not reason for distinguishing between accounts and general intangibles, both of
1263

Appendix B

which are dened in Section 9-106. To eliminate the two separate terms would cause great drafting diculty in preserving Article 9's present useful distinction in the inclusion in its scope of the sale of monetary obligations represented by accounts, contract rights and chattel paper and in the exclusion from its scope of the sale of non-monetary rights known as general intangibles. Therefore, the Committee proposes to retain the two terms. E-15. A more limited suggestion is to rectify the denitions of accounts and general intangibles. It has been pointed out that some obligations for payment of money are not accounts, but are general intangibles, because the denition of account is limited to rights to payment for goods sold or leased or for services rendered. Thus, rights to payments constituting royalties for use of patents, copyrights, etc., or for exhibition rights to moving pictures and television, seemingly constitute general intangibles rather than accounts. A potential source of error by inadvertence thus arises. The Committee nevertheless concluded that it would be undesirable to broaden the denition of accounts to include all rights for the payment of money, because too many standard forms of agreement use the term accounts and reect intention of the parties to include only traditional accounts arising from the sale of goods or services, and not miscellaneous rights for the payment of money. Attachment and Perfection E-16. The Code has two important concepts, attachment of security interests and perfection thereof. Attachment is in a sense dened in present Section 9-204. In general, it means the time when a security interest becomes enforceable between the primary parties because there is agreement, value has been furnished, and the debtor has rights in the collateral to which the agreement can apply. The term perfection is not dened by the Code. In general, it means the point at which a security interest becomes good against third parties when there is also attachment. The additional requirements for perfection beyond the requirements for attachment are set forth in Sections 9-302 to 9-305. It would be unwise to attempt a formal denition of perfection, because of the subtlety of the problems involved in rights against many groups of third persons. E-17. The Committee deemed the existing treatment of the concept of attachment in Section 9-203 and Section 9-204 (which also aects perfection, as indicated) to be unsatisfactory. Section 9-203 contains a statute of frauds which must be satised in order that the security interest be enforceable against the debtor or third parties, yet the combined treatments of attachment and perfection indicate that there could be perfection without compliance with the statute of frauds. This obvious anomaly would be corrected by proposed revisions of these sections. The three elements of attachment have been transferred to Section 9-203 from Section 9-204 and there combined with the requirement of a writing (except when the secured party is in possession), which thus becomes part of the concept of attachment. E-18. The Committee proposes to eliminate from Section 9-204 existing
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subsection (2) which states various times at which the debtor acquires right in certain kinds of collateral. Some of these statements, notably the statement in paragraph (d) that the debtor has no rights in an account until it comes into existence, have played an unfortunate part in confusing the application of bankruptcy law to Code security interests. None of them seems to serve any purpose. Proceeds E-19. Existing Section 9-203 provides that the word proceeds is a sufcient description in a security agreement of collateral constituting proceeds. This seems to imply that a claim to proceeds must be based on a term in a security agreement. Yet Section 9-306(2) contemplates that the secured party will have a right in proceeds following sale of original collateral, and this right is not made dependent on the existence of a term in the security agreement. The Committee proposes to resolve this apparent inconsistency by deleting the provision in Section 9-203 and substituting proposed Section 9-203(3) to the eect that a reference to proceeds is not necessary in the security agreement to give the secured party the automatic rights provided by Section 9-306. The Committee does not consider that this converts the security interest in proceeds into a non-contractual or statutory lien presenting problems under the Bankruptcy Act, for the security interest is still an aspect of the basically contractual security interest under the security agreement.6 E-20. Another anomaly appears in the provisions of present Section 9-306(3) (a) that the 10-day right to proceeds recognized by subsection (3) may be continued without further perfection if the led nancing statement covering the original collateral also covers proceeds. The form of nancing statement set forth in Section 9-402(3) makes provision for a claim to proceeds, and the forms prescribed by most state ling ocials contain a box by which a claim to proceeds may be made simply by checking the box. The claim is almost universally made in the case of inventory which is to be sold or receivables which are to be collected, thus producing proceeds; and the claim is very frequently made routinely in the cases of other collateral. There was deleted from Section 9-306 in the prior history of the Code a statement that a claim to proceeds constituted permission to sell, and a court has recently held that such a claim does not constitute permission to sell. Vermilion County Production Credit v. Izzard, 111 Ill.App.2d 190 (1969). E-21. Since the claim to proceeds is routinely made, there seems to be no reason that it be required to be made in the nancing statement in order to continue the perfection of the security interest in proceeds. If there is a claim to proceeds as presumed intent of the security agreement, notice of the claim comes from the claim to the original collateral claimed in the nancing statement, and nothing is accomplished by the routine checking of a box. Many privately printed forms have the box checked in the print
6 The Permanent Editorial Board amended the text of Section 9-203(3) to make it clear that the assertion thereof is a

matter of presumed intent and is unless otherwise agreed.

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itself. The Committee therefore proposes in Section 9-306(3) to eliminate any requirement for claiming proceeds specically. E-22. A problem appears as to whether perfection by ling as to original collateral automatically perfects as to all types of proceeds. One such problem has already been discussed, namely whether the claim to proceeds perfected by ling as to original collateral negates the basic provision of the Code that one cannot le as to instruments. See paragraph E-5 of this Statement. A provision has been added to Section 9-306(3) making it clear that the proceeds claim does not permit ling as to instruments. E-23. A similar problem arises when the appropriate place for ling as to accounts resulting from sale of inventory collateral under Section 9-103 is in another state where the debtor is located. The revision of Section 9-306(3) makes it clear that the perfection of the security interest in the accounts as proceeds will not last more than 10 days unless there is a ling as to the accounts in the appropriate jurisdiction. E-24. Another problem is whether the extension to proceeds of the led security interest in original collateral (perfected by checking a box as in the existing Code or automatically perfected as in the Committee's proposal, paragraph E-21 of this Statement) really serves the intended function of public notice of the security interest. Under the existing Section 9-306 the security interest in proceeds extends without limit through cash in the debtor's hand to repeated cycles of the business so long as the proceeds can be traced, unless sometimes terminated by priority rules like those in Sections 9-308 and 9-309 or by receipt of the cash by the secured party. See In re Platt, 58 Berks Co.L.J., 275, 6 UCC Rep. 275, 281 (Referee, E.D.Pa.1966), a'd 257 F.Supp. 478 (E.D.Pa.1966). Thus a nancing statement on automobiles could theoretically operate to perfect a security interest in an oil painting traded in for an automobile or bought with the cash proceeds thereof. Several possibilities of limiting the notice as to a security interest in proceeds resulting from a ling as to original collateral present themselves. The Committee has determined not to limit the proceeds claim applicable to direct trade-ins, but to limit the claim to proceeds which have been acquired through cash proceeds to cases where the description of collateral in the nancing statement indicates the types of property constituting these remote proceeds. See the proposed revision of Section 9-306(3). E-25. Several cases have held that the proceeds of insurance on destroyed or damaged collateral are not proceeds of the collateral within the meaning of Section 9-306(1). The Committee considers the result of these cases to be unsatisfactory and proposes to revise Section 9-306(1) to make clear that insurance proceeds are proceeds. But a possibility exists that, under a contract with an insurer through a co-insurance clause or a loss payable clause, a junior secured party will be entitled to receive the insurance proceeds, and the revision has been so drafted that the Code's proceeds rules will not operate to disturb contractual arrangements. E-26. Proceeds frequently nd their way to bank or deposit accounts, and Section 9-306(4)(b) expressly contemplates that the secured party will have a security interest in the proceeds so deposited. But existing Section 9-104(k) provides that Article 9 does not apply to deposit accounts and similar accounts. The Committee proposes to amend the treatment in
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Section 9-104 so that it is not inconsistent with the recognition of proceeds security interests in these accounts, and to add in Section 9-105 a new definition of deposit account to cover all the types of accounts intended to be covered by these provisions. E-27. Section 9-306(4) deals with cash proceeds, and is intended to substitute for dicult problems of tracing a provision that the secured party has a perfected security interest in cash proceeds (and deposit accounts derived therefrom) received within ten days before the institution of insolvency proceedings by or against the debtor, less the cash proceeds paid over to the debtor within the ten days. In the study of this subsection in connection with adoption of the Code in California, certain imperfections in the drafting were pointed out, and California amended the provision. The Committee recommends adoption of a clarifying amendment based on the California amendment. No signicant change of substance is intended. Priorities between Security Interests E-28. In many ways Article 9 facilitates the perfection of security interests. This ease of perfection brings to the fore numerous problems of priority between security interests, or between secured parties and other persons. Each proposed change may aect priority problems by aecting the time or the method by which perfection is achieved, as in the proposed limitations of perfection as to proceeds, paragraphs E-5, 22, 23 of this Statement. Certain priority problems are discussed elsewhere in this statementin Part A as to Fixtures; in Part E as to Sections 9-308 and 9-309; and in Part I as to the eect of lapse. Some of the major problems of priorities are discussed in the following paragraphs. A number of problems relate to the purchase money priority as to inventory in Section 9-312(3). E-29. The existing Section 9-312(3) does not state how often the notication by the purchase-money nancer to earlier nancers of record must be given. The Committee's revision will make the notice eective for ve years, by analogy to the duration of a nancing statement. E-30. The existing subsection requires notice to any secured party known to the purchase money secured party, regardless of perfection by the former. This emphasis on knowledge is inconsistent with the general disregard of knowledge as an operative fact in priority issues between secured parties in Article 9. It is also an ineective provision, because if the purchase money secured party fails to give the necessary notice to obtain priority over the earlier unperfected secured party under subsection (3), the purchase money secured party will nevertheless obtain priority under Section 9-312(5) as the rst to le or perfect. Finally, the existing subsection might be read to deny the contemplated priority to the purchase money secured party against another secured party to whom he has given proper notice unless he also gave notice to all other persons entitled to notice. The Committee proposes a revised Section 9-312(3) to rectify these points. E-31. Under the existing Code there is uncertainty as to the relationship
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of Section 9-312(3) to the period of temporary perfection for 21 days of an interest in inventory without either ling or possession under Section 9-304(5), typically coming through release of a document of title to the debtor following a documentary draft or letter of credit transaction. One could conceivably take the view that the security interest under Section 9-304(5) has priority against an earlier led security interest during the 21 days. If so, one would then have to decide either (a) that the security interest, if led before the end of the 21 days, continued to have priority without a notice; or (b) that the notice under Section 9-312(3) had to be given before the end of the 21 days; or (c) that the priority reversed after the 21 days. None of these results seems consistent with the obvious purpose of Section 9-312(3) to permit a rst-led inventory nancer to rely on his priority in making advances unless he receives notice of a competing purchase money security interest before the debtor receives the inventory. Accordingly, the Committee's proposed revision of Sections 9-304(5) and 9-312(3) requires the notice to be given before the debtor receives the inventory, and if this is done, the purchase money security interest obtains a priority and retains it so long as the interest remains perfected. The Committee's inquiry to several leading banks engaged in foreign trade indicated that this rule would not seriously inconvenience them, and the rule will certainly clarify the position of these banks and all other lenders when acting as general inventory nancers. E-32. The existing Code leaves it uncertain whether the ling required of a consignor under Section 2-326(3) includes a required notice to prior inventory nancers of the consignees under Section 9-312(3). An underlying inventory nancer assured of his rst-led position could as readily be deceived by consigned merchandise as he could by new inventory subject to the purchase money inventory nancing priority, in the absence of notice. Accordingly, the Committee proposes a new Section 9-114 to require the consignor to give the same notices as a purchase money secured party, to attain priority against earlier-led security interests in inventory of the debtor. These provisions are limited to true consignments. The usual rules apply to consignments that are deemed to be security interests. See Section 1-201(37). E-33. Another group of priority problems relates to the basic priority rules of Section 9-312(5). This subsection contains two principal rules. Paragraph (a) is a rst-to-le rule where both competing security interests are perfected by ling. Paragraph (b) is a rst-to-perfect rule when either of the security interests is or both of them are perfected otherwise than by ling. A trac rule is provided by existing Section 9-312(6) to the eect that a continuously perfected security interest shall be treated for the purpose of the foregoing rules as if at all times perfected in the manner it was rst perfected. The problems raised have been the subject of an enormous legal literature. They are complicated by the unforeseeable effect of the temporary perfection of security interests in proceeds under Section 9-306 without ling, and by speculation as to whether a secured party could claim that his security interest was originally perfected without ling under this rule even though the security interest in proceeds was claimed in his ling as to the original collateral. They are further complicated by the question whether dierent rules would apply when a
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nancing statement was drawn to cover, e.g., inventory and its proceeds (which would include accounts) and when it was drawn to cover inventory and accounts. E-34. The Committee is convinced that to settle these questions the present paragraphs (a) and (b) of Section 9-312(5) must be replaced by a single rule. The Committee proposes a revised Section 9-312(5) and the elimination of existing Section 9-312(6). Together with this treatment should be noted the fact that an interest in proceeds automatically arises from a led security interest in original collateral under the proposed revision of Section 9-306(3), subject to the limitations therein stated and discussed in paragraphs E-5, 22, 23 of this Statement. New proposed Section 9-312(6) makes it clear that subject to these limitations the ling as to original collateral constitutes a ling as to proceeds. E-35. The new rule ranks conicting perfected security interests by their priority in time, dating back to the respective times when without interruption the security interests were either perfected or were the subjects of appropriate lings. E-36. Perhaps the most debated subject under Article 9 has been the question whether between conicting security interests a priority as to original collateral confers a priority as to proceeds. On this topic the discussions as to proceeds (paragraphs E-1921, E-24, of this Statement) and as to rules of Sections 9-312(5) and (6) (paragraphs E-3334) are relevant. See also the following paragraphs E-3738. E-37. In the case of collateral other than inventory, e.g., equipment, assume that A has a prior purchase money security interest and B, although he was the rst to le, has a junior security interest. If the equipment was sold and proceeds resulted, it seems clear that the policy favoring the purchase money secured party in Section 9-312(4) should give A the rst claim to the proceeds. This is so even though the security interests will have been perfected simultaneously when the proceeds arose and the debtor acquired rights therein. The present Code does not provide for this result clearly, if at all, and the Committee proposes an amendment to Section 9-312(4) to accomplish it. E-38. Proper policy is much less clear when the collateral involved is inventory and proceeds consisting of accounts. (Policy as to other types of receivables as proceeds is expressed in Sections 9-308 and 9-309. See paragraph E-7 of this Statement.) Accounts may be nanced by some nancers without prior involvement in the inventory, and some have argued that one who provides nancing at the early inventory stage of the cycle of a business, which involves greater risk, is certainly to be preferred to one who provides nancing only at the later stage of the cycle, and that a prior or only claim to inventory must therefore carry through to accounts as proceeds. But others feel that accounts nancing is overall more important than inventory nancing, and the desirable rule is one which makes accounts nancing certain as to its legal position. Even if both competing nancers are involved in the inventory, a purchase money priority in inventory may not represent the order of priority in time on accounts, which may be far more important than inventory nancing in the particular case. A suggestion that the purchase money priority carry
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through to accounts if the notice provided by Section 9-312(3) has been given to accounts nancers has seeming merit, but in the Committee's view it has two major diculties: (a) The purchase-money priority as to inventory would be dicult to trace into accounts if the aected inventory was only part of the goods sold. (b) Accounts nancing is intricate, and not easily or safely terminated on receipt of an inventory purchase-money notice. Prevailing practice seems to be for accounts nancers to require covenants against competitive inventory nancing, and to declare a default unless any inventory nancier giving a purchase-money notice agrees not to assert a claim to the accounts. The Committee believes that where a nancing statement as to accounts nancing is led rst (with or without related inventory nancing), the security interest in accounts should not be defeated by any subsequent claim to accounts as proceeds of an inventory security interest which was led later. This result is accomplished by the absence in Section 9-312(3) of any priority rule carrying forward the purchase-money priority to proceeds which are accounts in contrast to the proposed addition to Section 9-312(4) (paragraph E-37); by the revised priority rule in Section 9-312(5); and by proposed Section 9-312(6) to the eect that a date of ling as to original collateral also denes the date of ling as to proceeds. Correspondingly, a nancing statement as to inventory (carrying with it a claim to proceeds) which is led rst will under the same provisions have priority over a later-led security interest in accounts. Priority of Future Advances E-39. Certain recent cases in lower courts raised the question whether a single nancing statement would be eective to perfect more than one advance on the collateral described, when the later advances were not under a future advance clause of a single security agreement but were under later security agreements and were not contemplated at the time of the original agreement. Some of the reasoning makes the matter depend on whether the original debt was fully paid o or was still in existence at the time of the later advances. Coin-O-Matic Service Co. v. Rhode Island Hospital Trust Co., 3 UCC Rep. 1112 (Super.Ct.R.I.1966); In re Merriman, 4 UCC Rep. 234 (Referee, S.D.Ohio 1967). In another case, in which the point was not directly involved, Safe Deposit Bank & Trust Co. v. Berman, 393 F.2d 401 (1st Cir.1968), the court cited In re Rivet, 4 CCH Instal. Credit Guide Par. 97,858, 4 UCC Rep. 1087 (Referee, E.D.Mich.1967), which was in harmony with the rst two cases cited but was subsequently reversed (see paragraph E-40). The Committee disapproves this line of cases, and believes that an appropriate nancing statement may perfect security interests securing advances made under agreements not contemplated at the time of the ling of the nancing statement, even if the advances then contemplated have been fully paid in the interim. Under the notice-ling procedures of the Code, the ling of a nancing statement is eective to perfect security interests as to which the other required elements for perfection exist, whether the security agreement involved is one existing at the date of the ling with an after-acquired property clause or a future advance clause, or whether the applicable security agreement is executed later. Indeed, Section 9-402(1) expressly contemplates that a nanc1270

1972 Amendments

ing statement may be led when there is no security agreement. In the Committee's opinion, the references to after-acquired property clauses and future advance clauses in Section 9-204 are limited to security agreements. This section follows Section 9-203, the section requiring a written security agreement, and its purpose is to make clear that conrmatory agreements are not necessary where the basic agreement has the clauses mentioned. The section has no reference to the operation of nancing statements under the Code's notice ling system. E-40. The Committee considered drafting a provision emphasizing its disagreement with the Coin-O-Matic line of cases, but concluded that the existing Code is clear enough, and should not be disturbed just to overrule some lower court cases. The Rivet case, cited by the First Circuit, has since been reversed by In re Rivet, 6 UCC Rep. 460 (E.D.Mich.1969). E-41. The priority of future advances against an intervening party has been the subject of much discussion and disagreement. E-42. Where both interests are led security interests, the rst-to-le rule of present Section 9-312(5)(a) or the corresponding proposed revision is clearly applicable. E-43. While, under the existing Code, the position of an intervening pledge in reference to a subsequent advance by an earlier-led secured party is debatable, the proposed unied priority rule of Section 9-312(5)(a) (paragraph E-35 of this Statement) would indicate that the subsequent advances by the rst-led party have priority, and subsequent advances under a security interest perfected by possession likewise have priority over an intervening led security interest. These priority rules are expressly stated in proposed Section 9-312(7). That proposal also deals with the rare case of the priority position of a subsequent advance made by a secured party whose security interest is temporarily perfected without either ling or possession, against an intervening secured party. Since there is no notice by the usual methods of ling or possession of the existence of the security interest, the subsequent advances rank only from the actual date of making unless made pursuant to commitment. E-44. In the Committee's view dierent problems exist with reference to the status of subsequent advances when the intervening party is a judgment creditor. He is not directly part of the Code's system of priorities. There should be a limit on the power of a debtor and secured party to squeeze out a judgment creditor who has successfully levied on a valuable equity subject to a security interest, through later enlargement of the security interest by an additional advance, unless that advance was committed in advance. Accordingly, the Committee proposes to clarify the present uncertain state of the law by a new Section 9-301(4) providing that a lien creditor does not take subject to a future advance made more than 45 days after he becomes a lien creditor unless it is made pursuant to commitment.7 A denition of the quoted phrase is proposed in Section 9-105(1). The 45-day period corresponds to a similar protection of advances
The Permanent Editorial Board amended Section 9-301(4) to continue the
7

priority of the subsequent advances beyond the 45 days and until the secured party 1271

Appendix B

made after the ling of tax liens in the Federal Tax Lien Act of 1966. E-45. A similar problem arises where the intervening party is a buyer of the collateral subject to the security interest. While buyers must necessarily take subject to rights of secured parties, the Committee feels that the buyer should take subject to future advances only to the extent that they are given pursuant to commitment or within the period of 45 days after the purchase but not later than the time that the secured party acquires knowledge of the purchase. The Committee has so proposed in Section 9-307(3). Eect of Knowledge on Priorities of Lien Creditors and Buyers E-46. Although knowledge of unperfected security interests does not in general aect the rights of other secured parties, knowledge of unperfected security interests does under Section 9-301 preclude the attainment of priority by lien creditors and buyers (other than buyers in ordinary course of trade protected by Section 9-307(1)). E-47. This result as to judgment creditors was severely criticized in California, which totally eliminated the element of knowledge, and gave priority to a person who became a lien creditor before the security interest was perfected, subject to a 10-day grace period. The Committee recommends the California change in Section 9-301(1)(b) but without the grace period, and a conforming change in Section 9-301(3). The Committee considered an intermediate position, making the decisive time for the existence of knowledge the point at which the creditor gave credit, not the point at which he became a lien creditor. But that position was severely criticized as inappropriate for tort creditors and as encouraging a race of diligence. E-48. Similar considerations might be argued to be applicable to buyers referred to in Section 9-301(1)(c) and (d). However, there seems to be no criticism of these provisions or demand for change, and the Committee has concluded not to recommend any change. Circular Priority E-49. The elimination of the element of knowledge from Section 9-301(1)(b) (paragraph E-47) removes one possibility of circular priority. Other such possibilities are resolved by the proposals as to lapse (paragraphs F-23 and I-7). But circular priority can still arise in other situations. The Committee considered a general provision on the subject, but decided that the situations were too infrequent and diverse and the proper solutions too unclear. F. Conict of Laws F-1. Section 9-103 dealing with interstate problems of perfection has occasioned much discussion, and the relationship between subsections (3) and (4) has been criticized as unclear by several courts. The committee has been aided by discussion with Professor Willis L.M. Reese, the Reporter of the Restatement Second of Conict of Laws, who recently completed his work on cognate material. The Committee proposes a complete revision of
acquires knowledge of the judgment lien. 1272

1972 Amendments

Section 9-103, and related changes in Sections 1-105 and 9-102. F-2. Section 9-103 was drafted in the light of the uncertainty whether the Code would be widely adopted, and the emphasis was on conicting rules of law and a desire to make the Code rules applicable where such a result was justied under general principles. Today, when 51 jurisdictions have adopted the Code, situations of actual conict in rules of law within the ambit of the Code will be few, and the emphasis may shift to the question of certainty as to where to le in order to perfect security interests. Scheme of the Section F-3. Section 9-102(1), basically intended as a scope provision on the coverage of Article 9, seems to deal with conict of laws matters by its phrase so far as concerns any personal property and xtures within the jurisdiction of this state. The Committee proposes to delete this phrase and a related cross-reference, thus making Section 9-102 silent on conicts of laws problems. F-4. The Committee proposes to delete references to validity of a security interest appearing sometimes but not consistently in existing Section 9-103. F-5. The eect of the foregoing changes will be to have questions as to the creation and validity of security interests determined according to the conict of laws rules in Section 1-105. The cross-reference in that section to Article 9 should be amended to exclude the reference to Section 9-102. Questions as to perfection and the eect of perfection or non-perfection of security interestsi.e., questions as to the rights of third partieswill be determined by Section 9-103. F-6. The basic rule of proposed Section 9-103, expressed in paragraph (1)(b), is believed to be that intended but not articulated in the existing section, namely, that perfection and the eect of perfection or nonperfection of a security interest are governed by the law (including the conict of law rules) of the jurisdiction where the collateral is when a conicting claim comes into existence.8 That state will ordinarily look for this purpose to the law of the state where the collateral was when the events claimed to constitute perfection occurred, but the section provides special rules in the cases discussed in the next ten paragraphs. Special Rules as to Jurisdiction Controlling Perfection The 10-Day9 Rule F-7. The relationship of the 30-day removal period in existing Section 9-103(3) to the four month removal period in that subsection is imperfectly stated. Paragraph (1)(c) of the revision limits the provision to purchase money security interests in goods and changes the 30 days to 10 days after the debtor receives possession, conforming to Sections 9-301(2) and
The text being submitted in the present printing changes this formulation to refer to the law of the jurisdiction where the collateral is when the last event occurs on
8

which is based the assertion that the security interest is perfected. 9 The Permanent Editorial Board changed the 10 days back to 30 days. 1273

Appendix B

9-312(4).9 The revision also makes clear that the function of the period is to have perfection controlled by the law of the state into which the parties intend to remove the collateral within that period, rather than the law of the state where the collateral is when the security interest attaches. The four month period discussed below is irrelevant to this purpose, and is placed in paragraph (1)(d). During the 10-day period,9 perfection is fully governed by the law of the state to which the parties intend to remove the collateral, whether or not it is removed to that state within the 10 days.9 If it is so taken, then perfection continues to be governed by the law of that state. If it is not so taken, the question of perfection reverts at the end of the 10 days9 to the state where the collateral then is. Paragraph (1)(c) described in this paragraph does not apply to the cases described in the next two paragraphs. Motor Vehicles F-8. Paragraph (2)(b), which to some extent covers the same ground as the existing subsection (4), excludes from the general rule of paragraph (1)(b) collateral covered by a certicate of title. Paragraph (2)(d) is a partial limitation on paragraph (2)(b). These paragraphs are discussed in the treatment of motor vehicles, Part G of this Statement. Intangibles and Mobile Goods F-9. Subsection (3) covers essentially the same ground as existing subsections (1) and (2). They are intended to determine the jurisdiction whose law governs perfection in the case of intangibles which have no location in fact, and mobile chattels which have no permanent location. Several substantial changes have been made therein as described in paragraphs F-10 to F-16 below. F-10. The existing subsection (1) provides that a nancing statement covering accounts shall be led in the jurisdiction where the assignor keeps his records concerning them. Existing subsection (2) provides that a nancing statement covering general intangibles shall be led in the jurisdiction of the chief place of business of the debtor. The use of separate tests for accounts and general intangibles has been criticized, because many groups of receivables may include items falling into both categories. See paragraph E-15 of this Statement. Moreover, in the type of accounts nancing known as factoring, the assignment is without recourse and the debtor may keep no records concerning the accounts after transfer. A debtor's place of business may be objectively more ascertainable than the place where he keeps accounts, and will not be confused by questions on the latter test arising from remote access computer operations. Accordingly, the Committee proposes to combine the two tests into the place of business test applicable to general intangibles. See also the next paragraph. F-11. The Committee recommends that the place of business used where
The Permanent Editorial Board changed the 10 days back to 30 days. 9 The Permanent Editorial Board changed the 10 days back to 30 days. 1274
9

The Permanent Editorial Board changed the 10 days back to 30 days. 9 The Permanent Editorial Board changed the 10 days back to 30 days.

1972 Amendments

there is more than one be redesignated chief executive oce instead of chief place of business. This will emphasize that what is intended is the executive oce rather than either a statutory oce or the site of the largest plant. While occasional situations of uncertainty could still arise, it is doubtful that there could be more than two possibilities in any case, and it would be easy to play safe by ling in both. See proposed paragraph (3)(d). F-12. Provision has also been added to paragraph (3)(d) covering cases where the debtor is an individual or otherwise has no place of business, in which case his location is deemed to be his residence. F-13. The coverage of the proposed subsection (3) would be extended to cover containers used on vehicles. The coverage would extend to inventory held for lease as well as inventory out on lease, thus accepting a California amendment designed to achieve consistency with the denition of inventory in Section 9-109(4). F-14. The coverage of subsection (3) would be extended by proposed subsection (4) to cover perfection of non-possessory security interests in chattel paper. The existing Code has no express provision as to the jurisdiction within which to le for chattel paper, thus presumably referring the matter to the phrase in existing Section 9-102: . . . this Article applies so far as concerns any . . . property . . . within the jurisdiction of this state . . .. But location is an unsatisfactory test for a ling as to chattel paper, because the paper's location is not visible to a prospective searcher for lings, it is readily transportable, and there may be more than one executed copy of the chattel paper. F-15. The Committee considered whether proposed subsection (3) should govern the state of perfection of security interests in chattel paper completely, as it does in the case of general intangibles and accounts, but concluded to draw a distinction between the conict of laws rule for nonpossessory perfection of a security interest in chattel paper (to which Section 9-103(3) is proposed to be made applicable) and the rule for pledge or possessory perfection thereof (which is left to the general principles of subsection (1), which prescribes the law of the state where the chattel paper is in fact). The basis for the distinction was the fact that in a nonpossessory perfection the problem is essentially similar to that applicable to accounts and general intangibles, but with a possessory perfection there are frequently local transactions between a local unit of a debtor and a local nancer, and in that event the governing considerations should not be referred to the law of a possibly remote jurisdiction where the chief executive oce of the debtor might be. F-16. The coverage of subsection (3) on its face applies even to foreign airplanes, in contradiction to the rules provided by the Geneva Convention, to which the United States and many important foreign countries are parties. This contradiction is recognized in existing Comment 6. The textual problem would be avoided by the Committee proposal to create an exemption from the Code's ling rules for matters controlled by treaty. See paragraph G-4 of this Statement. F-17. Since the place of ling under subsection (3) is independent of the lo-

1275

Appendix B

cation of the collateral, it is not aected by the 10-day rule9 (paragraph F-7, supra) or the four-month rule (paragraph F-19, infra). The only occasion for reling in cases subject to subsection (3) would be in cases of removal of the debtor's location, for which the Committee proposes a new paragraph (3)(e) providing for reling within four months after removal, in keeping with the comparable rule applicable to removal of collateral (paragraph F-19, infra). The Committee rearms the Permanent Editorial Board's rejection in Report No. 2 of the New York subsection (6) denying the need to rele on removal of the chief place of business.10 F-18. Proposed paragraph (3)(c) covers the ground of existing optional subsection (5) and the third sentence of existing subsection (2). It covers the case where the jurisdiction of the location of the debtor is not a domestic jurisdiction and does not provide for ling as to the collateral. In that case, perfection by ling in this state is authorized if this state bears an appropriate relation to the transaction.11 Perfection by notication to the account debtor is also authorized, except in a case of chattel paper covered by subsection (4). The Committee rearms the Permanent Editorial Board's rejection in Report No. 2 of the New York amendment proposing perfection without ling or notication. The Four Months Rule on Removals F-19. To the rules which indicate the jurisdiction whose law governs perfection and the eect of perfection or non-perfection in the rst instance (paragraphs F-3 to F-16, supra) the state whose law governs under paragraphs (1)(b) and (2)(b) (paragraph F-6, supra) adds its own local rule requiring reling within a stated period. A provision of this kind appears in existing subsection (3) and the Committee proposes renements thereof in proposed paragraphs (1)(a) and (2)(c). The 10-day rule (formerly 30 days)12 has been removed from these provisions and placed in paragraph (1)(c), paragraph F-7, supra, to avoid any possible reading that the two provisions are somehow interconnected. The debated question under the existing section as to the relationship between the four months rule of existing subsection (3) and the certicate of title provisions of existing subsection (4) is answered by provisions that proposed subsection (1) does not apply to goods covered by subsection (2). On subsection (2) see paragraphs G-10 to G-15 of this statement. F-20. The state whose law controls the conict and adds its local rule of reling is referred to in the draft as this state. If the litigation were to arise in a forum in another jurisdiction which recognized that the law of the state where the conict arose controlled, it would read the Code as if it were situated in this state.
9 The Permanent Editorial Board changed the 10 days back to 30 days. 10 The provision of New York's subsection (6) dealing with removal of the place where the records of accounts are kept becomes unnecessary under the Committee's proposal to eliminate this rule as to the place of ling for accounts.

The Permanent Editorial Board changed Section 9-103(3)(c) to provide for ling against a foreign debtor on this set of facts in the jurisdiction where its major executive oce in the United States is located. The Permanent Editorial Board changed the 10 days back to 30 days.
12

11

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1972 Amendments

F-21. Proposed paragraph (1)(d) renes the rule requiring reling within four months of removal into this state to cover the case where the existing ling in another jurisdiction would remain eective for less than four months. The period allowed within which to rele in this state is the shorter of the remaining period of eectiveness in the original jurisdiction or four months, whichever period rst expires. If the secured party could not locate the removed collateral in time to rele in the new jurisdiction in a shortened period, he could le a continuation statement in the original jurisdiction, thus giving himself the full four months to locate the collateral and rele in the removal jurisdiction. F-22. Existing subsection (3) has been construed by some to require some armative act of reperfection in the removal state, even though the original security interest was perfected without ling (e.g., a purchase money security interest in consumer goods under Section 9-302(1)). The proposed revision makes clear that no armative act of perfection is needed under such circumstances. On the other hand, existing subsection (3) fails to deal with ling which achieves a status beyond perfection under Section 9-307(2) for purchase money security interests in consumer goods, and the proposed paragraph (1)(d)(iii) treats this point expressly in a manner comparable to the rules described in the preceding paragraph. F-23. The eect of lapse after four months of a security interest perfected without local ling on rights arising within the four months is not specically covered in the present Code, but is referred to in existing Comment 7 to Section 9-103. Subparagraph (1)(d)(i) of the proposed revision makes clear that after lapse the security interest is deemed unperfected as against a person who became a purchaser after the removal. First National Bank of Bay Shore v. Stamper, 93 N.J.Super. 150, 225 A.2d 162 (1966) held in substance that a buyer during the four month period was a converter of the car, at the suit of a bank whose security interest was perfected in the state from which the car was removed. The case entirely fails to consider the eect of the subsequent lapse of the security interest of the bank for failure to reperfect after the four months. While technically the conversion was complete at the moment of purchase, it is to be hoped that the proposed clarication of the eect of lapse will cause similar cases to be analyzed in the future in terms of priority, not of conversion. (Other aspects of the Stamper case are discussed in paragraph G-15 of this Statement). F-24. Terms like removed and kept in Section 9-103 imply an idea of permanence, not just passing through the jurisdiction. They thus embody the same concept as the phrase kept in this state in present Section 9-103(3). F-25. New subsection (5) relating to oil, gas and mineral nancing, is discussed in paragraph D-4 of this Statement. G. Motor Vehicles and Related Problems of Perfection The integration of the provisions of Section 9-302 as to motor vehicles and related types of collateral has been much criticized, and has led to numerous non-uniform amendments. G-1. Paragraphs (c) and (d) of Section 9-302(1) provide that ling is required for motor vehicles required to be licensed, notwithstanding the
1277

Appendix B

absence of a ling requirement for purchase-money security interests in consumer goods. (The Committee proposes to omit paragraph (c) relating to farm equipment. See paragraph B-8 of this Statement.) The term required to be licensed is not as clear as it might be and the Committee proposes to change it to required to be registered. G-2. The Committee considered changing the word motor vehicle to vehicle or collateral, but concluded to leave this to the developing policy of individual states. Over-the-road commercial trailers and semi-trailers are not involved, because the paragraph applies only to consumer goods; but public policy and administration by motor vehicle commissioners may vary as to such items as boat trailers and mobile homes. Public policy as to mobile homes ought not now to be frozen in a uniform Code. As they get larger, they cease to be mobile and are not regularly moved over the highways; thus it is not clear that registration like other trailers is the appropriate legal scheme. G-3. The present formal inconsistency between the required ling for motor vehicles in subsection (1) and the declared inapplicability of the Code's ling requirements to certicated vehicles in subsection (3)(b) would be resolved in proposed revised subsection (3), which makes it clear that it overrides ling requirements of subsection (1). G-4. The existing and the proposed revised subsection (3) recognize other state and federal schemes for led public notice in lieu of Code ling. The Committee proposes an additional category of a ling scheme adopted under a treaty to which the United States is a party, which is intended to refer particularly to the Convention on the International Recognition of Rights in Aircraft (Geneva Convention). (See paragraph F-16 of this Statement.) G-5. Existing subsection (3) provides two alternatives. Alternative A was intended to refer to complete certicate of title laws for motor vehicles or the like. Alternative B was intended to apply to certicate of title laws which were not mandatory but permissive at least in part, and to convert them into mandatory laws by force of the Code (except as to inventory security interests, see the next paragraphs). Neither form of drafting has proved to be satisfactory. Many states have chosen to make express references to their statutes intended to be described, instead of leaving the matter to the Code's eort at a universal description. Moreover, permissive certicate of title laws have been replaced in general by complete laws, and the device of Alternative B is no longer necessary. The Committee therefore submits a revision of subsection (3) which recognizes that each state will list its own statutes intended to be covered. There will be great diversity because of the existence of central ling statutes in some states for cattle and the like; and because there is considerable variation as to the applicability of the certicate of title device to boats and boat trailers, mobile homes, farm tractors, construction machinery and the like. G-6. The Committee has revised subsection (4), partly for clarity, into new subsections (3) and (4). G-7. The revision also covers a point which is dealt with in the existing section only in Alternative B for subsection (3), namely, that Code ling
1278

1972 Amendments

should be required for security interests in inventory, because there is no reason that the Code's carefully worked out provisions for inventory to protect buyers in Section 9-307(1) and as to rights to proceeds in Section 9-306 should be confused by perfection under a certicate of title or other non-Code system. While the Code's sponsoring organizations cannot amend certicate of title laws, it is to be hoped that certicate of title laws will be amended or construed so that the Code ling system for inventory will be exclusive and will not be duplicated by the certicate of title system. There are indications in recent case law that the courts are already so construing certicate of title laws. G-8. The requirement in proposed paragraph (3)(b) for Code ling for security interests in inventory is limited to inventory situations controlled by state law. It is to be hoped that a state will avoid double ling by avoiding any requirement that inventory security interests created by dealers be shown on certicates of title. The Code cannot change the provisions of the Federal Aviation Act requiring all security interests in aircraft (including inventory security interests) to be led under the federal system and making that system exclusive. Fortunately, it has been held that Section 9-307(1) of the Code should apply to the rights of buyers in ordinary course of airplane inventory, although the federal system lacks a provision comparable to that section. Northern Illinois Corp. v. Bishop Distributing Co., 284 F.Supp. 121 (W.D.Mich.1969). G-9. The proposed revisions of subsections (3) and (4) of Section 9-302, like the existing subsections, apply only to property subject to the statutes referred to. Hence the substitute forms of public notice recognized in subsection (3) do not apply to the perfection of security interests in proceeds other than such property. Such security interests must be perfected under Code rules. Compare the proposed revision of Section 9-306(3), discussed in paragraphs E-5, 22, 23 of this Statement. G-10. The above discussion of Section 9-302 does not deal with the conict of law problems arising from the use of certicates of title. These problems are covered by existing Sections 9-103(3) and (4), the interrelationship of which has caused much confusion and criticism; and by revisions proposed in new Section 9-103(2). G-11. Proposed paragraph (2)(b) deals with collateral covered by a certicate of title. In general, a security interest perfected by notation on a certicate of title continues perfected so long as the certicate is outstanding or until the collateral is registered in another jurisdiction, notwithstanding removing the collateral into another state and keeping it there for more than four months. The Committee thus arms In re White, 266 F.Supp. 863 (N.D.N.Y.1967), and later cases in their interpretation of the relationship between the certicate of title provision of existing subsection (4) and the four months rule of existing subsection (3). G-12. If, however, reregistration occurs in another jurisdiction to which the collateral is removed while a certicate of title is left outstanding the security interest perfected by notation on the certicate of title remains perfected for four months after removal under Section 9-103(2)(c). This provision adopts the four months of proposed Section 9-103(1)(c), discussed in paragraphs F-1921 of this Statement, for there is no reason why rights
1279

Appendix B

on removal of collateral perfected on a certicate of title should receive less favorable treatment than rights in collateral otherwise perfected. G-13. Under the Uniform Certicate of Title Act and the Uniform Vehicle Code the four month period of continued perfection after removal commences from the time the rst certicate of title is issued in the state to which the collateral is removed, not from the time of removal. The Committee has chosen to commence the four months with removal, to keep the periods of Sections 9-103(1)(d) and 9-103(2) consistent. It is hoped that if the Committee's recommendations are approved, the National Conference of Commissioners on Uniform State Laws will conform its Uniform Act, and that the National Committee on Uniform Trac Laws and Ordinance will conform its Uniform Vehicle Code. G-14. Possibilities exist that a certicate of title may be issued in a state to which collateral is removed, and that because of fraudulent adavits or other fraudulent devices the certicate will fail to disclose a security interest perfected in another state, whether that state does or does not have a certicate of title law. Suppose under these circumstances that rights of a third party arise in reliance on the clean local certicate of title. What protection should the issuing state give to rights which arose in reliance on its own certicate of title as against rights which were perfected elsewhere but not shown thereon? The Committee treats this problem in proposed Section 9-103(2)(d). G-15. The Committee believes that more protection should be given to the local clean certicate of title than was accorded in First National Bank of Bay Shore v. Stamper, 93 N.J.Super. 150, 225 A.2d 162 (1966). The court there felt that it was required to recognize a security interest perfected in New York for four months after removal of the car into New Jersey, even though a New Jersey buyer had innocently bought the car within the period in reliance on a New Jersey certicate of title not showing the security interest. The court gave weight to the four month provision of existing Section 9-103(3) rather than to the condition of the New Jersey title under existing Section 9-103(4). It reasoned that Section 9-103(4) provides that perfection is governed by the law of the jurisdiction which issued the certicate, and that New Jersey recognizes foreign security interests after removal within the limits set by Section 9-103(3). This reasoning gives no scope to the introduction to Section 9-103(4): Notwithstanding subsections (2) and (3). (The lapse aspect of the Stamper case is discussed in paragraph F-23 of this Statement.) The Committee's structure in its proposed Section 9-103(2)(b) follows the structure of existing Section 9-103(4) and thus would not in itself preclude the Stamper reading. But the Committee believes that consumer buyers who give value and take delivery without knowledge of the security interest in situations like Stamper should be protected in their reliance on local clean certicates of title. Its proposed Section 9-103(2)(d) so provides. G-16. The Committee's proposed treatment does not apply to rights acquired while a distinctive certicate of title is outstanding as described in this paragraph. The Uniform Certicate of Title Act and Uniform Vehicle Code provide
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1972 Amendments

that where the vehicle comes from a state which did not require that security interests be noted on a certicate of title, the local certicate rst issued shall be distinctive and shall contain the legend: This vehicle may be subject to an undisclosed lien. If the Department receives no notice of a security interest within four months after issuance of such a certicate of title, such a certicate may be reissued without the legend. Other certicate of title laws contain comparable provisions. H. Scope Questions H-1. Several questions have been raised as to the status of security interests in benecial interests in trusts and estates. These are typically not commercial collateral, and a requirement of ling with respect thereto seems inappropriate and might act as an entrapment of secured parties who would fail to analyze the collateral as a general intangible. It would be possible to exclude this kind of collateral from Article 9 by a provision in Section 9-104, but the Committee recommends leaving this collateral subject to the general rules of security law provided by Article 9 but with an exclusion from ling by a provision in Section 9-302(1). H-2. Certain receipts issued by large grain dealers do not literally qualify as documents under Article 9, because the denition in Section 9-105(1) refers back to the denition of document of title in Section 1-201 (which requires issuance by a bailee) rather than to the provision in Section 7-201(2) which makes receipts issued by owners under specied conditions substantially the equivalent of warehouse receipts. The Committee proposes to clarify this by amendment of the denition in Section 9-105(1) to refer to both earlier sections. H-3. When the Code was drafted, railway equipment trusts were excluded from Article 9 by Section 9-104(e) in response to the argument that they were extremely specialized securities and the market in them should not be disturbed by new rules of law. The exclusion has subsequently been criticized as unsound. Opinion among railway authorities whom the Committee consulted was divided, but few of those suggesting retention had any specic reason therefor. The Committee proposes to delete the exclusion. The eect will be that railway equipment trusts will become subject to the general rules of security law provided by Article 9. It should be noted, however, that these rules are almost always subject to agreement of the parties. Ordinarily ling under Article 9 will not be required by reason of Section 9-302(3), because ling is controlled by Section 20(c) of the Interstate Commerce Act. I. Filing Problems Substantial changes have been made in Part 4 of Article 9 dealing with ling. The purpose of some of these appears in the discussions of Fixtures, Timber and Oil, Gas and Minerals in Parts A, C and D of this Statement. I-1. Far-ung railroad and other public utility corporations may have signalling systems or other chattels strung along their rights of way, and the chattels may be encumbered with a combined real estate and chattel indenture on the whole utility plant. Where the chattels are non-xtures, the Code would require one or at most two chattel lings. But where the chattels may be xtures, the Code would require ling in each county
1281

Appendix B

where the chattels exist, and with a xture ling including real estate descriptions. This is clearly unduly onerous. Numerous states have attempted to relieve against the burden by a variety of non-uniform amendments to various sections. The Committee has accepted from some of these amendments the concept of transmitting utility, for which it proposes a denition in Section 9-105. It proposes a Section 9-401(5) making all lings for transmitting utilities in the oce of the Secretary of State. This ling constitutes a xture ling (id.) but need not contain a description of the real estate (Proposed Section 9-402(5)). I-2. There has been much criticism of the provision in Section 9-403(2) which terminates the eectiveness of a nancing statement which states a maturity date 60 days after the stated maturity date. There seems to be no reason why a stated maturity date should terminate the eectiveness any sooner than a nancing statement which does not state the date. Even though the transaction has a maturity date, the application of this provision can be avoided simply by not stating the maturity date in the nancing statement. The requirement of a nancing statement and the form in Section 9-401(1) and (3) do not require the maturity date to be stated even if there is one. The Committee therefore proposes to eliminate the special rule in Section 9-403(2) applicable when a maturity date is stated, and to leave all nancing statements operative for ve years. I-3. There has been some objection to the ve year period, on the theory that where the duration of a transaction is longer than ve years, the nancing statement should be good for the duration of the transaction. The Committee has accepted this view in the cases of real estate mortgages which constitute xture security interests and transmitting utilities (Proposed Section 9-403(6)). I-4. The Committee has chosen, however, not to recommend this change generally, or in accordance with suggestions that it be made for all combined real estate and chattel mortgages, or all combined mortgages of corporations, or of listed corporations. The burden of chattel ling, even xture ling, is not too great in other than transmitting utility situations. The theory of the provisions for eectiveness of nancing statements under the present Code is that (except for the two cases just mentioned which involve ling in oces other than the usual oces), they last for ve years unless continuation statements are led, and that the les are therefore self-clearing. A ling ocer who arranges his lings by years can clear the lings of any year automatically after ve years. This would not be possible if there were exceptional cases running more than ve years. Moreover, searchers would have to go back to the eective date of the Code if there could be valid long-term lings. I-5. This operating scheme raises operating questions when eectiveness of the nancing statement has been extended by continuation statements, and the Committee has proposed in Section 9-403(3) that the ling ocer should work out a physical annexation of the nancing statement to the continuation statement to insure the preservation of those from an earlier year whose vitality has been continued. I-6. Other detailed suggestions have been made in Section 9-403 designed to permit preservation of microlm instead of the actual nancing state1282

1972 Amendments

ments, and on the other hand to preserve the record of lings beyond the point where termination statements have been led. Evidence of a perfection of a security interest in the past may be necessary for some time after the termination because of litigation involving bankruptcy preferences, fraudulent conveyances, or other related types of issues. I-7. The Code's provisions as to the eect of lapse have occasioned debate. Existing Section 9-403(2) provides that upon lapse the security interest becomes unperfected, but this statement does not explicitly indicate the result when there was a right junior to the lapsed security interest. It has been argued that since the junior party was charged with notice of the lapsed security interest, he should remain junior. Comment 3 to Section 9-403 and a corresponding Comment to Section 9-103 take the position, however, that the holder of a junior security interest defeats the holder of a lapsed security interest (see also paragraph F-23 of this Statement), but neither Comment deals with the position of a buyer who bought before the lapse. The Committee proposes in Sections 9-103(1)(d)(i) and 9-403(2) to make clear that after the lapse purchasersi.e., buyers and secured partieshave priority over the lapsed security interest. The negative inference is that judgment lienors remain subordinate.13 I-8. To avoid the question whether a nancing statement may lapse during a bankruptcy or other insolvency proceeding, the Committee has proposed in Section 9-403(2) that the nancing statement does not lapse during the proceeding and that the secured party has a minimum of 60 days after termination of the proceeding within which to rele under Article 9. Reling, however, requires a new nancing statement signed by the debtor; to avoid this, the secured party may le a continuation statement before the end of the ve-year period. I-9. A perpetual question has existed whether in ling against sole proprietorships or partnership debtors one may use a trade name, or whether the individual name of a proprietor is required, and whether the names of partners are required to be shown as debtors. There is substantial lack of uniformity in state instructions to ling ocers with respect to these matters. The Committee hopes to clarify these issues by its proposed Section 9-402(7) that one les against a partnership by the name in which it is known and that one les against an individual by his individual name. Neither the names of partners nor a trade name for individuals or partnerships need be shown. The Committee has considered the California provision that a trade name should be shown, but it seems to create too great a risk of insucient ling, because a secured party may not know of a trade name sometimes informally used by a debtor. Trade name statutes vary so widely in scope and in the eects of compliance or non-compliance that it has not seemed feasible to tie any requirements as to trade names to the existence of such statutes. I-10. There is presently much dierence in view as to whether a secured party is under a duty to rele where he knows of and particularly where he has consented to a debtor's transfer of the property to a new debtor.
In the case of Section 9-403(2), the Permanent Editorial Board extended this
13

rule to judgment lienors.

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Appendix B

The Committee has sought to standardize practices in these respects by proposing in Section 9-402(7) that no reling is necessary following a transfer of the collateral by the debtor. This provision is, of course, limited to the continued perfection of the security interest as to collateral transferred by the original debtor. If additional collateral is assigned after the transfer, even though the mechanism is an after-acquired property clause under a security agreement which the new debtor has assumed, it seems clear that a secured party could not be safe without a ling against the new debtor. I-11. A similar question arises with respect to the debtor's change of name. The Committee has sought to settle the matter by proposing in Section 9-402(7) that the ling is not eective as to new collateral after four months after the change of name unless the nancing statement is reled. The provision is so drafted that it will also apply to certain corporate readjustments. I-12. As to all of these problems of ling, the Committee is desirous of avoiding loss of security interests on mere technicalities. Accordingly, the Committee proposes to take existing Section 9-402(5) as to minor errors that are not seriously misleading, move it to the end of Section 9-402 as subsection (8), and to make it clearly applicable to all provisions of that section. I-13. Title companies have complained with some justice that practices are too loose in the use of the term xture in nancing statements as a catchall phrase as in descriptions like all machinery, equipment, tools and xtures situated at 14 Digby Road, Chicago. This leads to a question whether a xture ling is intended and whether a possible objection to the title to the real estate mentioned should be noted. This complaint, coupled with the fact that the Committee's proposals make clear that a xture ling should be indexed in the real estate records, has induced the Committee to propose blanks in the sample form in Section 9-402(3) for designating unmistakably when a nancing statement is intended to be led as a xture ling, and to require a statement to that eect in lings covered by Section 9-402(5). I-14. After considering developing practice and the needs of ling ocers for uniformity, the Committee proposes adoption of a non-uniform amendment made in some states which dierentiates in the ling fees between nancing statements in a form prescribed by the state ling ocer and ling statements in other forms. Section 9-403(5). See also Section 9-404(3). I-15. It is proposed to amend subsection (1) of Section 9-402 so that only the debtor need sign a nancing statement. However, subsection (4) would be amended to require both parties to sign an amendment to a nancing statement, thus precluding the possibility that either party could unilaterally prejudice the secured party's rights under a led nancing statement. J. Default J-1. Existing Section 9-501(3)(c) permits variation of the provisions of Section 9-505(1) with respect to compulsory disposition of collateral, but not the provisions of Section 9-505(2) or 9-504(3). This could be construed to mean that where the secured party proposes to retain the collateral in
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1-105

satisfaction of the obligation under Section 9-505(2), or xes a time of sale under Section 9-504(3), a debtor who acquiesces cannot waive the thirty day waiting period of Section 9-505(2) or the reasonable notication of Section 9-504(3). Such a result could not be justied. Accordingly, the Committee proposes to amend Section 9-501(3)(c) to extend the authorization of waivers to all of section 9-505 and to Section 9-504(3). J-2. In the Committee's opinion the secured party's thirty day wait under Section 9-505(2) before he can retain the collateral in satisfaction of the obligation is too long. Moreover, an extra time is involved because of the secured party's uncertainty as to when the debtor receives notication. These circumstances, coupled with the fact that the waiting period may be wasted if objection is received from the debtor or other party entitled to receive notication, probably defeat the intended purpose of the scheme, which is (at least in part) to avoid the creation of a deciency. It takes longer to clear title by taking the goods in satisfaction of the obligation than it does to sell. In the process of sale, a deciency is frequently established. If the program of Section 9-505(2) were made expeditious, deciencies might sometimes be avoided. Accordingly, the Committee proposes that the waiting period be cut down to twenty-one days after the mailing of the notice. J-3. A related diculty in Section 9-505(2) on accepting collateral in satisfaction of the obligation in lieu of sale and in Section 9-504(3) on sale, is the persons entitled to receive notice. Both sections now require notice (except in the case of consumer goods) not only to every other secured party who has led a nancing statement in this state but also to every other secured party known to the secured party giving the notice. These requirements put on the secured party the necessity of searching the record in every case and of keeping a record of every telephone call by a person claiming an interest, and determining whether such person is entitled to notice. In the Committee's opinion, this burden simply is not justied in the light of the few cases in which there will be junior security interests on le and even fewer cases in which there will be an equity for the junior party to be protected. The Committee proposes instead that the only persons (other than the debtor) who need be given notice under each section are those who have given the secured party written notice of their claims of interests in the collateral.

Amendments to Article 1
1-105. Territorial Application of the Act; Parties' Power to Choose Applicable Law. (1) Except as provided hereafter in this section, when a transaction bears a reasonable relation to this state and also to another state or nation the parties may agree that the law either of this state or of such other state or nation shall govern their rights and duties. Failing such agreement this Act applies to transactions bearing an appropriate relation to this state. (2) Where one of the following provisions of this Act species the applicable law, that provision governs and a contrary agreement is eective
1285

 1-105

Appendix B

only to the extent permitted by the law (including the conict of laws rules) so specied: Rights of creditors against sold goods. Section 2-402. Applicability of the Article on Bank Deposits and Collections. Section 4-102. Bulk transfers subject to the Article on Bulk Transfers. Section 6-102. Applicability of the Article on Investment Securities. Section 8-106. [Policy and scope of the Article on Secured Transactions. Sections 9-102 and 9-103.] Perfection provisions of the Article on Secured Transactions, Section 9-103. Reasons for 1972 Change
The reference to Section 9-102 has been deleted and a change made in Section 9-102 deleting any reference therein to conict of law problems, because there is no reason why the general principles of the present section should not be applicable to the choice of law problems within its scope. Section 9-103 continues to govern choice of law questions as to perfection of security interests and the eect of perfection and non-perfection thereof. The usual rule is that perfection is governed by the law of the jurisdiction in which the collateral is when the last event occurs on which is based the assertion that the security interest is perfected or unperfected. Section 9-103 contains special rules for the cases of intangibles which have no situs, certain types of movable goods, goods which the parties intended at the inception of the transaction to be kept in another jurisdiction, goods subject to certicate of title laws, and certain other cases. Section 9-103 also contains local law rules as to reperfection of security interests when collateral is moved from one jurisdiction to another.

1-201. General Denitions [Unchanged except for denitions (9) and (37) ]. (9) Buyer in ordinary course of business means a person who in good faith and without knowledge that the sale to him is in violation of the ownership rights or security interest of a third party in the goods buys in ordinary course from a person in the business of selling goods of that kind but does not include a pawnbroker. All persons who sell minerals or the like (including oil and gas) at wellhead or minehead shall be deemed to be persons in the business of selling goods of that kind. Buying may be for cash or by exchange of other property or on secured or unsecured credit and includes receiving goods or documents of title under a pre-existing contract for sale but does not include a transfer in bulk or as security for or in total or partial satisfaction of a money debt. (37) Security interest means an interest in personal property or xtures which secures payment or performance of an obligation. The retention or reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer (Section 2-401) is limited in eect to a reservation of a security interest. The term also includes any interest of a buyer of accounts[,] or chattel paper[, or contract rights] which is subject to Article 9. The special property interest of a buyer of goods on identication of such goods to a contract for sale under Section 2-401 is not a security interest, but a buyer may also acquire a security interest by complying with Article 9. Unless a lease or consignment is intended as security, reservation of title thereunder is not a security interest but a consignment is in any event subject to the provisions on consignment sales (Section 2-326). Whether a lease is intended as security is to be determined by the facts of
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5-116

each case; however, (a) the inclusion of an option to purchase does not of itself make the lease one intended for security, and (b) an agreement that upon compliance with the terms of the lease the lessee shall become or has the option to become the owner of the property for no additional consideration or for a nominal consideration does make the lease one intended for security. Reasons for 1972 Change of Denitions (9) and (37)
(9) The new language ts in with changes as to minerals in Section 9-103 which are explained in the references to minerals in the Reasons for Change and Comments to that section. (37) The omission of the term contract rights conforms to the elimination of that term from Article 9. See Reasons for Change under Section 9-106.

Amendment to Article 2
2-107. Goods to Be Severed From Realty: Recording. (1) A contract for the sale of [timber,] minerals or the like (including oil and gas) or a structure or its materials to be removed from realty is a contract for the sale of goods within this Article if they are to be severed by the seller but until severance a purported present sale thereof which is not eective as a transfer of an interest in land is eective only as a contract to sell. (2) A contract for the sale apart from the land of growing crops or other things attached to realty and capable of severance without material harm thereto but not described in subsection (1) or of timber to be cut is a contract for the sale of goods within this Article whether the subject matter is to be severed by the buyer or by the seller even though it forms part of the realty at the time of contracting, and the parties can by identication eect a present sale before severance. (3) The provisions of this section are subject to any third party rights provided by the law relating to realty records, and the contract for sale may be executed and recorded as a document transferring an interest in land and shall then constitute notice to third parties of the buyer's rights under the contract for sale. Reasons for 1972 Change
Several timber-growing states have changed the 1962 Code to make timber to be cut under a contract of severance goods, regardless of the question who is to sever them. The section is revised to adopt this change. Financing of the transaction is facilitated if the timber is treated as goods instead of real estate. A similar change is made in the denition of goods in Section 9-105. To protect persons dealing with timberlands, ling on timber to be cut is required in Part 4 of Article 9 to be made in real estate records in a manner comparable to xture ling.

Amendment to Article 5
5-116. Transfer and Assignment. (1) The right to draw under a credit can be transferred or assigned only when the credit is expressly designated as transferable or assignable. (2) Even though the credit specically states that it is nontransferable or nonassignable the beneciary may before performance of the conditions of
1287

 5-116

Appendix B

the credit assign his right to proceeds. Such an assignment is an assignment of [a contract right] an account under Article 9 on Secured Transactions and is governed by that Article except that (a) the assignment is ineective until the letter of credit or advice of credit is delivered to the assignee which delivery constitutes perfection of the security interest under Article 9; and (b) the issuer may honor drafts or demands for payment drawn under the credit until it receives a notication of the assignment signed by the beneciary which reasonably identies the credit involved in the assignment and contains a request to pay the assignee; and (c) after what reasonably appears to be such a notication has been received the issuer may without dishonor refuse to accept or pay even to a person otherwise entitled to honor until the letter of credit or advice of credit is exhibited to the issuer. (3) Except where the beneciary has eectively assigned his right to draw or his right to proceeds, nothing in this section limits his right to transfer or negotiate drafts or demands drawn under the credit. Reasons for 1972 Change
The change conforms to the deletion of the dened term contract right from Article 9.

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ARTICLE 9 SECURED TRANSACTIONS; SALES OF ACCOUNTS [, CONTRACT RIGHTS] AND CHATTEL PAPER
PART 1 SHORT TITLE, APPLICABILITY AND DEFINITIONS 9-102. Policy and [Scope] Subject Matter of Article. (1) Except as otherwise provided [in Section 9-103 on multiple state transactions and] in Section 9-104 on excluded transactions, this Article applies [so far as concerns any personal property and xtures within the jurisdiction of this state] (a) to any transaction (regardless of its form) which is intended to create a security interest in personal property or xtures including goods, documents, instruments, general intangibles, chattel paper or accounts [or contract rights]; and also (b) to any sale of accounts [contract rights] or chattel paper. (2) This Article applies to security interests created by contract including pledge, assignment, chattel mortgage, chattel trust, trust deed, factor's lien, equipment trust, conditional sale, trust receipt, other lien or title retention contract and lease or consignment intended as security. This Article does not apply to statutory liens except as provided in Section 9-310. (3) The application of this Article to a security interest in a secured obligation is not aected by the fact that the obligation is itself secured by a transaction or interest to which this Article does not apply.
Note: The adoption of this Article should be accompanied by the repeal of existing statutes dealing with conditional sales, trust receipts, factor's liens where the factor is given a nonpossessory lien, chattel mortgages, crop mortgages, mortgages on railroad equipment, assignment of accounts and generally statutes regulating security interests in personal property. Where the state has a retail installment selling act or small loan act, that legislation should be carefully examined to determine what changes in those acts are needed to conform them to this Article. This Article primarily sets out rules dening rights of a secured party against persons dealing with the debtor; it does not prescribe regulations and controls which may be necessary to curb abuses arising in the small loan business or in the nancing of consumer purchases on credit. Accordingly there is no intention to repeal existing regulatory acts in those elds [.] by enactment or re-enactment of Article 9. See Section 9-203(4) and the Note thereto.

Reasons for 1972 Change

The omissions in the rst paragraph of subsection (1) make applicable the general choice of law principles of Section 1-105 (except for special rules stated in Section 9-103), instead of an incomplete statement in this section. The omission in clause (1)(b) conforms to the elimination of the term contract rights from the Article. See Reasons for Change under Section 9-106.

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 9-103

Appendix B

[ 9-103. Accounts, Contract Rights, General Intangibles and Equipment Relating to Another Jurisdiction; and Incoming Goods Already Subject to a Security Interest]. [ (1) If the oce where the assignor of accounts or contract rights keeps his record concerning them is in this state, the validity and perfection of a security interest therein and the possibility and eect of proper ling is governed by this Article; otherwise by the law (including the conict of laws rules) of the jurisdiction where such oce is located.] [ (2) If the chief place of business of a debtor is in this state, this Article governs the validity and perfection of a security interest and the possibility and eect of proper ling with regard to general intangibles or with regard to goods of a type which are normally used in more than one jurisdiction (such as automotive equipment, rolling stock, airplanes, road building equipment, commercial harvesting equipment, construction machinery and the like) if such goods are classied as inventory by reason of their being leased by the debtor to others. Otherwise, the law (including the conict of laws rules) of the jurisdiction where such chief place of business is located shall govern. If the chief place of business is located in a jurisdiction which does not provide for perfection of the security interest by ling or recording in that jurisdiction, then the security interest may be perfected by ling in this state. [For the purpose of determining the validity and perfection of a security interest in an airplane, the chief place of business of a debtor who is a foreign air carrier under the Federal Aviation Act of 1958, as amended, is the designated oce of the agent upon whom service of process may be made on behalf of the debtor.]] [ (3) If personal property other than that governed by subsections (1) and (2) is already subject to a security interest when it is brought into this state, the validity of the security interest in this state is to be determined by the law (including the conict of laws rules) of the jurisdiction where the property was when the security interest attached. However, if the parties to the transaction understood at the time that the security interest attached that the property would be kept in this state and it was brought into this state within 30 days after the security interest attached for purposes other than transportation through this state, then the validity of the security interest in this state is to be determined by the law of this state. If the security interest was already perfected under the law of the jurisdiction where the property was when the security interest attached and before being brought into this state, the security interest continues perfected in this state for four months and also thereafter if within the four month period it is perfected in this state. The security interest may also be perfected in this state after the expiration of the four month period; in such case perfection dates from the time of perfection in this state. If the security interest was not perfected under the law of the jurisdiction where the property was when the security interest attached and before being brought into this state, it may be perfected in this state; in such case perfection dates from the time of perfection in this state.] [ (4) Notwithstanding subsections (2) and (3), if personal property is covered by a certicate of title issued under a statute of this state or any other jurisdiction which requires indication on a certicate of title of any security interest in the property as a condition of perfection, then the
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perfection is governed by the law of the jurisdiction which issued the certicate.] [[ (5) Notwithstanding subsection (1) and Section 9-302, if the oce where the assignor of accounts or contract rights keeps his records concerning them is not located in a jurisdiction which is a part of the United States, its territories or possessions, and the accounts or contract rights are within the jurisdiction of this state or the transaction which creates the security interest otherwise bears an appropriate relation to this state, this Article governs the validity and perfection of the security interest and the security interest may only be perfected by notication to the account debtor.]] 9-103. Perfection of Security Interests in Multiple State Transactions. (1) Documents, instruments and ordinary goods. (a) This subsection applies to documents and instruments and to goods other than those covered by a certicate of title described in subsection (2), mobile goods described in subsection (3), and minerals described in subsection (5). (b) Except as otherwise provided in this subsection, perfection and the eect of perfection or non-perfection of a security interest in collateral are governed by the law of the jurisdiction where the collateral is when the last event occurs on which is based the assertion that the security interest is perfected or unperfected. (c) If the parties to a transaction creating a purchase money security interest in goods in one jurisdiction understand at the time that the security interest attaches that the goods will be kept in another jurisdiction, then the law of the other jurisdiction governs the perfection and the eect of perfection or non-perfection of the security interest from the time it attaches until thirty days after the debtor receives possession of the goods and thereafter if the goods are taken to the other jurisdiction before the end of the thirty-day period. (d) When collateral is brought into and kept in this state while subject to a security interest perfected under the law of the jurisdiction from which the collateral was removed, the security interest remains perfected, but if action is required by Part 3 of this Article to perfect the security interest, (i) if the action is not taken before the expiration of the period of perfection in the other jurisdiction or the end of four months after the collateral is brought into this state, whichever period rst expires, the security interest becomes unperfected at the end of that period and is thereafter deemed to have been unperfected as against a person who became a purchaser after removal; (ii) if the action is taken before the expiration of the period specied in subparagraph (i), the security interest continues perfected thereafter; (iii) for the purpose of priority over a buyer of consumer goods (subsection (2) of Section 9-307), the period of the eectiveness of a ling in the jurisdiction from which the collateral is removed is governed by the rules with respect to perfection in subparagraphs (i) and (ii).
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 9-103

Appendix B

(2) Certicate of title. (a) This subsection applies to goods covered by a certicate of title issued under a statute of this state or of another jurisdiction under the law of which indication of a security interest on the certicate is required as a condition of perfection. (b) Except as otherwise provided in this subsection, perfection and the eect of perfection or non-perfection of the security interest are governed by the law (including the conict of laws rules) of the jurisdiction issuing the certicate until four months after the goods are removed from that jurisdiction and thereafter until the goods are registered in another jurisdiction, but in any event not beyond surrender of the certicate. After the expiration of that period, the goods are not covered by the certicate of title within the meaning of this section. (c) Except with respect to the rights of a buyer described in the next paragraph, a security interest, perfected in another jurisdiction otherwise than by notation on a certicate of title, in goods brought into this state and thereafter covered by a certicate of title issued by this state is subject to the rules stated in paragraph (d) of subsection (1). (d) If goods are brought into this state while a security interest therein is perfected in any manner under the law of the jurisdiction from which the goods are removed and a certicate of title is issued by this state and the certicate does not show that the goods are subject to the security interest or that they may be subject to security interests not shown on the certicate, the security interest is subordinate to the rights of a buyer of the goods who is not in the business of selling goods of that kind to the extent that he gives value and receives delivery of the goods after issuance of the certicate and without knowledge of the security interest. (3) Accounts, general intangibles and mobile goods. (a) This subsection applies to accounts (other than an account described in subsection (5) on minerals) and general intangibles and to goods which are mobile and which are of a type normally used in more than one jurisdiction, such as motor vehicles, trailers, rolling stock, airplanes, shipping containers, road building and construction machinery and commercial harvesting machinery and the like, if the goods are equipment or are inventory leased or held for lease by the debtor to others, and are not covered by a certicate of title described in subsection (2). (b) The law (including the conict of laws rules) of the jurisdiction in which the debtor is located governs the perfection and the eect of perfection or non-perfection of the security interest. (c) If, however, the debtor is located in a jurisdiction which is not a part of the United States, and which does not provide for perfection of the security interest by ling or recording in that jurisdiction, the law of the jurisdiction in the United States in which the debtor has its major executive oce in the United States governs the perfection and the eect of perfection or non-perfection of the security interest through ling. In the alternative, if the debtor is located in a jurisdiction which is not a part of the United States or Canada and the collateral is accounts or general intangibles for money due or to become due, the security interest may be perfected by notication to the account debtor. As used in this paragraph,
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9-103

United States includes its territories and possessions and the Commonwealth of Puerto Rico. (d) A debtor shall be deemed located at his place of business if he has one, at his chief executive oce if he has more than one place of business, otherwise at his residence. If, however, the debtor is a foreign air carrier under the Federal Aviation Act of 1958, as amended, it shall be deemed located at the designated oce of the agent upon whom service of process may be made on behalf of the foreign air carrier. (e) A security interest perfected under the law of the jurisdiction of the location of the debtor is perfected until the expiration of four months after a change of the debtor's location to another jurisdiction, or until perfection would have ceased by the law of the rst jurisdiction, whichever period rst expires. Unless perfected in the new jurisdiction before the end of that period, it becomes unperfected thereafter and is deemed to have been unperfected as against a person who became a purchaser after the change. (4) Chattel paper. The rules stated for goods in subsection (1) apply to a possessory security interest in chattel paper. The rules stated for accounts in subsection (3) apply to a non-possessory security interest in chattel paper, but the security interest may not be perfected by notication to the account debtor. (5) Minerals. Perfection and the eect of perfection or non-perfection of a security interest which is created by a debtor who has an interest in minerals or the like (including oil and gas) before extraction and which attaches thereto as extracted, or which attaches to an account resulting from the sale thereof at the wellhead or minehead are governed by the law (including the conict of laws rules) of the jurisdiction wherein the wellhead or minehead is located. Reasons for 1972 Change
The section has been completely rewritten to clarify the relationship of its several provisions to each other and to other sections dening the applicable law. Now that the Code has been adopted in all states but Louisiana and also adopted in the District of Columbia and the Virgin Islands, the emphasis in the revision has been to make clear where perfection of a security interest must take place, rather than on problems of actual conicts of rules of law. 1. The section now concerns itself exclusively with perfection of security interests and the eect of perfection or non-perfection thereof. The 1962 Code has several references to the validity of a security agreement, and these have been deleted. Likewise, a deletion has been made from Section 9-102 of the language which went beyond that section's basic function of dening the scope of Article 9 and purported to state a choice of law rule. These two changes make it clear that Article 9 does not govern problems of choice of law between the original parties, and that this question is governed by the general choice of law provision in Section 1-105. 2. While most of the substantive materials of the section are in the 1962 Text, the statement thereof and their relationship to each other were not clear. In the revision they are claried according to the following structure: The basic rule of this section is that the controlling law, as to perfection of the security interests and the eect of perfection or non-perfection, is the law of the jurisdiction where the collateral is when the last event occurs on which is based the assertion that the security interest is perfected or unperfected (paragraph (1)(b)). There are certain exceptions: (i) In the case of a purchase money security interest in goods, where the parties intended to 1293

 9-103

Appendix B

remove the collateral to another jurisdiction within 30 days after the debtor received possession of the goods, the law of the latter jurisdiction will govern the initial perfection until the expiration of the 30-day period, and thereafter if the goods are removed to the other jurisdiction before the end of the period (paragraph (1)(c)). (ii) Where the collateral is covered by a certicate of title, perfection will be governed by the law of the issuing jurisdiction (subsection (2)). (iii) If the collateral is certain mobile goods or certain intangibles, perfection will be governed by the law of the jurisdiction wherein is located the debtor (subsection (3)). Where the collateral has been removed from the jurisdiction whose law rst governed, the jurisdiction into which it is removed (i.e., this state) adds a local requirement of reperfection to the requirements of the state from which the collateral was removedi.e., reling is required within 4 months after removal, or within any lesser period during which perfection would have continued in the other jurisdiction (paragraphs (1)(d) and (2)(c)). 3. The two former rules for determining place of perfection as to intangibles (namely, for accounts, the oce where the records were kept concerning the accounts; and for general intangibles, the chief place of business of the debtor) have been consolidated into the rule that the ling is at the debtor's location. That location will ordinarily be the oce designated in the 1962 Text as chief place of business, now redesignated as chief executive oce. A new provision (paragraph (3)(e)) has been added to cover the case where that oce moves from one jurisdiction to another. A principal objection to the original rule that the place for ling as to accounts was the place where the debtor kept his records with respect to them was that persons seeking to search records might not know where this place might be, in the case of a far-ung debtor or of multicorporate enterprises with central accounting. Where the debtor assigned his accounts without recourse, as in factoring, he might keep few records with respect to them. Moreover, it was thought undesirable to have one rule for accounts and another rule for general intangibles, because in many nancing situations both types of receivables may be involved. See discussion in Reasons for Change to Section 9-106. Therefore, it was decided to adopt for both types of intangibles the rule heretofore applicable to general intangibles.

9-104. Transactions Excluded From Article. This Article does not apply (a) to a security interest subject to any statute of the United States [such as the Ship Mortgage Act, 1920,] to the extent that such statute governs the rights of parties to and third parties aected by transactions in particular types of property; or (b) to a landlord's lien; or (c) to a lien given by statute or other rule of law for services or materials except as provided in Section 9-310 on priority of such liens; or (d) to a transfer of a claim for wages, salary or other compensation of an employee; or [ (e) to an equipment trust covering railway rolling stock; or] (e) to a transfer by a government or governmental subdivision or agency; or (f) to a sale of accounts [, contract rights] or chattel paper as part of a sale of the business out of which they arose, or an assignment of accounts [, contract rights] or chattel paper which is for the purpose of collection only, or a transfer of a [contract] right to payment under a contract to an assignee who is also to do the performance under the contract or a transfer of a single account to an assignee in whole or partial satisfaction of a preexisting indebtedness; or (g) to a transfer of an interest in or claim in or under any policy of insurance, except as provided with respect to proceeds (Section 9-306) and priorities in proceeds (Section 9-312); or
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(h) to a right represented by a judgment (other than a judgment taken on a right to payment which was collateral); or (i) to any right of set-o; or (j) except to the extent that provision is made for xtures in Section 9-313, to the creation or transfer of an interest in or lien on real estate, including a lease or rents thereunder; or (k) to a transfer in whole or in part of [any of the following:] any claim arising out of tort; [any deposit, savings, passbook or like account maintained with a bank, savings and loan association, credit union or like organization.]; or (l) to a transfer of an interest in any deposit account (subsection (1) of Section 9-105), except as provided with respect to proceeds (Section 9-306) and priorities in proceeds (Section 9-312). Reasons for 1972 Change
Former paragraph (e), excluding railway equipment trusts from the coverage of Article 9, has been deleted. The whole thrust of Article 9 is to eliminate dierences based on the form of a transaction, and the equipment trust serves the same function as other purchase money forms of nancing. In fact, a form known as the New York equipment trust comes closer to a conditional sale contract then it does to a Pennsylvania equipment trust, and thus the former exclusion left substantial uncertainty. Railway nancing on rolling stock will continue to be exempt from the ling provisions of Article 9 by virtue of Section 9-302(3) and (4). Thus, the principal purpose of the former exclusion will be retained. There is, however, no reason why the other provisions of Article 9 as to the rights of parties, manner of foreclosure, etc., should not be available to the parties to railway nancing, since these problems are not adequately covered in any other statutes. A new paragraph (e) has been added to make clear that this Article does not apply to security interests created by governmental debtors. Other changes reect the elimination of the term contract rights and the fact that, while transfers of claims under insurance policies and deposit accounts are in general excluded from the Article by this section, proceeds claims thereto are subject to Section 9-306.

9-105. Denitions and Index of Denitions. (1) In this Article unless the context otherwise requires: (a) Account debtor means the person who is obligated on an account, chattel paper[, contract right] or general intangible; (b) Chattel paper means a writing or writings which evidence both a monetary obligation and a security interest in or a lease of specic goods, but a charter or other contract involving the use or hire of a vessel is not chattel paper. When a transaction is evidenced both by such a security agreement or a lease and by an instrument or a series of instruments, the group of writings taken together constitutes chattel paper; (c) Collateral means the property subject to a security interest, and includes accounts[, contract rights] and chattel paper which have been sold; (d) Debtor means the person who owes payment or other performance of the obligation secured, whether or not he owns or has rights in the collateral, and includes the seller of accounts[, contract rights] or chattel paper. Where the debtor and the owner of the collateral are not the same person, the term debtor means the owner of the collateral in any provision of the Article dealing with the collateral, the obligor in
1295

 9-105

Appendix B

any provision dealing with the obligation, and may include both where the context so requires; (e) Deposit account means a demand, time, savings, passbook or like account maintained with a bank, savings and loan association, credit union or like organization, other than an account evidenced by a certicate of deposit; (f) [ (e) ] Document means document of title as dened in the general denitions of Article 1 (Section 1-201) [;], and a receipt of the kind described in subsection (2) of Section 7-201; (g) Encumbrance includes real estate mortgages and other liens on real estate and all other rights in real estate that are not ownership interests; (h) [ (f) ] Goods includes all things which are movable at the time the security interest attaches or which are xtures (Section 9-313), but does not include money, documents, instruments, accounts, chattel paper, general intangibles, [contract rights and other things in action,] or minerals or the like (including oil and gas) before extraction. Goods also includes standing timber which is to be cut and removed under a conveyance or contract for sale, the unborn young of animals, and growing crops; (i) [ (g) ] Instrument means a negotiable instrument (dened in Section 3-104), or a security (dened in Section 8-102) or any other writing which evidences a right to the payment of money and is not itself a security agreement or lease and is of a type which is in ordinary course of business transferred by delivery with any necessary indorsement or assignment; (j) Mortgage means a consensual interest created by a real estate mortgage, a trust deed on real estate, or the like; (k) An advance is made pursuant to commitment if the secured party has bound himself to make it, whether or not a subsequent event of default or other event not within his control has relieved or may relieve him from his obligation; (l) [ (h) ] Security agreement means an agreement which creates or provides for a security interest; (m) [ (i) ] Secured party means a lender, seller or other person in whose favor there is a security interest, including a person to whom accounts[, contract rights] or chattel paper have been sold. When the holders of obligations issued under an indenture of trust, equipment trust agreement or the like are represented by a trustee or other person, the representative is the secured party; (n) Transmitting utility means any person primarily engaged in the railroad, street railway or trolley bus business, the electric or electronics communications transmission business, the transmission of goods by pipeline, or the transmission or the production and transmission of electricity, steam, gas or water, or the provision of sewer service. (2) Other denitions applying to this Article and the sections in which they appear are: Account. Section 9-106.
1296

1972 Amendments

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Attach. Section 9-203. Construction mortgage. Section 9-313(1). Consumer goods. Section 9-109(1). [Contract right. Section 9-106.] Equipment. Section 9-109(2). Farm products. Section 9-109(3). Fixture. Section 9-313. Fixture ling. Section 9-313. General intangibles. Section 9-106. Inventory. Section 9-109(4). Lien creditor. Section 9-301(3). Proceeds. Section 9-306(1). Purchase money security interest. Section 9-107. United States. Section 9-103. (3) The following denitions in other Articles apply to this Article: Check. Section 3-104. Contract for sale. Section 2-106. Holder in due course. Section 3-302. Note. Section 3-104. Sale. Section 2-106. (4) In addition Article 1 contains general denitions and principles of construction and interpretation applicable throughout this Article. Reasons for 1972 Change
A denition of transmitting utility has been added to identify a class of debtor with special ling problems on farung properties, for which special ling rules are stated in Part 4. A denition of deposit account has been added to facilitate references to such accounts in the section on proceeds (Section 9-306). A denition of pursuant to commitment has been added as the basis for use of this concept in Sections 9-301, 9-307, and 9-312. Denitions of encumbrance and mortgage have been added as the basis for the use thereof in Section 9-313. The denition of document has been amended to include therein the kind of receipt issued by a person who is not technically a warehouseman, as described in Section 7-201(2). The exclusion of other things in action from the denition of goods has been deleted as unnecessary. General intangibles, which under Section 9-106 includes things in action, are themselves excluded from the denition of goods. Other minor changes reect the elimination of the classication contract right in Section 9-106.

9-106. Denitions: Account; [Contract Right;] General Intangibles. Account means any right to payment for goods sold or leased or for services rendered which is not evidenced by an instrument or chattel paper[.], whether or not it has been earned by performance. [Contract right means any right to payment under a contract not yet earned by performance and not evidenced by an instrument or chattel paper.] General intangibles means any personal property (including things in action) other than goods, accounts, [contract rights,] chattel paper, documents, [and] instruments,
1297

 9-106

Appendix B

and money. All rights to payment earned or unearned under a charter or other contract involving the use or hire of a vessel and all rights incident to the charter or contract are [contract rights and neither] accounts [nor general intangibles]. Reasons for 1972 Change
The term contract right has been eliminated as unnecessary. As indicated by a sentence now being eliminated from Section 9-306(1), contract right was thought of as an account before the right to payment became unconditional by performance by the creditor. But the distinction between account and contract right was not used in the Article except in subsection (2) to Section 9-318 on the right of original parties to modify an assigned contract, and that subsection has been redrafted to preserve the distinction without needing the term contract right. The term has been troublesome in creating a proceeds problem where a contract right becomes an account by performance; in the Code's former denial that there could be any right in an account until it came into existence (former Section 9-204(2)(d)), notwithstanding a security interest in the preexisting contract right; and in the danger of inadequate description in nancing statements by claiming accounts or general intangibles when before performance they should have been described as contract rights; and in other respects. Money is expressly excluded from the catch-all denition, general intangible, to preclude any possible reading that a security interest in money may be perfected by ling. The other changes are conforming changes.

9-114. Consignment. (1) A person who delivers goods under a consignment which is not a security interest and who would be required to le under this Article by paragraph (3)(c) of Section 2-326 has priority over a secured party who is or becomes a creditor of the consignee and who would have a perfected security interest in the goods if they were the property of the consignee, and also has priority with respect to identiable cash proceeds received on or before delivery of the goods to a buyer, if (a) the consignor complies with the ling provision of the Article on Sales with respect to consignments (paragraph (3)(c) of Section 2-326) before the consignee receives possession of the goods; and (b) the consignor gives notication in writing to the holder of the security interest if the holder has led a nancing statement covering the same types of goods before the date of the ling made by the consignor; and (c) the holder of the security interest receives the notication within ve years before the consignee receives possession of the goods; and (d) the notication states that the consignor expects to deliver goods on consignment to the consignee, describing the goods by item or type. (2) In the case of a consignment which is not a security interest and in which the requirements of the preceding subsection have not been met, a person who delivers goods to another is subordinate to a person who would have a perfected security interest in the goods if they were the property of the debtor. Reasons for 1972 Adoption of New Section
An uncertainty has existed under the 1962 Code whether the ling rule in Section 2-326(3) applicable to true consignments requires only ling under Part 4 of Article 9 or also requires notice to prior inventory secured parties of the debtor under Section 9-312(3). The new Section 9-114 accepts the latter view, and provides in substance that, in order to protect his ownership of the consigned goods, the consignor must give the same notice to an 1298

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inventory secured party of the debtor that he would have to give if his transaction with the consignee was in the form of a security transaction instead of in the form of a consignment. This new section follows closely the language of Section 9-312(3).

PART 2 VALIDITY OF SECURITY AGREEMENT AND RIGHTS OF PARTIES THERETO 9-203. Attachment and Enforceability of Security Interest; Proceeds; Formal Requisites. [ (1) Subject to the provisions of Section 4-208 on the security interest of a collecting bank and Section 9-113 on a security interest arising under the Article on Sales, a security interest is not enforceable against the debtor or third parties unless (a) the collateral is in the possession of the secured party; or (b) the debtor has signed a security agreement which contains a description of the collateral and in addition, when the security interest covers crops or oil, gas or minerals to be extracted or timber to be cut, a description of the land concerned. In describing collateral, the word proceeds is sucient without further description to cover proceeds of any character.] (1) Subject to the provisions of Section 4-208 on the security interest of a collecting bank and Section 9-113 on a security interest arising under the Article on Sales, a security interest is not enforceable against the debtor or third parties with respect to the collateral and does not attach unless (a) the collateral is in the possession of the secured party pursuant to agreement, or the debtor has signed a security agreement which contains a description of the collateral and in addition, when the security interest covers crops growing or to be grown or timber to be cut, a description of the land concerned; and (b) value has been given; and (c) the debtor has rights in the collateral. (2) A security interest attaches when it becomes enforceable against the debtor with respect to the collateral. Attachment occurs as soon as all of the events specied in subsection (1) have taken place unless explicit agreement postpones the time of attaching. (3) Unless otherwise agreed a security agreement gives the secured party the rights to proceeds provided by Section 9-306. (4) [ (2) ] A transaction, although subject to this Article, is also subject to *, and in the case of conict between the provisions of this Article and any such statute, the provisions of such statute control. Failure to comply with any applicable statute has only the eect which is specied therein.
Note: At * in subsection (4) insert reference to any local statute regulating small loans, retail installment sales and the like. The foregoing subsection (4) is designed to make it clear that certain transactions, although subject to this Article, must also comply with other applicable legislation. This Article is designed to regulate all the security aspects of transactions within its scope. There is, however, much regulatory legislation, particularly in the consumer eld, which supplements this Article and should not be repealed by its enactment. Examples are 1299

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Appendix B

small loan acts, retail installment selling acts and the like. Such acts may provide for licensing and rate regulation and may prescribe particular forms of contract. Such provisions should remain in force despite the enactment of this Article. On the other hand if a retail installment selling act contains provisions on ling, rights on default, etc., such provisions should be repealed as inconsistent with this Article[.] except that inconsistent provisions as to deciencies, penalties, etc., in the Uniform Consumer Credit Code and other recent related legislation should remain because those statutes were drafted after the substantial enactment of the Article and with the intention of modifying certain provisions of this Article as to consumer credit.

Reasons for 1972 Change

Subsection (1) has been revised to incorporate into the concept of enforceability of a security interest the elements of agreement, value, and rights in the collateral, which formerly were stated in Section 9-204. These are combined with the requirement of written agreement (unless the security interest is evidenced by possession of the collateral by the secured party), and the security interest is said to attach when all of the events specied have occurred. This drafting cures the former anomaly that a security interest could attach and be perfected, and yet be unenforceable against anyone for lack of a written security agreement. The requirement that a security agreement covering oil, gas or minerals to be extracted contain a description of the land concerned has been eliminated since the Article does not recognize a security interest in such collateral until it has been extracted from the land. The former reference to proceeds in subsection (1) has been eliminated and new subsection (3) added to make clear that claims to proceeds under Section 9-306 do not require a statement in the security agreement, for it is assumed that the parties so intend unless otherwise agreed.

9-204. [When Security Interest Attaches;] After-Acquired Property; Future Advances. [ (1) A security interest cannot attach until there is agreement (subsection (3) of Section 1-201) that it attach and value is given and the debtor has rights in the collateral. It attaches as soon as all of the events in the preceding sentence have taken place unless explicit agreement postpones the time of attaching.] [ (2) For the purposes of this section the debtor has no rights (a) in crops until they are planted or otherwise become growing crops, in the young of livestock until they are conceived; (b) in sh until caught, in oil, gas or minerals until they are extracted, in timber until it is cut; (c) in a contract right until the contract has been made; (d) in an account until it comes into existence.] [ (3) Except as provided in subsection (4) a security agreement may provide that collateral, whenever acquired, shall secure all obligations covered by the security agreement.] [ (4) No security interest attaches under an after-acquired property clause (a) to crops which become such more than one year after the security agreement is executed except that a security interest in crops which is given in conjunction with a lease or a land purchase or improvement transaction evidenced by a contract, mortgage or deed of trust may if so agreed attach to crops to be grown on the land concerned during the period of such real estate transaction; (b) to consumer goods other than accessions (Section 9-314) when
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1972 Amendments

9-205

given as additional security unless the debtor acquires rights in them within ten days after the secured party gives value.] (1) Except as provided in subsection (2), a security agreement may provide that any or all obligations covered by the security agreement are to be secured by after-acquired collateral. (2) No security interest attaches under an after-acquired property clause to consumer goods other than accessions (Section 9-314) when given as additional security unless the debtor acquires rights in them within ten days after the secured party gives value. (3) [ (5) ] Obligations covered by a security agreement may include future advances or other value whether or not the advances or value are given pursuant to commitment (subsection (1) of Section 9-105). Reasons for 1972 Change
Former subsection (1) has been eliminated. The term attach has been moved to Section 9-203 and related to the concept of enforceability of the security interest between the parties to the security agreement contained in that section. Former subsection (2) has been eliminated as unnecessary and in some cases confusing. Its operation appeared to be arbitrary, and it is believed that the questions considered are best left to the courts. Former subsections (3) and (5), now subsections (1) and (3), have been rewritten for clarity. Former subsection (4) is redesignated (2), and clause (a) thereof relating to crops eliminated. That clause provided that no security interest in crops attaches under an afteracquired property clause to crops which become such more than one year after the security agreement, unless the agreement involved certain real estate transactions. The obvious purpose of this provision was to protect a necessitous farmer from encumbering his crops for many years in the future. The provision did not work because there was no corresponding limit on the scope of a nancing statement covering crops, and under the Code's noticeling rules the priority position of a security arrangement covering successive crops would be as eectively protected by the ling of a rst nancing statement whether the granting clause as to successive crops was in one security agreement with an after-acquired property clause or in a succession of security agreements. On the other hand the clause did require an annual security agreement for crops even when the encumbrance on crops was agreed to as part of a long-term nancing covering farm machinery and other assets. The provision thus appeared to be meaningless in operation except to cause unnecessary paperwork, but it did introduce some element of uncertainty as to its purpose.

9-205. Use or Disposition of Collateral Without Accounting Permissible. A security interest is not invalid or fraudulent against creditors by reason of liberty in the debtor to use, commingle or dispose of all or part of the collateral (including returned or repossessed goods) or to collect or compromise accounts [contract rights] or chattel paper, or to accept the return of goods or make repossessions, or to use, commingle or dispose of proceeds, or by reason of the failure of the secured party to require the debtor to account for proceeds or replace collateral. This section does not relax the requirements of possession where perfection of a security interest depends upon possession of the collateral by the secured party or by a bailee. Reasons for 1972 Change
The change reects the deletion of the dened term contract right from the Article. 1301

Appendix B

PART 3 RIGHTS OF THIRD PARTIES; PERFECTED AND UNPERFECTED SECURITY INTERESTS; RULES OF PRIORITY 9-301. Persons Who Take Priority Over Unperfected Security Interests; Right of Lien Creditor. (1) Except as otherwise provided in subsection (2), an unperfected security interest is subordinate to the rights of (a) persons entitled to priority under Section 9-312; (b) a person who becomes a lien creditor [without knowledge of the security interest and] before [it] the security interest is perfected; (c) in the case of goods, instruments, documents, and chattel paper, a person who is not a secured party and who is a transferee in bulk or other buyer not in ordinary course of business, or is a buyer of farm products in ordinary course of business, to the extent that he gives value and receives delivery of the collateral without knowledge of the security interest and before it is perfected; (d) in the case of accounts [, contract rights,] and general intangibles, a person who is not a secured party and who is a transferee to the extent that he gives value without knowledge of the security interest and before it is perfected. (2) If the secured party les with respect to a purchase money security interest before or within ten days after the debtor receives possession of the collateral [comes into possession of the debtor], he takes priority over the rights of a transferee in bulk or of a lien creditor which arise between the time the security interest attaches and the time of ling. (3) A lien creditor means a creditor who has acquired a lien on the property involved by attachment, levy or the like and includes an assignee for benet of creditors from the time of assignment, and a trustee in bankruptcy from the date of the ling of the petition or a receiver in equity from the time of appointment. [Unless all the creditors represented had knowledge of the security interest such a representative of creditors is a lien creditor without knowledge even though he personally has knowledge of the security interest.] (4) A person who becomes a lien creditor while a security interest is perfected takes subject to the security interest only to the extent that it secures advances made before he becomes a lien creditor or within 45 days thereafter or made without knowledge of the lien or pursuant to a commitment entered into without knowledge of the lien. Reasons for 1972 Change
Paragraph (1)(b) has been amended to eliminate the element of knowledge in the conditions under which a lien creditor may defeat an unperfected security interest. Knowledge of the security interest will no longer subordinate the lien creditor to the unled security interest. The former section denied the lien creditor priority even though he had no knowledge when he got involved by extending credit, if he acquired knowledge while attempting to extricate himself. It was completely inconsistent in spirit with the rules of priority between security interests, where knowledge plays a very minor role. The change in subsection (2) is made to conform the language to that of the related pro1302

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vision in Section 9-312(4). The second sentence of subsection (3) is deleted because the question of knowledge has been eliminated from paragraph (1)(b). New subsection (4) deals with the question of the extent to which advances made under a perfected security interest after the rights of a lien creditor have attached to the collateral will come ahead of the position of the lien creditor. This subsection should be read with Section 9-307(3) (which deals with the same problem in the case of an intervening buyer) and Section 9-312(7) (which deals with the same problem in the case of a secured party), and paragraph (5) of Reasons for Change under Section 9-312. In the case of the lien creditors dealt with by this subsection, the rule chosen is crucial to the priority of the security interest for advances over a federal tax lien for 45 days after the tax lien has been led, as contemplated under section 6323(c)(2) and (d) of the Internal Revenue Code of 1954 as amended by the Federal Tax Lien Act of 1966. The actual importance of the priority rule chosen between a secured party and possible lien creditors during the 45 days is believed to be slight; but the rule chosen is essential to give the secured party the protection against Federal tax liens believed to have been intended by the Federal Tax Lien Act of 1966, the operation of which is made to depend on state law. The rule of state law was not certain before this revision. Accordingly, the priority of the security interest for future advances over the judgment lien has to be absolute for the 45 days, without regard to any knowledge of the secured party that the judgment lien exists. After the 45 days the priority of the security interest depends on the secured party's lack of knowledge of the lien at the time he makes the subsequent advance or commits to do so.

9-302. When Filing Is Required to Perfect Security Interest; Security Interests to Which Filing Provisions of This Article Do Not Apply. (1) A nancing statement must be led to perfect all security interests except the following: (a) a security interest in collateral in possession of the secured party under Section 9-305; (b) a security interest temporarily perfected in instruments or documents without delivery under Section 9-304 or in proceeds for a 10 day period under Section 9-306; [ (c) a purchase money security interest in farm equipment having a purchase price not in excess of $2500; but ling is required for a xture under Section 9-313 or for a motor vehicle required to be licensed;] (c) a security interest created by an assignment of a benecial interest in a trust or a decedent's estate; (d) a purchase money security interest in consumer goods; but ling is required [for a xture under Section 9-313 or for a motor vehicle required to be licensed;] for a motor vehicle required to be registered; and xture ling is required for priority over conicting interests in xtures to the extent provided in Section 9-313; (e) an assignment of accounts [or contract rights] which does not alone or in conjunction with other assignments to the same assignee transfer a signicant part of the outstanding accounts [or contract rights] of the assignor; (f) a security interest of a collecting bank (Section 4-208) or arising under the Article on Sales (see Section 9-113) or covered in subsection (3) of this section; (g) an assignment for the benet of all the creditors of the transferor, and subsequent transfers by the assignee thereunder.
1303

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Appendix B

(2) If a secured party assigns a perfected security interest, no ling under this Article is required in order to continue the perfected status of the security interest against creditors of and transferees from the original debtor. [ (3) The ling provisions of this Article do not apply to a security interest in property subject to a statute (a) of the United States which provides for a national registration or ling of all security interests in such property; or
Note: States to select either Alternative A or Alternative B.

Alternative A (b) of this state which provides for central ling of, or which requires indication on a certicate of title of, such security interests in such property. Alternative B (b) of this state which provides for central ling of security interests in such property, or in a motor vehicle which is not inventory held for sale for which a certicate of title is required under the statutes of this state if a notation of such a security interest can be indicated by a public ofcial on a certicate or a duplicate thereof.] [ (4) A security interest in property covered by a statute described in subsection (3) can be perfected only by registration or ling under that statute or by indication of the security interest on a certicate of title or duplicate thereof by a public ocial.] (3) The ling of a nancing statement otherwise required by this Article is not necessary or eective to perfect a security interest in property subject to (a) a statute or treaty of the United States which provides for a national or international registration or a national or international certicate of title or which species a place of ling dierent from that specied in this Article for ling of the security interest; or (b) the following statutes of this state; [[list any certicate of title statute covering automobiles, trailers, mobile homes, boats, farm tractors, or the like, and any central ling statute *.]]; but during any period in which collateral is inventory held for sale by a person who is in the business of selling goods of that kind, the ling provisions of this Article (Part 4) apply to a security interest in that collateral created by him as debtor; or (c) a certicate of title statute of another jurisdiction under the law of which indication of a security interest on the certicate is required as a condition of perfection (subsection (2) of Section 9-103). (4) Compliance with a statute or treaty described in subsection (3) is equivalent to the ling of a nancing statement under this Article, and a security interest in property subject to the statute or treaty can be perfected only by compliance therewith except as provided in Section 9-103 on multiple state transactions. Duration and renewal of perfection of a security interest perfected by compliance with the statute or treaty are governed by the provisions of the statute or treaty; in other respects the security interest is subject to this Article.
1304

1972 Amendments
*

9-304

Note: It is recommended that the provisions of certicate of title acts for perfection of security interests by notation on the certicates should be amended to exclude coverage of inventory held for sale.

Reasons for 1972 Change

Former paragraph (1)(c), which created a nonling rule for purchase money security interests in certain farm equipment, has been eliminated. The analogy drawn in the 1962 Code of farm equipment to consumer goods (for which a similar nonling rule is provided in paragraph (1)(d)) is believed to be inappropriate. The eect of the rule was to make farmers' equipment unavailable to them as collateral for loans from some lenders. A new paragraph (1)(c) exempts from ling rules security interests created by assignments of benecial interests in trusts and estates, because these assignments are not ordinarily thought of as subject to this Article, and a ling rule might operate to defeat many assignments. The requirement of ling for purchase-money security interests in consumer goods which are xtures has been made applicable only for priority against real estate interests (Section 9-313). A new paragraph (1)(g) has been added exempting from ling assignments for the benet of creditors because they are not nancing transactions. Former subsections (3) and (4) have been rewritten into new subsections (3) and (4). The alternatives of former subsection (3) had proved unacceptable formulations in many states. The states adopted non-uniform amendments to use language more closely geared to their certicate of title laws than the uniform alternatives. It is believed that the simplest thing is to have each state specify its statutes intended to be applicable as it adopts the revised Article 9. Former Alternative B to subsection (3) has been abandoned as no longer serving any purpose: it had been an attempt to convert obsolete non-mandatory certicate of title laws into laws under which notation on the certicate of title was the necessary method of perfection of a security interest. Subsection (3) continues to carry the thought that was formerly only in Alternative Bnamely, that the certicate of title procedure does not control the perfection of inventory or oor plan security interests, but instead normal Code ling rules are applicable. Non-uniform variations to the contrary under some state laws are believed to increase operating burdens and it is hoped that the states will abandon them. References to federal statutes have been broadened to include treaties.

9-304. Perfection of Security Interest in Instruments, Documents, and Goods Covered by Documents; Perfection by Permissive Filing; Temporary Perfection Without Filing or Transfer of Possession. (1) A security interest in chattel paper or negotiable documents may be perfected by ling. A security interest in money or instruments (other than instruments which constitute part of chattel paper) can be perfected only by the secured party's taking possession, except as provided in subsections (4) and (5) of this section and subsections (2) and (3) of Section 9-306 on proceeds. (2) During the period that goods are in the possession of the issuer of a negotiable document therefor, a security interest in the goods is perfected by perfecting a security interest in the document, and any security interest in the goods otherwise perfected during such period is subject thereto. (3) A security interest in goods in the possession of a bailee other than one who has issued a negotiable document therefor is perfected by issuance of a document in the name of the secured party or by the bailee's receipt of notication of the secured party's interest or by ling as to the goods.
1305

 9-304

Appendix B

(4) A security interest in instruments or negotiable documents is perfected without ling or the taking of possession for a period of 21 days from the time it attaches to the extent that it arises for new value given under a written security agreement. (5) A security interest remains perfected for a period of 21 days without ling where a secured party having a perfected security interest in an instrument, a negotiable document or goods in possession of a bailee other than one who has issued a negotiable document therefor (a) makes available to the debtor the goods or documents representing the goods for the purpose of ultimate sale or exchange or for the purpose of loading, unloading, storing, shipping, transshipping, manufacturing, processing or otherwise dealing with them in a manner preliminary to their sale or exchange, [; or] but priority between conicting security interests in the goods is subject to subsection (3) of Section 9-312; or (b) delivers the instrument to the debtor for the purpose of ultimate sale or exchange or of presentation, collection, renewal or registration of transfer. (6) After the 21 day period in subsections (4) and (5) perfection depends upon compliance with applicable provisions of this Article. Reasons for 1972 Change
The change in subsection (1) corrects an inadvertent omission in the 1962 Text, and makes clear that a security interest in money cannot be perfected by ling. A provision has been added to subsection (5) making it clear that the 21-day period referred to therein deals only with perfection, but that there must be compliance with the notice provisions of Section 9-312(3) in order to achieve priority over earlier inventory nancers. Corresponding clarifying changes have been made in Section 9-312(3).

9-305. When Possession by Secured Party Perfects Security Interest Without Filing. A security interest in letters of credit and advices of credit (subsection (2)(a) of Section 5-116), goods, instruments, money, negotiable documents or chattel paper may be perfected by the secured party's taking possession of the collateral. If such collateral other than goods covered by a negotiable document is held by a bailee, the secured party is deemed to have possession from the time the bailee receives notication of the secured party's interest. A security interest is perfected by possession from the time possession is taken without relation back and continues only so long as possession is retained, unless otherwise specied in this Article. The security interest may be otherwise perfected as provided in this Article before or after the period of possession by the secured party. Reasons for 1972 Change
The change corresponds to the change in Section 9-304 to clarify the special position of money.

9-306. Proceeds; Secured Party's Rights on Disposition of Collateral. (1) [Proceeds includes whatever is received when collateral or proceeds is sold, exchanged, collected or otherwise disposed of. The term also includes the account arising when the right to payment is earned under a contract right.]
1306

1972 Amendments

9-306

Proceeds includes whatever is received upon the sale, exchange, collection or other disposition of collateral or proceeds. Insurance payable by reason of loss or damage to the collateral is proceeds, except to the extent that it is payable to a person other than a party to the security agreement. Money, checks, deposit accounts, and the like are cash proceeds. All other proceeds are non-cash proceeds. (2) Except where this Article otherwise provides, a security interest continues in collateral notwithstanding sale, exchange or other disposition thereof [by the debtor] unless [his action was] the disposition was authorized by the secured party in the security agreement or otherwise, and also continues in any identiable proceeds including collections received by the debtor. (3) The security interest in proceeds is a continuously perfected security interest if the interest in the original collateral was perfected but it ceases to be a perfected security interest and becomes unperfected ten days after receipt of the proceeds by the debtor unless [ (a) a led nancing statement covering the original collateral also covers proceeds; or] (a) a led nancing statement covers the original collateral and the proceeds are collateral in which a security interest may be perfected by ling in the oce or oces where the nancing statement has been led and, if the proceeds are acquired with cash proceeds, the description of collateral in the nancing statement indicates the types of property constituting the proceeds; or (b) a led nancing statement covers the original collateral and the proceeds are identiable cash proceeds; or (c) [ (b) ] the security interest in the proceeds is perfected before the expiration of the ten day period. Except as provided in this section, a security interest in proceeds can be perfected only by the methods or under the circumstances permitted in this Article for original collateral of the same type. (4) In the event of insolvency proceedings instituted by or against a debtor, a secured party with a perfected security interest in proceeds has a perfected security interest only in the following proceeds: (a) in identiable non-cash proceeds[;] and in separate deposit accounts containing only proceeds; (b) in identiable cash proceeds in the form of money which is [not] neither commingled with other money [or] nor deposited in a [bank] deposit account prior to the insolvency proceedings; (c) in identiable cash proceeds in the form of checks and the like which are not deposited in a [bank] deposit account prior to the insolvency proceedings; and (d) in all cash and [bank] deposit accounts of the debtor [if other cash] in which proceeds have been commingled with other funds, [or deposited in a bank account,] but the perfected security interest under this paragraph (d) is (i) subject to any right of set-o; and (ii) limited to an amount not greater than the amount of any cash
1307

 9-306

Appendix B

proceeds received by the debtor within ten days before the institution of the insolvency proceedings [and commingled or deposited in a bank account prior to the insolvency proceedings less the amount of cash proceeds received by the debtor and paid over to the secured party during the ten day period,] less the sum of (I) the payments to the secured party on account of cash proceeds received by the debtor during such period and (II) the cash proceeds received by the debtor during such period to which the secured party is entitled under paragraphs (a) through (c) of this subsection (4). (5) If a sale of goods results in an account or chattel paper which is transferred by the seller to a secured party, and if the goods are returned to or are repossessed by the seller or the secured party, the following rules determine priorities: (a) If the goods were collateral at the time of sale, for an indebtedness of the seller which is still unpaid, the original security interest attaches again to the goods and continues as a perfected security interest if it was perfected at the time when the goods were sold. If the security interest was originally perfected by a ling which is still eective, nothing further is required to continue the perfected status; in any other case, the secured party must take possession of the returned or repossessed goods or must le. (b) An unpaid transferee of the chattel paper has a security interest in the goods against the transferor. Such security interest is prior to a security interest asserted under paragraph (a) to the extent that the transferee of the chattel paper was entitled to priority under Section 9-308. (c) An unpaid transferee of the account has a security interest in the goods against the transferor. Such security interest is subordinate to a security interest asserted under paragraph (a). (d) A security interest of an unpaid transferee asserted under paragraph (b) or (c) must be perfected for protection against creditors of the transferor and purchasers of the returned or repossessed goods. Reasons for 1972 Change
The rst sentence of subsection (1) is rewritten for clarity. The former second sentence of subsection (1) is omitted consistently with the abandonment of the term contract right in Section 9-106. The new second sentence of subsection (1) is intended to overrule various cases to the effect that proceeds of insurance on collateral are not proceeds of the collateral. The except clause is intended to say that if the insurance contract species the person to whom the insurance is payable, the concept of proceeds will not interfere with performance of the contract. Heretofore an apparent inconsistency and ambiguity has existed between the last sentence of Section 9-203(1)(b) of the 1962 Code, which indicated that a claim to proceeds had to be an express term of a security agreement, and Section 9-306(2), which indicated that a right to proceeds was automatic without reference to a term of a security agreement. This ambiguity has been claried in favor of an automatic right to proceeds, on the theory that this is the intent of the parties, unless otherwise agreed. Further, there has been eliminated the requirement of claiming proceeds in a nancing statement, which had resulted in a checking of a box on each nancing statement in order to claim proceeds. Instead, the led claim to the original collateral is treated as constituting automatically a ling as to proceeds. To this principle, a limitation has been stated: Where the ling as to the original collateral is an inappropriate means of perfection as to proceeds of certain 1308

1972 Amendments

9-308

types, or is made at a place that is inappropriate as to such proceeds, the led claim to the original collateral perfects the claim to proceeds for only 10 days. One example of this is negotiable instruments as proceeds, as to which ling is inappropriate under Section 9-304(1). Another example is the case of accounts as proceeds of inventory, as to which under the rules of Section 9-103 the state of ling for the accounts might be dierent from the state of ling for the inventory. The revised subsection (4) is a clarication based on the California revision. It makes clear that the claim to cash allowed in insolvency is exclusive of any other claim based on tracing.

9-307. Protection of Buyers of Goods. (1) A buyer in ordinary course of business (subsection (9) of Section 1-201) other than a person buying farm products from a person engaged in farming operations takes free of a security interest created by his seller even though the security interest is perfected and even though the buyer knows of its existence. (2) In the case of consumer goods [and in the case of farm equipment having an original purchase price not in excess of $2500 (other than xtures, see Section 9-313) ], a buyer takes free of a security interest even though perfected if he buys without knowledge of the security interest, for value and for his own personal, family or household purposes [or his own farming operations] unless prior to the purchase the secured party has led a nancing statement covering such goods. (3) A buyer other than a buyer in ordinary course of business (subsection (1) of this section) takes free of a security interest to the extent that it secures future advances made after the secured party acquires knowledge of the purchase, or more than 45 days after the purchase, whichever rst occurs, unless made pursuant to a commitment entered into without knowledge of the purchase and before the expiration of the 45 day period. Reasons for 1972 Change
The change in subsection (2) is a conforming change made necessary by the deletion of Section 9-302(1)(c) of the 1962 Code, which provided in substance that a purchase money security interest in farm equipment having an original purchase price not in excess of $2500 need not be led. The omission of that provision in Subsection 9-302(1) makes any corresponding reference unnecessary in the present section. Subsection (3) is one of three new provisions clarifying the extent to which future advances under a security interest may outrank an intervening right. See Sections 9-301(4) and 9-312(7) and paragraph (5) of Reasons for Change under Section 9-312.

9-308. Purchase of Chattel Paper and [Non-Negotiable] Instruments. [A purchaser of chattel paper or a non-negotiable instrument who gives new value and takes possession of it in the ordinary course of his business and without knowledge that the specic paper or instrument is subject to a security interest has priority over a security interest which is perfected under Section 9-304 (permissive ling and temporary perfection). A purchaser of chattel paper who gives new value and takes possession of it in the ordinary course of his business has priority over a security interest in chattel paper which is claimed merely as proceeds of inventory subject to a security interest (Section 9-306), even though he knows that the specic paper is subject to the security interest.] A purchaser of chattel paper or an instrument who gives new value and
1309

 9-308

Appendix B

takes possession of it in the ordinary course of his business has priority over a security interest in the chattel paper or instrument (a) which is perfected under Section 9-304 (permissive ling and temporary perfection) or under Section 9-306 (perfection as to proceeds) if he acts without knowledge that the specic paper or instrument is subject to a security interest; or (b) which is claimed merely as proceeds of inventory subject to a security interest (Section 9-306) even though he knows that the specic paper or instrument is subject to the security interest. Reasons for 1972 Change
The section has been rewritten for clarity. Another purpose of the changes is to make the rules of this section applicable to negotiable instruments. Heretofore, the holder of a negotiable instrument was under some circumstances in a less protected position against competing claims than the holder of chattel paper. The holder of a negotiable instrument had protection only if he achieved the holder in due course status referred to in Section 9-309, which status would not be achieved if the holder had knowledge of a conicting proceeds claim. In contrast, the holder of chattel paper who met the stated conditions was protected under the second sentence of Section 9-308 of the 1962 Code even if he had knowledge of the conicting proceeds claim. Under the changes, the holder of a negotiable instrument who may not qualify as holder in due course may nevertheless qualify for the protections of this section.

9-312. Priorities Among Conicting Security Interests in the Same Collateral. [ (1) The rules of priority stated in the following sections shall govern where applicable: Section 4-208 with respect to the security interest of collecting banks in items being collected, accompanying documents and proceeds; Section 9-301 on certain priorities; Section 9-304 on goods covered by documents; Section 9-306 on proceeds and repossessions; Section 9-307 on buyers of goods; Section 9-308 on possessory against nonpossessory interests in chattel paper or non-negotiable instruments; Section 9-309 on security interests in negotiable instruments, documents or securities; Section 9-310 on priorities between perfected security interests and liens by operation of law; Section 9-313 on security interests in xtures as against interests in real estate; Section 9-314 on security interests in accessions as against interest in goods; Section 9-315 on conicting security interests where goods lose their identity or become part of a product; and Section 9-316 on contractual subordination.] (1) The rules of priority stated in other sections of this Part and in the following sections shall govern when applicable: Section 4-208 with respect to the security interests of collecting banks in items being collected, accompanying documents and proceeds; Section 9-103 on security interests related to other jurisdictions; Section 9-114 on consignments. (2) A perfected security interest in crops for new value given to enable the debtor to produce the crops during the production season and given not more than three months before the crops become growing crops by planting or otherwise takes priority over an earlier perfected security interest to the extent that such earlier interest secures obligations due more than six months before the crops become growing crops by planting or otherwise, even though the person giving new value had knowledge of the earlier security interest.
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9-312

[ (3) A purchase money security interest in inventory collateral has priority over a conicting security interest in the same collateral if (a) the purchase money security interest is perfected at the time the debtor receives possession of the collateral; and (b) any secured party whose security interest is known to the holder of the purchase money security interest or who, prior to the date of the ling made by the holder of the purchase money security interest, had led a nancing statement covering the same items or type of inventory, has received notication of the purchase money security interest before the debtor receives possession of the collateral covered by the purchase money security interest; and (c) such notication states that the person giving the notice has or expects to acquire a purchase money security interest in inventory of the debtor, describing such inventory by item or type.] (3) A perfected purchase money security interest in inventory has priority over a conicting security interest in the same inventory and also has priority in identiable cash proceeds received on or before the delivery of the inventory to a buyer if (a) the purchase money security interest is perfected at the time the debtor receives possession of the inventory; and (b) the purchase money secured party gives notication in writing to the holder of the conicting security interest if the holder had led a nancing statement covering the same types of inventory (i) before the date of the ling made by the purchase money secured party, or (ii) before the beginning of the 21 day period where the purchase money security interest is temporarily perfected without ling or possession (subsection (5) of Section 9-304); and (c) the holder of the conicting security interest receives the notication within ve years before the debtor receives possession of the inventory; and (d) the notication states that the person giving the notice has or expects to acquire a purchase money security interest in inventory of the debtor, describing such inventory by item or type. (4) A purchase money security interest in collateral other than inventory has priority over a conicting security interest in the same collateral or its proceeds if the purchase money security interest is perfected at the time the debtor receives possession of the collateral or within ten days thereafter. (5) In all cases not governed by other rules stated in this section (including cases of purchase money security interests which do not qualify for the special priorities set forth in subsections (3) and (4) of this section), priority between conicting security interests in the same collateral shall be determined [as follows: (a) in the order of ling if both are perfected by ling, regardless of which security interest attached rst under Section 9-204(1) and whether it attached before or after ling; (b) in the order of perfection unless both are perfected by ling, regardless of which security interest attached rst under Section 9-204(1) and,
1311

 9-312

Appendix B

in the case of a led security interest, whether it attached before or after ling; and (c) in the order of attachment under Section 9-204(1) so long as neither is perfected.] according to the following rules: (a) Conicting security interests rank according to priority in time of ling or perfection. Priority dates from the time a ling is rst made covering the collateral or the time the security interest is rst perfected, whichever is earlier, provided that there is no period thereafter when there is neither ling nor perfection. (b) So long as conicting security interests are unperfected, the rst to attach has priority. [ (6) For the purpose of the priority rules of the immediately preceding subsection, a continuously perfected security interest shall be treated at all times as if perfected by ling if it was originally so perfected and it shall be treated at all times as if perfected otherwise than by ling if it was originally perfected otherwise than by ling.] (6) For the purposes of subsection (5) a date of ling or perfection as to collateral is also a date of ling or perfection as to proceeds. (7) If future advances are made while a security interest is perfected by ling or the taking of possession, the security interest has the same priority for the purposes of subsection (5) with respect to the future advances as it does with respect to the rst advance. If a commitment is made before or while the security interest is so perfected, the security interest has the same priority with respect to advances made pursuant thereto. In other cases a perfected security interest has priority from the date the advance is made. Reasons for 1972 Change
(1) The change in subsection (1) is primarily a simplication of statement. (2) Changes have been made in subsection (3) to answer unresolved questions under the 1962 Code. (a) One change answers the question how often a notice must be given under that subsection. The period of ve years has been chosen by analogy to the duration of a nancing statement. (b) Another change answers the question of the priority status of the security interest in inventory temporarily perfected for 21 days without ling or perfection in a situation which begins with release of a pledged document under Section 9-304(5). The answer provided is the usual rule that the purchase-money claimant to preserve his priority resulting from the document must give the required notice before the debtor receives possession of the inventory. If the secured party fails to give timely notice, he loses his priority under this subsection. (c) One of the most widely discussed questions under the 1962 Code was the question of the priority between a person claiming accounts as proceeds of inventory and a person claiming the accounts by direct ling with respect thereto. One issue was whether the special position of an inventory nancer as a purchase money nancer or as the rst nancer in the business cycle of the debtor gave him any special position as to accounts resulting from the inventory. In general, as revised, a negative answer has been given, and a prior right to inventory does not confer a prior right to any proceeds except identiable cash proceeds received on or before the delivery of the inventory (i.e., without the intervention of an account). Other aspects of this issue are discussed under subsection (5) of this section. (3) A dierent answer has been given in subsection (4) relating to purchase money security interests in collateral other than inventory. Here, where it is not ordinarily expected 1312

1972 Amendments

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that the collateral will be sold and that proceeds will result, it seems appropriate to give the party having a purchase money security interest in the original collateral an equivalent priority in its proceeds. The 1962 Code was unclear on this point. (4) Existing subsection (5) contains two principal rules. Paragraph (a) is a rst-to-le rule where both competing security interests are perfected by ling. Paragraph (b) is a rst-toperfect rule when either of the security interests is or both of them are perfected otherwise than by ling. A trac rule is provided by existing subsection (6) to the eect that a continuously perfected security interest shall be treated for the purpose of the foregoing rules as if at all times perfected in the manner it was rst perfected. The problems raised have been the subject of an enormous legal literature. They are complicated by the unforeseeable eect of the temporary perfection of security interest in proceeds without ling under Section 9-306, and by speculation as to whether a secured party could claim that his security interest was originally perfected without ling under this rule even though the security interest in proceeds was claimed in his ling as to the original collateral. They are further complicated by the question whether dierent rules would apply when a nancing statement was drawn to cover, e.g., inventory and its proceeds (which would include accounts) and when it was drawn to cover inventory and accounts. To settle these questions it is proposed to replace the present paragraphs (a) and (b) of subsection (5) by a single rule, subsection (5), and to eliminate existing subsection (6). Together with this treatment should be noted the fact that a ling as to proceeds automatically arises from a led security interest in original collateral under the proposed revision of Section 9-306(3), subject to limitations therein discussed. New proposed subsection (6) makes it clear that subject to these limitations the time of ling or perfection as to original collateral is the time of ling or perfection as to proceeds. The rule of proposed subsection (5) ranks conicting perfected security interests by their priority in time, dating back to the respective times when without interruption the security interests were either perfected or were the subjects of appropriate lings. Perhaps the most debated subject under Article 9 has been the question whether between conicting security interests a priority as to original collateral confers a priority as to proceeds. As indicated above, in the case of collateral other than inventory, e.g., equipment, it seems clear that the policy favoring the purchase money secured party in Section 9-312(4) should give him the rst claim to the proceeds. This is so even though the security interests will have been perfected simultaneously when the proceeds arise and the debtor acquires rights therein. Proper policy is much less clear when the collateral involved is inventory and proceeds consisting of accounts. (Policy as to other types of receivables as proceeds is expressed in Sections 9-308 and 9-309). Accounts nancing is more important in the economy than the nancing of the kinds of inventory that produce accounts, and the desirable rule is one which makes accounts nancing certain as to its legal position. Therefore, the rule proposed is that where a nancing statement as to accounts is led rst (with or without related inventory nancing), the security interest in accounts should not be defeated by any subsequent claim to accounts as proceeds of a security interest in inventory led later. There is therefore no provision in Section 9-312(3) carrying forward to accounts any priority right in inventory, and proposed subsections (5) and (6) adhere rmly to the principle that a date of ling as to original collateral also denes the date of ling as to proceeds. Correspondingly, a nancing statement as to inventory (carrying with it a claim to proceeds) which is led rst will under the same provisions have priority over a later-led security interest in accounts. (5) The priority of future advances against an intervening party has been the subject of much discussion and disagreement. Where both interests are led security interests, the rst-to-le rule of present Section 9-312(5)(a) or the corresponding proposed revision is clearly applicable. Under the 1962 Code, the position of an intervening pledgee in reference to a subsequent advance by an earlier-led secured party is debatable. The proposed unied priority rule of subsection 9-312(5) would indicate that subsequent advances by the rst-led party have priority, and subsequent advances under a security interest perfected by possession likewise have priority over an intervening led security interest. These priority rules are expressly stated in proposed subsection (7). That proposal also deals with the rare case of the priority position of a subsequent advance made by a secured party whose security interest is temporarily perfected without either ling or possession, against an intervening secured party. Since there is no notice by the usual methods of ling or posses1313

 9-312

Appendix B

sion of the existence of the security interest, the subsequent advances rank only from the actual date of making unless made pursuant to commitment. Dierent but related problems exist with reference to the status of subsequent advances when the intervening party is a judgment creditor. He is not directly part of the Code's system of priorities. It seems unfair to make it possible for a debtor and secured party with knowledge of the judgment lien to squeeze out a judgment creditor who has successfully levied on a valuable equity subject to a security interest, by permitting later enlargement of the security interest by an additional advance, unless that advance was committed in advance without such knowledge. Proposed Section 9-301(4) provides that a lien creditor does not take subject to a subsequent advance unless it is given or committed without knowledge, but there is an exception protecting future advances within 45 days after the levy regardless of knowledge. The 45-day period corresponds to a provision on protection of advances made after the ling of tax liens in the Federal Tax Lien Act of 1966. A similar problem arises where the intervening party is a buyer of the collateral subject to the security interest. While buyers must necessarily take subject to rights of secured parties, the buyer should take subject to subsequent advances only to the extent that they are given pursuant to commitment or within the period of 45 days after the purchase but not later than the time that the secured party acquires knowledge of the purchase. It is so proposed in Section 9-307(3). A denition of the quoted phrase appears in Section 9-105.

9-313. Priority of Security Interests in Fixtures. [ (1) The rules of this section do not apply to goods incorporated into a structure in the manner of lumber, bricks, tile, cement, glass, metal work and the like and no security interest in them exists under this Article unless the structure remains personal property under applicable law. The law of this state other than this Act determines whether and when other goods become xtures. This Act does not prevent creation of an encumbrance upon xtures or real estate pursuant to the law applicable to real estate.] [ (2) A security interest which attaches to goods before they become xtures takes priority as to the goods over the claims of all persons who have an interest in the real estate except as stated in subsection (4).] [ (3) A security interest which attaches to goods after they become xtures is valid against all persons subsequently acquiring interests in the real estate except as stated in subsection (4) but is invalid against any person with an interest in the real estate at the time the security interest attaches to the goods who has not in writing consented to the security interest or disclaimed an interest in the goods as xtures.] [ (4) The security interests described in subsections (2) and (3) do not take priority over (a) a subsequent purchaser for value of any interest in the real estate; or (b) a creditor with a lien on the real estate subsequently obtained by judicial proceedings; or (c) a creditor with a prior encumbrance of record on the real estate to the extent that he makes subsequent advances if the subsequent purchase is made, the lien by judicial proceedings is obtained, or the subsequent advance under the prior encumbrance is made or contracted for without knowledge of the security interest and before it is perfected. A purchaser of the real estate at a foreclosure sale other than an encumbrancer purchasing at his own foreclosure sale is a subsequent purchaser within this section.]
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1972 Amendments

9-313

(1) In this section and in the provisions of Part 4 of this Article referring to xture ling, unless the context otherwise requires (a) goods are xtures when they become so related to particular real estate that an interest in them arises under real estate law (b) a xture ling is the ling in the oce where a mortgage on the real estate would be led or recorded of a nancing statement covering goods which are or are to become xtures and conforming to the requirements of subsection (5) of Section 9-402 (c) a mortgage is a construction mortgage to the extent that it secures an obligation incurred for the construction of an improvement on land including the acquisition cost of the land, if the recorded writing so indicates. (2) A security interest under this Article may be created in goods which are xtures or may continue in goods which become xtures, but no security interest exists under this Article in ordinary building materials incorporated into an improvement on land. (3) This Article does not prevent creation of an encumbrance upon xtures pursuant to real estate law. (4) A perfected security interest in xtures has priority over the conicting interest of an encumbrancer or owner of the real estate where (a) the security interest is a purchase money security interest, the interest of the encumbrancer or owner arises before the goods become xtures, the security interest is perfected by a xture ling before the goods become xtures or within ten days thereafter, and the debtor has an interest of record in the real estate or is in possession of the real estate; or (b) the security interest is perfected by a xture ling before the interest of the encumbrancer or owner is of record, the security interest has priority over any conicting interest of a predecessor in title of the encumbrancer or owner, and the debtor has an interest of record in the real estate or is in possession of the real estate; or (c) the xtures are readily removable factory or oce machines or readily removable replacements of domestic appliances which are consumer goods, and before the goods become xtures the security interest is perfected by any method permitted by this Article; or (d) the conicting interest is a lien on the real estate obtained by legal or equitable proceedings after the security interest was perfected by any method permitted by this Article. (5) A security interest in xtures, whether or not perfected, has priority over the conicting interest of an encumbrancer or owner of the real estate where (a) the encumbrancer or owner has consented in writing to the security interest or has disclaimed an interest in the goods as xtures; or (b) the debtor has a right to remove the goods as against the encumbrancer or owner. If the debtor's right terminates, the priority of the security interest continues for a reasonable time. (6) Notwithstanding paragraph (a) of subsection (4) but otherwise subject to subsections (4) and (5), a security interest in xtures is subordinate to a construction mortgage recorded before the goods become xtures if the
1315

 9-313

Appendix B

goods become xtures before the completion of the construction. To the extent that it is given to renance a construction mortgage, a mortgage has this priority to the same extent as the construction mortgage. (7) In cases not within the preceding subsections, a security interest in xtures is subordinate to the conicting interest of an encumbrancer or owner of the related real estate who is not the debtor. (8) [ (5) ] When [under subsections (2) or (3) or (4) a] the secured party has priority over [the claims of all persons who have interests in] all owners and encumbrancers of the real estate, he may, on default, subject to the provisions of Part 5, remove his collateral from the real estate but he must reimburse any encumbrancer or owner of the real estate who is not the debtor and who has not otherwise agreed for the cost of repair of any physical injury, but not for any diminution in value of the real estate caused by the absence of the goods removed or by any necessity of replacing them. A person entitled to reimbursement may refuse permission to remove until the secured party gives adequate security for the performance of this obligation. Reasons for 1972 Change
As the Code came to be widely enacted, the real estate bar came to realize the impact of the xture provisions on real estate nancing and real estate titles. They apparently had not fully appreciated the impact of these provisions of Article 9 on real estate matters during the enactment of the Code, because of the commonly-held assumption that Article 9 was concerned only with chattel security matters. The treatment of xtures in pre-Code law had varied widely from state to state. The treatment in Article 9 was based generally on prior treatment in the Uniform Conditional Sales Act, which, however, had been enacted in only a dozen states. In other states the word xture had come to mean that a former chattel had become real estate for all purposes and that any chattel rights therein were lost. For lawyers trained in such states the Code provisions seemed to be extreme. Some sections of the real estate bar began attempting with some success to have Section 9-313 amended to bring it closer to the preCode law in their states. In some states, such as California and Iowa, Section 9-313 simply was not enacted. Even supporters of Article 9 and of its xture provisions came to recognize that there were some ambiguities in Section 9-313, particularly in its application to construction mortgages, and also in its failure to make it clear that ling of xture security interests was to be in real estate records where they could be found by a standard real estate search. Section 9-313 and related provisions of Part 4 have been redrafted to meet the legitimate criticisms and to make a substantial shift in the law in favor of construction mortgages. The specic changes are described in the 1972 Comments to Section 9-313, and the Comments to the several sections of Part 4.

9-318. Defenses Against Assignee; Modication of Contract After Notication of Assignment; Term Prohibiting Assignment Ineective; Identication and Proof of Assignment. (1) Unless an account debtor has made an enforceable agreement not to assert defenses or claims arising out of a sale as provided in Section 9-206 the rights of an assignee are subject to (a) all the terms of the contract between the account debtor and assignor and any defense or claim arising therefrom; and (b) any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives notication of the assignment. (2) So far as the right to payment or a part thereof under an assigned
1316

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9-401

contract has not been fully earned by performance, [right has not already become an account,] and notwithstanding notication of the assignment, any modication of or substitution for the contract made in good faith and in accordance with reasonable commercial standards is eective against an assignee unless the account debtor has otherwise agreed but the assignee acquires corresponding rights under the modied or substituted contract. The assignment may provide that such modication or substitution is a breach by the assignor. (3) The account debtor is authorized to pay the assignor until the account debtor receives notication that the [account] amount due or to become due has been assigned and that payment is to be made to the assignee. A notication which does not reasonably identify the rights assigned is ineective. If requested by the account debtor, the assignee must seasonably furnish reasonable proof that the assignment has been made and unless he does so the account debtor may pay the assignor. (4) A term in any contract between an account debtor and an assignor [which] is ineective if it prohibits assignment of an account [or contract right to which they are parties is ineective] or prohibits creation of a security interest in a general intangible for money due or to become due or requires the account debtor's consent to such assignment or security interest. Reasons for 1972 Change
The principal changes conform to the elimination of the term contract right in Section 9-106. Minor changes in subsections (3) and (4) eliminate technical diculties in the 1962 Code which arose out of the fact that the term account debtor used in these subsections is dened to include debtors under general intangibles and chattel paper, and is therefore broader than the term account heretofore used in these subsections. Subsection (4) is broadened to apply to general intangibles for money due as well as to accounts.

PART 4 FILING 9-401. Place of Filing; Erroneous Filing; Removal of Collateral.

First Alternative Subsection (1)

(1) The proper place to le in order to perfect a security interest is as follows: (a) when the collateral is timber to be cut or is minerals or the like (including oil and gas) or accounts subject to subsection (5) of Section 9-103, or when the nancing statement is led as a xture ling (Section 9-313) and the collateral is goods which [at the time the security interest attaches] are or are to become xtures, then in the oce where a mortgage on the real estate [concerned] would be led or recorded; (b) in all other cases, in the oce of the [[Secretary of State]].
Second Alternative Subsection (1)

(1) The proper place to le in order to perfect a security interest is as follows: (a) when the collateral is equipment used in farming operations, or farm products, or accounts [, contract rights] or general intangibles arising from or relating to the sale of farm products by a farmer, or consumer
1317

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Appendix B

goods, then in the oce of the in the county of the debtor's residence or if the debtor is not a resident of this state then in the oce of the in the county where the goods are kept, and in addition when the collateral is crops growing or to be grown in the oce of the in the county where the land [on which the crops are growing or to be grown] is located; (b) when the collateral is [goods which at the time the security interest attaches are or are to become xtures] timber to be cut or is minerals or the like (including oil and gas) or accounts subject to subsection (5) of Section 9-103, or when the nancing statement is led as a xture ling (Section 9-313) and the collateral is goods which are or are to be become xtures, then in the oce where a mortgage on the real estate [concerned] would be led or recorded; (c) in all other cases, in the oce of the [[Secretary of State]].
Third Alternative Subsection (1)

(1) The proper place to le in order to perfect a security interest is as follows: (a) when the collateral is equipment used in farming operations, or farm products, or accounts [, contract rights] or general intangibles arising from or relating to the sale of farm products by a farmer, or consumer goods, then in the oce of the in the county of the debtor's residence or if the debtor is not a resident of this state then in the oce of the in the county where the goods are kept, and in addition when the collateral is crops growing or to be grown in the oce of the in the county where the land [on which the crops are growing or to be grown] is located; (b) when the collateral is [goods which at the time the security interest attaches are or are to become xtures] timber to be cut or is minerals or the like (including oil and gas) or accounts subject to subsection (5) of Section 9-103, or when the nancing statement is led as a xture ling (Section 9-313) and the collateral is goods which are or are to become xtures, then in the oce where a mortgage on the real estate [concerned] would be led or recorded; (c) in all other cases, in the oce of the [[Secretary of State]] and in addition, if the debtor has a place of business in only one county of this state, also in the oce of of such county, or, if the debtor has no place of business in this state, but resides in the state, also in the oce of of the county in which he resides.
Note: One of the three alternatives should be selected as subsection (1).

(2) A ling which is made in good faith in an improper place or not in all of the places required by this section is nevertheless eective with regard to any collateral as to which the ling complied with the requirements of this Article and is also eective with regard to collateral covered by the nancing statement against any person who has knowledge of the contents of such nancing statement. (3) A ling which is made in the proper place in this state continues effective even though the debtor's residence or place of business or the location of the collateral or its use, whichever controlled the original ling, is thereafter changed.
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1972 Amendments
Language in double brackets is Alternative Subsection (3)

9-401

[[ (3) A ling which is made in the proper county continues eective for four months after a change to another county of the debtor's residence or place of business or the location of the collateral, whichever controlled the original ling. It becomes ineective thereafter unless a copy of the nancing statement signed by the secured party is led in the new county within said period. The security interest may also be perfected in the new county after the expiration of the four-month period; in such case perfected dates from the time of perfection in the new county. A change in the use of the collateral does not impair the eectiveness of the original ling.]] (4) [If collateral is brought into this state from another jurisdiction, the] The rules stated in Section 9-103 determine whether ling is necessary in this state. (5) Notwithstanding the preceding subsections, and subject to subsection (3) of Section 9-302, the proper place to le in order to perfect a security interest in collateral, including xtures, of a transmitting utility is the oce of the [[Secretary of State]]. This ling constitutes a xture ling (Section 9-313) as to the collateral described therein which is or is to become xtures. (6) For the purposes of this section, the residence of an organization is its place of business if it has one or its chief executive oce if it has more than one place of business.
Note: Subsection (6) should be used only if the state chooses the Second or Third Alternative Subsection (1).

Reasons for 1972 Change

The several alternatives for subsection (1) have been rewritten to provide for ling in the real estate records of security interests intended to give a priority as a xture ling under Section 9-313. This requirement for ling in real estate records applies only if the priority advantages of Section 9-313 are desired. If the secured party is not concerned about priority against real estate parties, he can le for a xture as for an ordinary chattel, in the chattel records, omitting the ling in the real estate records, and he will have a security interest perfected against everyone but real estate parties. In the case of a purchase money security interest in consumer goods, he need not le at all. See Section 9-313(1)(d). For the question of the eect of the regular chattel ling in lieu of xture ling in the event of the debtor's bankruptcy, see Comment 4(c) to Section 9-313. This requirement for ling in real estate records applies also to timber to be cut and to minerals or the like (including oil and gas) nanced at the wellhead or minehead or accounts resulting from the sale thereof. This ling is not merely in the oce where a mortgage of real estate would be recorded, but it is intended that it be led in the real estate records. This is made clear by the model form in Section 9-402(3) which recites that the nancing statement is to be led for record in the real estate records, the required recital in Section 9-402(5), and the provision of Section 9-403(7) requiring the indexing thereof in the real estate records. Thus, it is intended that these lings will be readily disclosed on any real estate search and they can be treated like any real estate encumbrance so disclosed. A new subsection (5) makes clear that a nancing statement led against a transmitting utility (Section 9-105) need be led only in the oce of the [Secretary of State] and not locally. Special provision had to be made for ling where these far-ung utilities were debtors. If the problem were only on non-xtures, not more than one local ling would have been necessary under any of the alternative versions of subsection (1), but the problem was more dicult in the case of xtures, where the standard rule would require ling with real estate descriptions in every county where there were xtures. There has been some diculty in the concept that one les against farmers at their residences, in view of the number of incorporated farms. A new subsection (6) is therefore 1319

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Appendix B

added to dene the residence of an organization. Subsection (6) is also needed if the provision of the Third Alternative Subsection (1) for double ling against local business debtors is adopted.

9-402. Formal Requisites of Financing Statement; Amendments; Mortgage as Financing Statement. (1) A nancing statement is sucient if it gives the names of the debtor and the secured party, is signed by the debtor [and the secured party], gives an address of the secured party from which information concerning the security interest may be obtained, gives a mailing address of the debtor and contains a statement indicating the types, or describing the items, of collateral. A nancing statement may be led before a security agreement is made or a security interest otherwise attaches. When the nancing statement covers crops growing or to be grown [or goods which are or are to become xtures], the statement must also contain a description of the real estate concerned. When the nancing statement covers timber to be cut or covers minerals or the like (including oil and gas) or accounts subject to subsection (5) of Section 9-103, or when the nancing statement is led as a xture ling (Section 9-313) and the collateral is goods which are or are to become xtures, the statement must also comply with subsection (5). A copy of the security agreement is sucient as a nancing statement if it contains the above information and is signed by [both parties.] the debtor. A carbon, photographic or other reproduction of a security agreement or a nancing statement is sucient as a nancing statement if the security agreement so provides or if the original has been led in this state. (2) A nancing statement which otherwise complies with subsection (1) is sucient [although] when it is signed [only] by the secured party instead of the debtor if it is led to perfect a security interest in (a) collateral already subject to a security interest in another jurisdiction when it is brought into this state, or when the debtor's location is changed to this state. Such a nancing statement must state that the collateral was brought into this state or that the debtor's location was changed to this state under such circumstances; or (b) proceeds under Section 9-306 if the security interest in the original collateral was perfected. Such a nancing statement must describe the original collateral; or (c) collateral as to which the ling has lapsed; or (d) collateral acquired after a change of name, identity or corporate structure of the debtor (subsection (7)). (3) A form substantially as follows is sucient to comply with subsection (1): Name of debtor (or assignor) Address Name of secured party (or assignee) Address 1. This nancing statement covers the following types (or items) of property:
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1972 Amendments

9-402

(Describe) 2. (If collateral is crops) The above described crops are growing or are to be grown on: (Describe Real Estate) [3. (If collateral is goods which are or are to become xtures) The above described goods are axed or to be axed to: (Describe Real Estate) ] 3. (If applicable) The above goods are to become xtures on* (Describe Real Estate) and this nancing statement is to be led [[for record]] in the real estate records. (If the debtor does not have an interest of record) The name of a record owner is 4. (If [proceeds or] products of collateral are claimed) [Proceeds] Products of the collateral are also covered. (use whichever is applicable) ( ( ( ( Signature of Debtor (or Assignor) Signature of Secured Party (or Assignee)

(4) A nancing statement may be amended by ling a writing signed by both the debtor and the secured party. An amendment does not extend the period of eectiveness of a nancing statement. [The term nancing statement as used in this Article means the original nancing statement and any amendments but if] If any amendment adds collateral, it is eective as to the added collateral only from the ling date of the amendment. In this Article, unless the context otherwise requires, the term nancing statement means the original nancing statement and any amendments. (5) A nancing statement covering timber to be cut or covering minerals or the like (including oil and gas) or accounts subject to subsection (5) of Section 9-103, or a nancing statement led as a xture ling (Section 9-313) where the debtor is not a transmitting utility, must show that it covers this type of collateral, must recite that it is to be led [[for record]] in the real estate records, and the nancing statement must contain a descrip[Section 9-402] *Where appropriate substitute either The above timber is standing on . . .. or The above minerals or the like (including oil and gas) or accounts will be nanced at the wellhead or minehead of the well or mine located on . . ..

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Appendix B

tion of the real estate [[sucient if it were contained in a mortgage of the real estate to give constructive notice of the mortgage under the law of this state]]. If the debtor does not have an interest of record in the real estate, the nancing statement must show the name of a record owner. (6) A mortgage is eective as a nancing statement led as a xture ling from the date of its recording if (a) the goods are described in the mortgage by item or type, (b) the goods are or are to become xtures related to the real estate described in the mortgage, (c) the mortgage complies with the requirements for a nancing statement in this section other than a recital that it is to be led in the real estate records, and (d) the mortgage is duly recorded. No fee with reference to the nancing statement is required other than the regular recording and satisfaction fees with respect to the mortgage. (7) A nancing statement suciently shows the name of the debtor if it gives the individual, partnership or corporate name of the debtor, whether or not it adds other trade names or the names of partners. Where the debtor so changes his name or in the case of an organization its name, identity or corporate structure that a led nancing statement becomes seriously misleading, the ling is not eective to perfect a security interest in collateral acquired by the debtor more than four months after the change, unless a new appropriate nancing statement is led before the expiration of that time. A led nancing statement remains eective with respect to collateral transferred by the debtor even though the secured party knows of or consents to the transfer. (8) [ (5) ] A nancing statement substantially complying with the requirements of this section is eective even though it contains minor errors which are not seriously misleading.
Note: Language in double brackets is optional. Note: Where the state has any special recording system for real estate other than the usual grantor-grantee index (as, for instance, a tract system or a title registration or Torrens system) local adaptations of subsection (5) and Section 9-403(7) may be necessary. See Mass.Gen.Laws Chapter 106, Section 9-409.

Reasons for 1972 Change

Certain changes are conforming changes to new requirements of Section 9-401 that certain nancing statements covering such collateral as timber and minerals be led in the real estate records. Persons interested in real estate have complained with some justice that the provisions of the 1962 Code failed in several ways to tie the xture lings to the real estate search system. Among these was the absence of clear specication that the xture security interest was to be indexed in the real estate records. On this point, a responsive change has been made in Section 9-403. Other objections related to the adequacy of the real estate description and to the fact that the debtor might not be an owner of an interest of record in the real estate. The optional language in subsection (5) is designed to meet the objection as to real estate descriptions but without imposing on a xturesecured party the duty of obtaining a legal description unless the state's recording system requires it. While no doubt a full legal description is proper practice in conveyancing, it is believed that something signicantly less, like a street address, would be adequate in most states, and would frequently be a guide to a recorded map. Where a state has a tract index system or other special system not dependent on a grantor-grantee index, special adaptations may be required and no attempt is made in the Code to deal with all such situations. Another objection of real estate parties has been that the name of the debtor might not be in the real estate chain of title and there have been numerous non-uniform amendments to Sections 9-401, 9-402, or 9-403 designed to require the showing of the name of the record owners of the real estate in the nancing statement. Since Section 9-313(4)(a) and (b) permit xture ling against persons in possession of the real estate who do not have 1322

1972 Amendments

9-403

interests of record, Section 9-402 requires the naming of an owner of record of the real estate in such cases, and Section 9-403(7) requires indexing the xture ling against the name. Subsection (6) makes it possible for a real estate mortgage to serve as a nancing statement, and a related change in Section 9-403(6) makes it unnecessary to le continuation statements for such a nancing statement. Subsection (1) has been changed to require only the signature of the debtor rather than that of the secured party. The requirement of signatures of secured parties has sometimes misled secured parties, who are accustomed to pre-Code practice and real estate practice under which only the debtor, not the secured party, need sign such instruments as chattel mortgages and real estate mortgages. Thus, when the security agreement was used as the nancing statement, it might have been defective under the 1962 Code for failure to have the signature of the secured party. This change also ts in with the provisions of Section 9-403(6), under which a real estate mortgage (customarily signed only by the debtor) may be eective as a nancing statement. Changes in the form of nancing statement in subsection (3) conform to the foregoing and are also intended to have the secured party make clear when a nancing statement is intended to be led in real estate records. This had been a matter of some concern when the parties used the term xture loosely in their description of goods. Certain of the changes in Section 9-402 are not related to real estate lings. The changes in paragraph (2)(a) conform to Section 9-103(3), which requires reling when the debtor's location changes. Additions in subsections (2)(d) and (7) relating to the problem of the name of the debtor against which a ling should be made and the eect of transfer are discussed in the related Comments.

9-403. What Constitutes Filing; Duration of Filing; Eect of Lapsed Filing; Duties of Filing Ocer. (1) Presentation for ling of a nancing statement and tender of the ling fee or acceptance of the statement by the ling ocer constitutes ling under this Article. (2) Except as provided in subsection (6)a [ (2)A] led nancing statement [which states a maturity date of the obligation secured of ve years or less is eective until such maturity date and thereafter for a period of sixty days. Any other led nancing statement] is eective for a period of ve years from the date of ling. The eectiveness of a led nancing statement lapses [on the expiration of such sixty day period after a stated maturity date or] on the expiration of [such ve] the ve year period [, as the case may be] unless a continuation statement is led prior to the lapse. If a security interest perfected by ling exists at the time insolvency proceedings are commenced by or against the debtor, the security interest remains perfected until termination of the insolvency proceedings and thereafter for a period of sixty days or until expiration of the ve year period, whichever occurs later. Upon [such] lapse the security interest becomes unperfected, unless it is perfected without ling. If the security interest becomes unperfected upon lapse, it is deemed to have been unperfected as against a person who became a purchaser or lien creditor before lapse. [A led nancing statement which states that the obligation secured is payable on demand is eective for ve years from the date of ling.] (3) A continuation statement may be led by the secured party [ (i) within six months before and sixty days after a stated maturity date of ve years or less, and (ii) otherwise] within six months prior to the expiration of the ve year period specied in subsection (2). Any such continuation statement must be signed by the secured party, identify the original statement by le number and state that the original statement is still eective.
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Appendix B

A continuation statement signed by a person other than the secured party of record must be accompanied by a separate written statement of assignment signed by the secured party of record and complying with subsection (2) of Section 9-405, including payment of the required fee. Upon timely ling of the continuation statement, the eectiveness of the original statement is continued for ve years after the last date to which the ling was eective whereupon it lapses in the same manner as provided in subsection (2) unless another continuation statement is led prior to such lapse. Succeeding continuation statements may be led in the same manner to continue the eectiveness of the original statement. Unless a statute on disposition of public records provides otherwise, the ling ocer may remove a lapsed statement from the les and destroy it[.] immediately if he has retained a microlm or other photographic record, or in other cases after one year after the lapse. The ling ocer shall so arrange matters by physical annexation of nancing statements to continuation statements or other related lings, or by other means, that if he physically destroys the nancing statements of a period more than ve years past, those which have been continued by a continuation statement or which are still eective under subsection (6) shall be retained. (4) Except as provided in subsection (7) a [ (4) A] ling ocer shall mark each statement with a [consecutive] le number and with the date and hour of ling and shall hold the statement or a microlm or other photographic copy thereof for public inspection. In addition the ling ocer shall index the statements according to the name of the debtor and shall note in the index the le number and the address of the debtor given in the statement. [ (5) The uniform fee for ling, indexing and furnishing ling data for an original or a continuation statement shall be $ ] (5) The uniform fee for ling and indexing and for stamping a copy furnished by the secured party to show the date and place of ling for an original nancing statement or for a continuation statement shall be $ if the statement is in the standard form prescribed by the [[Secretary of State]] and otherwise shall be $ , plus in each case, if the nancing statement is subject to subsection (5) of Section 9-402, $ . The uniform fee for each name more than one required to be indexed shall be $ . The secured party may at his option show a trade name for any person and an extra uniform indexing fee of $ shall be paid with respect thereto. (6) If the debtor is a transmitting utility (subsection (5) of Section 9-401) and a led nancing statement so states, it is eective until a termination statement is led. A real estate mortgage which is eective as a xture ling under subsection (6) of Section 9-402 remains eective as a xture ling until the mortgage is released or satised of record or its eectiveness otherwise terminates as to the real estate. (7) When a nancing statement covers timber to be cut or covers minerals or the like (including oil and gas) or accounts subject to subsection (5) of Section 9-103, or is led as a xture ling, [[it shall be led for record and]] the ling ocer shall index it under the names of the debtor and any owner of record shown on the nancing statement in the same fashion as if
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9-404

they were the mortgagors in a mortgage of the real estate described, and, to the extent that the law of this state provides for indexing of mortgages under the name of the mortgagee, under the name of the secured party as if he were the mortgagee thereunder, or where indexing is by description in the same fashion as if the nancing statement were a mortgage of the real estate described.
Note: In states in which writings will not appear in the real estate records and indices unless actually recorded the bracketed language in subsection (7) should be used.

Reasons for 1972 Change

The change in subsection (2) makes every nancing statement (except those described in subsection (6)), eective for a full ve years, thus changing the rule of the 1962 Code that a nancing statement which showed a maturity less than 5 years was eective only for the period until maturity plus 60 days. This limitation could have been easily evaded simply by not showing a maturity, even though there was one. The change facilitates renewals or extensions up to a maximum combined duration of ve years, without the danger of the nancing statement ceasing to be eective. Subsection (2) also recognizes that nancing statements might expire during an insolvency proceeding. While the prevailing line of decisions is to the eect that the situation is frozen at the moment of bankruptcy without an obligation to rele, there are contrary decisions, and this situation might prove an inadvertent trap to a secured party who failed to rele or le a continuation statement during a bankruptcy. The change continues the validity of the nancing statement until the end of the insolvency proceedings and for 60 days thereafter, or until the expiration of the ve-year period, whichever is later. Ordinarily, if the secured party expects that the secured debt may continue in existence after the end of the insolvency proceedings, he should le a continuation statement on the normal schedule, to preserve the ling for use at the end of the insolvency proceeding and to preclude any discontinuity of the lings. Subsection (2) also claries the eect of lapse, a matter on which there has been some dispute among writers on the subject. Compare also Section 9-103(1)(d). Subsection (5) is intended to adopt non-uniform amendments made in some states giving the ling ocer authority to charge extra fees if the nancing statement does not conform to a uniform prescribed size and content. It also permits the secured party to show a trade name at his option and to have it indexed for an extra fee. New subsection (6) deals with transmitting utilities (Sections 9-105 and 9-401(5)) and also with real estate mortgages which are eective as nancing statements under Section 9-402(6). In these special cases a nancing statement is good indenitely and its validity is not limited to ve years. The ling in real estate records of a nancing statement which is also a real estate mortgage will give notice to persons searching the record as to this continuing validity and will not interfere with the purpose of the Code's standard rule of ve-year validity for nancing statements. The name of a transmitting utility should give equivalent notice in lings against that kind of company. The purpose of the standard rule is to permit the les to be self-clearing, so that whether or not termination statements have been led, the ling ocer can clear the les after a suitable period after the ve-year validity expires, unless the duration of the nancing statement has been continued by a continuation statement. Various technical changes in this section are designed to facilitate the handling of nancing statements by ling ocers in reference to the use of microlm, etc., and to carry out the principle of the self-clearing nature of the les after ve years. New subsection (7) deals with a point in reference to xtures on which the 1962 Code was properly subject to criticism, namely, that it was not explicitly stated that the xture ling in the county where a real estate mortgage would be recorded was intended to be made and be indexed in the real estate records. This principle is now stated and is also made applicable to timber to be cut and to minerals and the like (including oil and gas) nanced at the wellhead or minehead or accounts resulting from the sale thereof. The other minor changes coordinate with the addition of subsection (7) to Section 9-402.

9-404. Termination Statement. (1) If a nancing statement covering consumer goods is led on or after
1325

 9-404

Appendix B

, then within one month or within ten days following written demand by the debtor after there is no outstanding secured obligation and no commitment to make advances, incur obligations or otherwise give value, the secured party must le with each ling ocer with whom the nancing statement was led, a termination statement to the eect that he no longer claims a security interest under the nancing statement, which shall be identied by le number. In other cases whenever [Whenever] there is no outstanding secured obligation and no commitment to make advances, incur obligations or otherwise give value, the secured party must on written demand by the debtor send the debtor, for each ling ocer with whom the nancing statement was led, a termination statement to the eect that he no longer claims a security interest under the nancing statement, which shall be identied by le number. A termination statement signed by a person other than the secured party of record must [include or] be accompanied by [the assignment or] a separate written statement of assignment signed by the secured party of record [that he has assigned the security interest to the signer of the termination statement. and] complying with subsection (2) of Section 9-405, including payment of the required fee. [The uniform fee for ling and indexing such an assignment or statement thereof shall be $ .] If the aected secured party fails to le such a termination statement as required by this subsection, or to send such a termination statement within ten days after proper demand therefor he shall be liable to the debtor for one hundred dollars, and in addition for any loss caused to the debtor by such failure. (2) On presentation to the ling ocer of such a termination statement he must note it in the index. [The ling ocer shall remove from the les, mark terminated and send or deliver to the secured party the nancing statement and any continuation statement, statement of assignment or statement of release pertaining thereto.] If he has received the termination statement in duplicate, he shall return one copy of the termination statement to the secured party stamped to show the time of receipt thereof. If the ling ocer has a microlm or other photographic record of the nancing statement, and of any related continuation statement, statement of assignment and statement of release, he may remove the originals from the les at any time after receipt of the termination statement, or if he has no such record, he may remove them from the les at any time after one year after receipt of the termination statement. (3) If the termination statement is in the standard form prescribed by the [[Secretary of State]], the uniform fee for ling and indexing [a] the termination statement [including sending or delivering the nancing statement] shall be $ , and otherwise shall be $ , plus in each case an additional fee of $ for each name more than one against which the termination statement is required to be indexed.
Note: The date to be inserted should be the eective date of the revised Article 9.

Reasons for 1972 Change

The additions to subsection (1) require the ling of termination statements in the case of consumer goods even without a demand by the consumer. It is believed that consumers will frequently not understand the importance of making demand in order to clear the les. The scope of the change is not as great as might rst appear, because (1) ling is not required for purchase money security interests in consumer goods, except in the case of motor 1326

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vehicles (Section 9-302(1)(d)); and (2) perfection of security interests in most motor vehicles is governed by certicate of title laws, not by the provisions of Article 9. The other changes are purely formal and tie in with corresponding changes in ling mechanics in other sections.

9-405. Assignment of Security Interest; Duties of Filing Ocer; Fees. (1) A nancing statement may disclose an assignment of a security interest in the collateral described in the nancing statement by indication in the nancing statement of the name and address of the assignee or by an assignment itself or a copy thereof on the face or back of the statement. [Either the original secured party or the assignee may sign this statement as the secured party.] On presentation to the ling ocer of such a nancing statement the ling ocer shall mark the same as provided in Section 9-403(4). The uniform fee for ling, indexing and furnishing ling data for a nancing statement so indicating an assignment shall be $ if the statement is in the standard form prescribed by the [[Secretary of State]] and otherwise shall be $ , plus in each case an additional fee of $ for each name more than one against which the nancing statement is required to be indexed. (2) A secured party may assign of record all or part of his rights under a nancing statement by the ling in the place where the original nancing statement was led of a separate written statement of assignment signed by the secured party of record and setting forth the name of the secured party of record and the debtor, the le number and the date of ling of the nancing statement and the name and address of the assignee and containing a description of the collateral assigned. A copy of the assignment is sucient as a separate statement if it complies with the preceding sentence. On presentation to the ling ocer of such a separate statement, the ling ocer shall mark such separate statement with the date and hour of the ling. He shall note the assignment on the index of the nancing statement, or in the case of a xture ling, or a ling covering timber to be cut, or covering minerals or the like (including oil and gas) or accounts subject to subsection (5) of Section 9-103, he shall index the assignment under the name of the assignor as grantor and, to the extent that the law of this state provides for indexing the assignment of a mortgage under the name of the assignee, he shall index the assignment of the nancing statement under the name of the assignee. The uniform fee for ling, indexing and furnishing ling data about such a separate statement of assignment shall be $ if the statement is in the standard form prescribed by the [[Secretary of State]] and otherwise shall be $ , plus in each case an additional fee of $ for each name more than one against which the statement of assignment is required to be indexed. Notwithstanding the provisions of this subsection, an assignment of record of a security interest in a xture contained in a mortgage eective as a xture ling (subsection (6) of Section 9-402) may be made only by an assignment of the mortgage in the manner provided by the law of this state other than this Act. (3) After the disclosure or ling of an assignment under this section, the assignee is the secured party of record.
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Appendix B

Reasons for 1972 Change

The changes are all conforming changes connecting with changes in mechanics in other sections of Part 4; with the addition of timber and minerals or the like (including oil and gas) at wellhead or minehead and accounts resulting from the sale thereof to the groups of collateral which must be led and indexed in the real estate records; and with the provision (Section 9-402(6)) that a mortgage of real estate may act as a nancing statement of xtures.

9-406. Release of Collateral; Duties of Filing Ocer; Fees. A secured party of record may by his signed statement release all or a part of any collateral described in a led nancing statement. The statement of release is sucient if it contains a description of the collateral being released, the name and address of the debtor, the name and address of the secured party, and the le number of the nancing statement. A statement of release signed by a person other than the secured party of record must be accompanied by a separate written statement of assignment signed by the secured party of record and complying with subsection (2) of Section 9-405, including payment of the required fee. Upon presentation of such a statement of release to the ling ocer he shall mark the statement with the hour and date of ling and shall note the same upon the margin of the index of the ling of the nancing statement. The uniform fee for ling and noting such a statement of release shall be $ if the statement is in the standard form prescribed by the [[Secretary of State]] and otherwise shall be $ , plus in each case an additional fee of $ for each name more than one against which the statement of release is required to be indexed. Reasons for 1972 Change
The changes are merely conforming changes to changes in other sections.

[[ 9-407. Information From Filing Ocer]]. [[ (1) If the person ling any nancing statement, termination statement, statement of assignment, or statement of release, furnishes the ling ocer a copy thereof, the ling ocer shall upon request note upon the copy the le number and date and hour of the ling of the original and deliver or send the copy to such person.]] [[ (2) Upon request of any person, the ling ocer shall issue his certicate showing whether there is on le on the date and hour stated therein, any presently eective nancing statement naming a particular debtor and any statement of assignment thereof and if there is, giving the date and hour of ling of each such statement and the names and addresses of each secured party therein. The uniform fee for such a certicate shall be $ [plus $ for each nancing statement and for each statement of assignment reported therein.] if the request for the certicate is in the standard form prescribed by the [[Secretary of State]] and otherwise shall be $ [plus $ for each nancing statement and for each statement of assignment reported therein.] Upon request the ling ofcer shall furnish a copy of any led nancing statement or statement of assignment for a uniform fee of $ per page.]] Reasons for 1972 Change
The change in this optional section is merely a conforming change to the changes in other sections. 1328

1972 Amendments

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Note: This section is proposed as an optional provision to require ling ocers to furnish certicates. Local law and practices should be consulted with regard to the advisability of adoption.

9-408. Financing Statements Covering Consigned or Leased Goods. A consignor or lessor of goods may le a nancing statement using the terms consignor, consignee, lessor, lessee or the like instead of the terms specied in Section 9-402. The provisions of this Part shall apply as appropriate to such a nancing statement but its ling shall not of itself be a factor in determining whether or not the consignment or lease is intended as security (Section 1-201(37)). However, if it is determined for other reasons that the consignment or lease is so intended, a security interest of the consignor or lessor which attaches to the consigned or leased goods is perfected by such ling. Reasons for 1972 Adoption of New Section
This new section adapts the ling system of the Article to consignments and leases. Filing of consignments is required under certain conditions (Sections 2-326(3), 9-114). Filing of true leases which are not security interests (Section 1-201(37)) is not required; but because the question whether a lease is a true lease may be a close one, ling is permitted for leases.

PART 5 DEFAULT 9-501. Default; Procedure When Security Agreement Covers Both Real and Personal Property. (1) When a debtor is in default under a security agreement, a secured party has the rights and remedies provided in this Part and except as limited by subsection (3) those provided in the security agreement. He may reduce his claim to judgment, foreclose or otherwise enforce the security interest by any available judicial procedure. If the collateral is documents the secured party may proceed either as to the documents or as to the goods covered thereby. A secured party in possession has the rights, remedies and duties provided in Section 9-207. The rights and remedies referred to in this subsection are cumulative. (2) After default, the debtor has the rights and remedies provided in this Part, those provided in the security agreement and those provided in Section 9-207. (3) To the extent that they give rights to the debtor and impose duties on the secured party, the rules stated in the subsections referred to below may not be waived or varied except as provided with respect to compulsory disposition of collateral (subsection (3) of Section 9-504 and [ (subsection (1) of] Section 9-505) and with respect to redemption of collateral (Section 9-506) but the parties may by agreement determine the standards by which the fulllment of these rights and duties is to be measured if such standards are not manifestly unreasonable: (a) subsection (2) of Section 9-502 and subsection (2) of Section 9-504 insofar as they require accounting for surplus proceeds of collateral; (b) subsection (3) of Section 9-504 and subsection (1) of Section 9-505 which deal with disposition of collateral;
1329

 9-501

Appendix B

(c) subsection (2) of Section 9-505 which deals with acceptance of collateral as discharge of obligation; (d) Section 9-506 which deals with redemption of collateral; and (e) subsection (1) of Section 9-507 which deals with the secured party's liability for failure to comply with this Part. (4) If the security agreement covers both real and personal property, the secured party may proceed under this Part as to the personal property or he may proceed as to both the real and the personal property in accordance with his rights and remedies in respect of the real property in which case the provisions of this Part do not apply. (5) When a secured party has reduced his claim to judgment the lien of any levy which may be made upon his collateral by virtue of any execution based upon the judgment shall relate back to the date of the perfection of the security interest in such collateral. A judicial sale, pursuant to such execution, is a foreclosure of the security interest by judicial procedure within the meaning of this section, and the secured party may purchase at the sale and thereafter hold the collateral free of any other requirements of this Article. Reasons for 1972 Change
The change is purely technical, to clear up an ambiguity as to whether a debtor could after default agree on the time within which a sale might be held or the time after which a secured party might keep the goods in lieu of a sale.

9-502. Collection Rights of Secured Party. (1) When so agreed and in any event on default the secured party is entitled to notify an account debtor or the obligor on an instrument to make payment to him whether or not the assignor was theretofore making collections on the collateral, and also to take control of any proceeds to which he is entitled under Section 9-306. (2) A secured party who by agreement is entitled to charge back uncollected collateral or otherwise to full or limited recourse against the debtor and who undertakes to collect from the account debtors or obligors must proceed in a commercially reasonable manner and may deduct his reasonable expenses of realization from the collections. If the security agreement secures an indebtedness, the secured party must account to the debtor for any surplus, and unless otherwise agreed, the debtor is liable for any deciency. But, if the underlying transaction was a sale of accounts [, contract rights,] or chattel paper, the debtor is entitled to any surplus or is liable for any deciency only if the security agreement so provides. Reasons for 1972 Change
The change is only the deletion of the term contract rights, which is being eliminated as a dened term under the Article.

9-504. Secured Party's Right to Dispose of Collateral After Default; Eect of Disposition. (1) A secured party after default may sell, lease or otherwise dispose of any or all of the collateral in its then condition or following any commercially reasonable preparation or processing. Any sale of goods is subject to the Article on Sales (Article 2). The proceeds of disposition shall be applied in the order following to
1330

1972 Amendments

9-504

(a) the reasonable expenses of retaking, holding, preparing for sale or lease, selling, leasing and the like and, to the extent provided for in the agreement and not prohibited by law, the reasonable attorneys' fees and legal expenses incurred by the secured party; (b) the satisfaction of indebtedness secured by the security interest under which the disposition is made; (c) the satisfaction of indebtedness secured by any subordinate security interest in the collateral if written notication of demand therefor is received before distribution of the proceeds is completed. If requested by the secured party, the holder of a subordinate security interest must seasonably furnish reasonable proof of his interest, and unless he does so, the secured party need not comply with his demand. (2) If the security interest secures an indebtedness, the secured party must account to the debtor for any surplus, and, unless otherwise agreed, the debtor is liable for any deciency. But if the underlying transaction was a sale of accounts [, contract rights,] or chattel paper, the debtor is entitled to any surplus or is liable for any deciency only if the security agreement so provides. (3) Disposition of the collateral may be by public or private proceedings and may be made by way of one or more contracts. Sale or other disposition may be as a unit or in parcels and at any time and place and on any terms but every aspect of the disposition including the method, manner, time, place and terms must be commercially reasonable. Unless collateral is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market, reasonable notication of the time and place of any public sale or reasonable notication of the time after which any private sale or other intended disposition is to be made shall be sent by the secured party to the debtor, if he has not signed after default a statement renouncing or modifying his right to notication of sale. In the case of consumer goods no other notication need be sent. In other cases notication shall be sent to any other secured party from whom the secured party has received (before sending his notication to the debtor or before the debtor's renunciation of his rights) written notice of a claim of an interest in the collateral [and except in the case of consumer goods to any other person who has a security interest in the collateral and who has duly led a nancing statement indexed in the name of the debtor in this state or who is known by the secured party to have a security interest in the collateral]. The secured party may buy at any public sale and if the collateral is of a type customarily sold in a recognized market or is of a type which is the subject of widely distributed standard price quotations he may buy at private sale. (4) When collateral is disposed of by a secured party after default, the disposition transfers to a purchaser for value all of the debtor's rights therein, discharges the security interest under which it is made and any security interest or lien subordinate thereto. The purchaser takes free of all such rights and interests even though the secured party fails to comply with the requirements of this Part or of any judicial proceedings (a) in the case of a public sale, if the purchaser has no knowledge of any defects in the sale and if he does not buy in collusion with the secured party, other bidders or the person conducting the sale; or
1331

 9-504

Appendix B

(b) in any other case, if the purchaser acts in good faith. (5) A person who is liable to a secured party under a guaranty, indorsement, repurchase agreement or the like and who receives a transfer of collateral from the secured party or is subrogated to his rights has thereafter the rights and duties of the secured party. Such a transfer of collateral is not a sale or disposition of the collateral under this Article. Reasons for 1972 Change
Under the 1962 Code the secured party giving notice of sale had to notify (except in the case of consumer goods) not only every other person who had duly led a nancing statement indexed in the name of the debtor in the state and who still had a security interest in the collateral, but also any other person known by the secured party to have an interest in the collateral. This meant that the secured party had to search the records in every case of notice of sale, to ascertain whether there were any other secured parties with nancing statements that might be deemed to cover the collateral in question. Moreover, he ran the risk that some informal communication by letter, or even orally, might be deemed to have given him knowledge of the interest of that other party. These burdens of searching the record and of checking the secured party's les were greater than the circumstances called for because as a practical matter there would seldom be a junior secured party who really had an interest needing protection in the case of a foreclosure sale. Therefore, a change is made requiring notice to persons other than the debtor only if such persons had notied the secured party in writing of their claim of an interest in the collateral before he sent his notication to the debtor or before the debtor's renunciation of his rights. Express provision is made to recognize the right of a debtor to renounce or modify his right to notice after, but not before, default. A corresponding change is made in Section 9-505.

9-505. Compulsory Disposition of Collateral; Acceptance of the Collateral as Discharge of Obligation. (1) If the debtor has paid sixty per cent of the cash price in the case of a purchase money security interest in consumer goods or sixty per cent of the loan in the case of another security interest in consumer goods, and has not signed after default a statement renouncing or modifying his rights under this Part a secured party who has taken possession of collateral must dispose of it under Section 9-504 and if he fails to do so within ninety days after he takes possession the debtor at his option may recover in conversion or under Section 9-507(1) on secured party's liability. (2) In any other case involving consumer goods or any other collateral a secured party in possession may, after default, propose to retain the collateral in satisfaction of the obligation. Written notice of such proposal shall be sent to the debtor [and except in the case of consumer goods to any other secured party who has a security interest in the collateral and who has duly led a nancing statement indexed in the name of the debtor in this state or is known by the secured party in possession to have a security interest in it. If the debtor or other person entitled to receive notication objects in writing within thirty days from the receipt of the notication or if any other secured party objects in writing thirty days after the secured party obtains possession the secured party must dispose of the collateral under Section 9-504.] if he has not signed after default a statement renouncing or modifying his rights under this subsection. In the case of consumer goods no other notice need be given. In other cases notice shall be sent to any other secured party from whom the secured party has received (before sending his notice to the debtor or before the debtor's renunciation of his rights) written notice of a claim of an interest in the collateral. If the secured
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9-505

party receives objection in writing from a person entitled to receive notication within twenty-one days after the notice was sent, the secured party must dispose of the collateral under Section 9-504. In the absence of such written objection the secured party may retain the collateral in satisfaction of the debtor's obligation. Reasons for 1972 Change
Under subsection (2) of this section the secured party may in lieu of sale give notice to the debtor and certain other persons that he proposes to retain the collateral in lieu of sale. Under the 1962 Code the other persons were the same as those who were entitled to notice of sale under Section 9-504(3), and such other persons are limited by the change in the same fashion as they were limited in Section 9-504(3) and for the same reasons. See the Reasons for Change under Section 9-504.

1333

ARTICLE 11 EFFECTIVE DATE AND TRANSITION PROVISIONS

Notes: This material has been numbered Article 11 to distinguish it from Article 10, the transition provision of the 1962 Code, which may still remain in eect in some states to cover transition problems from pre-Code law to the original Uniform Commercial Code. Adaptation may be necessary in particular states. The terms [old Code] and [new Code] and [old U.C.C.] and [new U.C.C.] are used herein, and should be suitably changed in each state.

This draft was prepared by the Reporters and has not been passed upon by the Review Committee, the Permanent Editorial Board, the American Law Institute, or the National Conference of Commissioners on Uniform State Laws. It is submitted as a working draft which may be adapted as appropriate in each state. The Discussions were written by the Reporters to assist in understanding the purpose of the drafts.

11-101. Eective Date. This Act shall become eective at 12:01 A.M. on , 19 . Discussion
An eective date substantially after enactment is advisable to allow ample time for relings as required.

11-102. Preservation of Old Transition Provision. The provisions of [here insert reference to the original transition provision in the particular state] shall continue to apply to [the new U.C.C.] and for this purpose the [old U.C.C. and new U.C.C.] shall be considered one continuous statute. Discussion
This section may be necessary in states in which the U.C.C. has only recently been eective. It preserves the principle of Section 10-102(2) of the 1962 Code that pre-Code transactions continue to be governed by pre-Code law. A dierent principle is set forth in this Article 11 for transition problems between the [old Code] and the [new Code], because the changes are not nearly as great. That principle is that the [new Code] governs (with minor exceptions).

11-103. Transition to [New Code]General Rule. Transactions validly entered into after [eective date of old U.C.C.] and before [eective date of new U.C.C.], and which were subject to the provisions of [old U.C.C.] and which would be subject to this Act as amended if they had been entered into after the eective date of [new U.C.C.] and the rights, duties and interests owing from such transactions remain valid after the latter date and may be terminated, completed, consummated or enforced as required or permitted by the [new U.C.C.]. Security interests arising out of such transactions which are perfected when [new U.C.C.] becomes eective shall remain perfected until they lapse as provided in [new U.C.C.], and may be continued as permitted by [new U.C.C.], except as stated in Section 11-105.
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1972 Amendments

11-105

Discussion
This makes the [new Code] applicable to existing security interests, e.g., the revised notice provisions of Part 5 will apply to existing security interests. This would be so even if a 30-day notice period concerning retention of the collateral in lieu of sale were running on the eective date of the [new Code]. Suppose that a security interest attached in State A and the secured party led in State B and assumed that he had 30 days to have the goods reach State B, in a non-purchase money case, under Section 9-103(3) of the [old Code]. Section 9-103(1)(c) of the [new Code] limits the 30-day provision on intended removals to purchase money cases. So long as an ample period of waiting and familiarization is allowed under Section 11-101, this should cause no practical problem. The except clause at the end is necessary because of the possibility that new nancing statements would have to be led in dierent oces.

11-104. Transition Provision on Change of Requirement of Filing. A security interest for the perfection of which ling or the taking of possession was required under [old U.C.C.] and which attached prior to the effective date of [new U.C.C.] but was not perfected shall be deemed perfected on the eective date of [new U.C.C.] if [new U.C.C.] permits perfection without ling or authorizes ling in the oce or oces where a prior ineective ling was made. Discussion
This covers the case of a purchase money security interest in consumer goods, which would not have had to be led under the original Code if the goods had not been xtures. Under the [new Code] the security interest will be perfected without ling, subject to the rights of real estate parties. Section 9-301(1)(d). This also covers the case of factory or oce machinery or replacement consumer goods appliances where the ling of a nancing statement under the original Code in the regular chattel les was invalid because the goods were xtures, but under the [new Code] that ling would be proper. Under the [old Code] the status of assignments of revenues and similar collateral for governmental obligations was unclear. Section 9-104(e) of the [new Code] will make clear that Article 9 does not apply to these transfers. Section 11-108 of this draft may apply on the theory that the changes made by the [new Code] are considered to be merely declaratory. If this does not dispose of the matter, and if it might sometime be held that an assignment by a municipality had been ineective for lack of ling, this provision would then apply from the eective date of the [new Code].

11-105. Transition Provision on Change of Place of Filing. (1) A nancing statement or continuation statement led prior to [eective date of new U.C.C.] which shall not have lapsed prior to [the eective date of new U.C.C.] shall remain eective for the period provided in the [old Code], but not less than ve years after the ling. (2) With respect to any collateral acquired by the debtor subsequent to the eective date of [new U.C.C.], any eective nancing statement or continuation statement described in this section shall apply only if the ling or lings are in the oce or oces that would be appropriate to perfect the security interests in the new collateral under [new U.C.C.]. (3) The eectiveness of any nancing statement or continuation statement led prior to [eective date of new U.C.C.] may be continued by a continuation statement as permitted by [new U.C.C.], except that if [new U.C.C.] requires a ling in an oce where there was no previous nancing
1335

 11-105

Appendix B

statement, a new nancing statement conforming to Section 11-106 shall be led in that oce. (4) If the record of a mortgage of real estate would have been eective as a xture ling of goods described therein if [new U.C.C.] had been in eect on the date of recording the mortgage, the mortgage shall be deemed eective as a xture ling as to such goods under subsection (6) of Section 9-402 of the [new U.C.C.] on the eective date of [new U.C.C.]. Discussion
Subsection (1): All existing nancing statements with a duration of less than 5 years are extended to the full 5 years. In the case of transmitting utilities for which a special rule of longer validity had been provided, the special rule will be continued. Subsection (2) makes clear that all existing nancing statements and continuations on the eective date remain valid for the remainder of the ve years as to existing collateral, even though the appropriate place for ling may have changed under the new rules for accounts, general intangibles, etc. The existing lings also apply to new collateral acquired after the eective date, unless the appropriate ling place is dierent under the new rules. In that case there will have to be a new ling on the eective date to catch new collateral. Subsection (3): A continuation statement may be led after the eective date, but if the appropriate places under the new rules are dierent, the ling should be a nancing statement. Subsection (4) retroactively validates real estate mortgage recording as xture ling.

11-106. Required Relings. (1) If a security interest is perfected or has priority when this Act takes eect as to all persons or as to certain persons without any ling or recording, and if the ling of a nancing statement would be required for the perfection or priority of the security interest against those persons under [new U.C.C.], the perfection and priority rights of the security interest continue until 3 years after the eective date of [new U.C.C.]. The perfection will then lapse unless a nancing statement is led as provided in subsection (4) or unless the security interest is perfected otherwise than by ling. (2) If a security interest is perfected when [new U.C.C.] takes eect under a law other than [U.C.C.] which requires no further ling, reling or recording to continue its perfection, perfection continues until and will lapse 3 years after [new U.C.C.] takes eect, unless a nancing statement is led as provided in subsection (4) or unless the security interest is perfected otherwise than by ling, or unless under subsection (3) of Section 9-302 the other law continues to govern ling. (3) If a security interest is perfected by a ling, reling or recording under a law repealed by this Act which required further ling, reling or recording to continue its perfection, perfection continues and will lapse on the date provided by the law so repealed for such further ling, reling or recording unless a nancing statement is led as provided in subsection (4) or unless the security interest is perfected otherwise than by ling. (4) A nancing statement may be led within six months before the perfection of a security interest would otherwise lapse. Any such nancing statement may be signed by either the debtor or the secured party. It must identify the security agreement, statement or notice (however denominated in any statute or other law repealed or modied by this Act), state the ofce where and the date when the last ling, reling or recording, if any,
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11-108

was made with respect thereto, and the ling number, if any, or book and page, if any, of recording and further state that the security agreement, statement or notice, however denominated, in another ling oce under the [U.C.C.] or under any statute or other law repealed or modied by this Act is still eective. Section 9-401 and Section 9-103 determine the proper place to le such a nancing statement. Except as specied in this subsection, the provisions of Section 9-403(3) for continuation statements apply to such a nancing statement. Discussion
Subsection (1) covers farm equipment perfected without ling. The three-year period ought to cover most existing transactions. It also applies to equipment trusts, and would appear to allow three years for ling. But generally ling under Article 9 for equipment trusts is excluded by Section 9-302(3), and the old pre-amendment ling under the Interstate Commerce Act will continue to serve the purpose. Subsection (2) covers transmitting utility statutes and the like which were outside the Code, and provided for indenite duration. It allows three years for reling. But perfection under a certicate of title law or the like continues to be eective. Some states dealt with transmitting utilities by internal amendment of the Code to permit ling which was good indenitely. Section 11-105(1) operates to validate those lings indenitely even though they may not have been in the Secretary of State's oce. Similarly, Section 11-105(1) would preserve the eect of Ohio's present Section 9-403(2), which in eect makes nancing statements related to combined real estate and chattel mortgages good for the duration of the real estate mortgage, whether or not the chattels are xtures. Subsection (3) covers the case (if any) where a prior transmitting utility provision outside the Code had a ling of limited duration. Subsection (4) covers a case where an ordinary continuation statement cannot be led because the original ling was a non-Code ling or was a Code ling in a dierent ling oce. It was thought advisable to use the concept of nancing statement rather than the concept of continuation statement for these fact situations.

11-107. Transition Provisions as to Priorities. Except as otherwise provided in [Article 11], [old U.C.C.] shall apply to any questions of priority if the positions of the parties were xed prior to the eective date of [new U.C.C.]. In other cases questions of priority shall be determined by [new U.C.C.]. Discussion
Most questions of priority can be broken down to questions between two parties, and the rule is that the [new Code] applies unless the rights of both parties were xed under the [old Code]. If a creditor acquires knowledge of an unled security interest before the eective date of the [new Code], but gets his judgment after the eective date, the rule of the [new Code] governs, since he has no rights until after judgment and levy.

11-108. Presumption that Rule of Law Continues Unchanged. Unless a change in law has clearly been made, the provisions of [new U.C.C.] shall be deemed declaratory of the meaning of the [old U.C.C.]. Discussion
This asserts that the new Code is declaratory, except where a change is clearly intended. This is an eort to minimize transitional problems.

1337

APPENDIX C 1977 Ocial Text Showing Changes Made in former Text of Article 8, Investment Securities, and of Related Sections and Reasons for Changes Reporter's Introductory Comment This proposed revision of Article 8 of the Uniform Commercial Code is an outgrowth of the work of the Committee on Stock Certicates of the Section of Corporation, Banking and Business Law of the American Bar Association. That committee, formed in 1971 in response to the Paperwork Crunch in the securities markets during the late 1960's, was charged with determining what legislation, if any, would be advisable to facilitate the elimination, or reduction in the use, of stock certicates and with drafting such legislation as was proposed. The committee's report, issued on September 15, 1975, contained two principal recommendations: 1) that the Model Business Corporation Act be amended in order to permit the issuance of corporate stock in uncerticated form and 2) that Article 8 of the Uniform Commercial Code (and related sections of other Articles) be revised to provide rules to regulate the rights, duties and obligations of the issuers of, and persons dealing with, uncerticated investment securities. Appendix B of the report was a suggested revision of Article 8. The suggested revision of Article 8 was submitted by the committee to the Permanent Editorial Board for the Uniform Commercial Code which, in turn, referred it to its 348 Committee for review and comment. The revision, with changes suggested by the 348 Committee, was subsequently reviewed by the Permanent Editorial Board and further drafts were presented before the 1976 meeting of the National Conference of Commissioners on Uniform State Laws, the Council of the American Law Institute and the 1977 Annual Meeting of the American Law Institute. At its 1977 meeting, the NCCUSL approved the substance of the revision and referred it to its Committee on Style. That committee made a number of stylistic changes in wording, punctuation and the like, and its product is presented herewith. In this introductory comment, section references are to the revised Article unless preceded by the word present. Detailed Reasons for 1977 Change follow almost every section of the revision, but the pattern is summarized in this introductory comment in the hope that it will be helpful to an understanding of the general scheme of the revision. Scope Perhaps the best approach to describing the scope of the revision is rst to state what it does not do. The revision does not compel the issuance of uncerticated securities by any issuer. Furthermore, the revision does not authorize the issuance of uncerticated securities, a function of the state corporation laws. What the revision is intended to accomplish is to set
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forth a coherent group of rules for the issuers, buyers, sellers and other persons dealing with uncerticated securities, to the same extent that present Article 8 deals with these matters with respect to certicated securities. Although the primary focus of inquiry regarding the possible elimination of certicates has been on corporate stock, the revision is broad enough to cover uncerticated debt securities, should such be issued in the future. It might be noted that the most signicant uncerticated system now in operation is that conducted by the Federal Reserve Banks for United States Government Bonds. It is possible, and, indeed, probable, that particular issues of securities may, temporarily or even permanently, be partly certicated and partly uncerticated. If such be the case, the choice of form will lie with the owner and provisions are made for exchangeability at the owner's option [8-407]. The present denition of security [present 8-102(1)(a) ] is restated, in somewhat changed form but without intended change of substance, as the denition of certicated security [8-102(1)(a) ]. A parallel denition of uncerticated security is then provided, diering in that it does not require representation by an instrument and somewhat narrower in scope to eliminate the inclusion of some interests, e.g., bank accounts, that a broad construction might otherwise include [8-102(1)(b) ]. It is not intended that either denition coincide with the denition of security for other purposes, e.g., the federal securities laws. See Comment 3 to Section 8-102. Approach There has been a conscious attempt to disturb present Article 8 as little as possible. First, the subject-matter content and order of the forty-one numbered sections of the present statute have been preserved. Only four sections have been added. Three of these have no application to wholly certicated systems [8-108, 8-407 & 8-408]. Secondly, with the exception of only two present sections [8-313 & 8-317] and the other new section [8-321], there has been no attempt to change the law with respect to certicated securities. In some instances, where there seemed to be compelling reasons to do so, certain wording and structure have been changed, but without any intention to change the substance. In most instances, the language of the present Article, as it applies to certicated securities, has been preserved with minor stylistic changes. Finally, the rules governing uncerticated securities have been formulated to conform as closely as possible to the rules for certicated securities, consistent, of course, with such changes as are demanded by the absence of an indispensable instrument. For example, the rights of secured parties [8-207], the appropriate person to initiate requests for registration of transfer [8-308] and the assurances an issuer may require as a condition to complying with such requests [8-402] have been structured in a way to produce a minimum of disparity of results and procedures whether certicated or uncerticated securities are involved. Transfer The essential dierence between a certicated and an uncerticated security, and that from which the principal diculties arise, is that the former is represented by an instrument, which may be treated as the prop1339

Appendix C

erty it represents, and the latter is not. Under present Article 8, transfer of a certicated security by purchase, a term which includes all voluntary transfers whether or not for value [present 1-201(32) ], is accomplished by delivery of the certicated security to the purchaser [present 8-301(1) ] or by some other method deemed to constitute delivery to the purchaser [present 8-313(1) ]. Obviously, when a security is uncerticated, there is no instrument to deliver. In the revised Article, the transfer rules are collected in a single subsection [8-313(1) ] and are expressly made exclusive. The basic rule for certicated securities, transfer by delivery, is restated [8-313(1)(a) ] and a coordinate rule for uncerticated securities, transfer by registration, is added [8-313(1)(b) ]. The present rule, that delivery to the purchaser's broker of a certicated security issued in the name of or specially indorsed to the purchaser constitutes transfer to the purchaser, is preserved [8-313(1)(c) ], but is expanded to cover such delivery not only to the purchaser's broker but to any nancial intermediary acting for the purchaser. A nancial intermediary is dened to include (in addition to brokers) banks, clearing corporations and other entities which regularly maintain security accounts for their customers [8-313(4) ]. The remaining subparagraphs recognize current security-holding practices and provide explicitly for the transfer of ownership of both certicated and uncerticated securities controlled by third parties. Thus, when the controlling party is a clearing corporation [8-102(3) ], transfer is eected merely by book entry [8-313(1)(g) ]. When the controlling party is a nancial intermediary, but not a clearing corporation, transfer is eected by conrmation to the purchaser accompanied by book entry [8-313(1)(d) ]. When the controlling party is not a nancial intermediary, transfer is effected by acknowledgment to the purchaser [8-313(1)(e) & (f) ]. Three provisions apply only to the creation and release of security interests [8-313(1)(h), (i) & (j) ]. Registration of Transfer Registration of transfer of a certicated security is requested by presenting the security itself, duly indorsed, to the issuer [8-401(1) ]. With uncerticated securities that procedure is unavailable, and the request for registration of transfer is made by an instruction [8-308(4) ] which normally will be a signed writing [8-308(5)(a) ] but which may, under the terms of a written agreement, be in other than written form [8-308(5)(b) ]. To be eective, an instruction must be originated by an appropriate person who, for an unencumbered security, is the registered owner or his representative [8-308(7)(a) & (8) ]. Upon receipt of an instruction, the issuer is under a duty to eect a duly requested registration [8-401(1) ], liable for delay or failure to comply [8-401(2) ], entitled to certain assurances [8-402], and liable for improper registration [8-404(3) ] in much the same manner applicable to requests for registration of transfer of a certicated security. Within two business days after registration of transfer of an uncerticated security, the issuer must send a written statement conrming the registration to both the transferor [8-408(5) ] and the transferee [8-408(1)
1340

1977 Amendments

]. The statement sent to the transferor will alert him to take appropriate action if the transfer was unauthorized or otherwise improper. The statement sent to the transferee will assure him that the transfer has been properly registered and will also serve as notice to him of any liens [8-103(b) ], restrictions [8-204(b) ] or claims [8-304(2) ] to which the uncerticated security may be subject. Unless a transferee for value is relying on a third party, e.g., his broker, it is anticipated that he may withhold his consideration, in escrow or otherwise, until he receives an appropriate statement from the issuer. Creation of Security Interests A security interest in a certicated security is normally created by delivery (pledge) of the security, duly indorsed, to the secured party (pledgee). The physical procedure is indistinguishable from an outright transfer. The pledgee may elect to leave the security registered in the name of the debtor or to cause the registration of transfer to himself or his nominee. A security interest in an uncerticated security may be created by registration of transfer to the secured party, a procedure which involves no concepts distinct from those involved in any outright transfer of an uncerticated security. The secured party will be in essentially the same position as the pledgee of a certicated security who obtains registration of transfer to himself. This revision provides an additional method for evidencing a security interest in an uncerticated securityregistration of pledge [8-108]. This is intended to create a situation analogous to that when the pledgee of a certicated security leaves the security registered in the debtor's name. Registration of pledge is eected by submission of an instruction [8-308(4) ] to the issuer, originated by the registered owner or his representative [8-308(7)(a) & (8) ]. The procedure for registration follows that established for registration of transfer. The issuer is obligated to send conrmatory statements to the pledgee and owner immediately following registration [8-408(2) ] and the pledgee, like the buyer, may choose to await receipt of the statement before advancing the loan. Once a pledge has been registered, the registered owner continues to enjoy all the rights of an owner (dividends, voting rights, notices, etc.) [8-207(2) ] except onethe power to order transfer. That power passes exclusively to the registered pledgee [8-207(3) ] and only the pledgee or his representative is an appropriate person to originate a transfer instruction [8-308(7)(b) & (8) ]. This is substantially the situation that exists when a certicated security is pledged. The still registered owner is recognized as such by the issuer [8-207(1) ], but the pledgee's possession of the duly indorsed certicate achieves the dual purpose of depriving the debtor of his power to transfer and conferring that power on the pledgee. The registered pledgee of an uncerticated security may exercise his transfer power in three ways: by outright transfer free of his pledge [8-207(4)(a) ]; by transfer of ownership subject to his pledge [8-207(4)(b) ]; or by transfer of his security interest to another secured party [8-207(4)(c) ]. There is one area of disparity between the pledge of a certicated secu1341

Appendix C

rity and the registered pledge of an uncerticated security. When a certicated security is held by a pledgee without registration of transfer, additional securities distributed with respect to the pledged security, e.g., stock dividends, will necessarily be delivered to the registered owner, since the issuer is unaware of the pledgee's interest. When an uncerticated security is subject to a registered pledge, such additional securities will, if uncerticated, be registered subject to the pledge [8-207(6)(a) ] or, if certicated, will be delivered to the pledgee [8-207(6)(b) ]. This appears to be a desirable result which is impractical to obtain under the pledge of a certicated security. Similarly, securities issued or money paid in exchange for an uncerticated security will be subject to the pledgee's control [8-207(6) ]. Under the revised Article, the transfer rules are exclusive and expressly include the transfer of security interests [8-313(1) ]. Thus, the creation of security interests is conditioned upon the use of an eective means of transfer [8-321(1) ]. The transfer rules include the physical delivery of a certicated security [8-313(1)(a) ] and the registration of either pledge or transfer of an uncerticated security [8-313(1)(b) ]. They also include provisions when securities are controlled by third parties. When the controlling party is a clearing corporation [8-102(3) ], transfer is eected by book entry [8-313(1)(g) ]. When the controlling party is a nancial intermediary [8-313(4) ], but not a clearing corporation, transfer is eected by conrmation to the secured party accompanied by a book entry [8-313(1)(d) ]. When the controlling party is not a nancial intermediary, e.g., a prior pledgee, transfer is eected by acknowledgment to the secured party [8-313(1)(e) & (f) ]. Security interests created by any of these methods are enforceable even without a written agreement signed by the debtor [8-321(2) ] since they involve either possession by the secured party or the functional equivalent thereof. In addition, three methods of transfer, applicable only to the creation of security interests, are provided [8-313(1)(h), (i) & (j) ]. These methods do require a written security agreement signed by the debtor and are included to permit the continuation of practices which result in perfected nonpossessory security interests under present Article 9 [present 9-304(4) & 9-305] and to document the creation of a security interest in securities already held in the debtor's account by a nancial intermediary. Perfection of Security Interests The security interest of the pledgee of a certicated security is both created [present 9-203(1)(a) ] and perfected [present 9-304(1) ] by the secured party's possession. Possessory security interests are expressly exempted from the normal ling requirements of Article 9 [9-302(1)(a) ]. A nonpossessory security interest may be perfected by notice to a bailee [present 9-305] or, under certain conditions and for temporary periods, automatically [present 9-304(4) & (5) ]. Under the revised Article, a security interest which is eectively created is also perfected [8-321(2) ]. If the security interest is created under the provision which corresponds to the present provision of Article 9 for temporary automatic perfection [8-313(1)(i) ], perfection expires at the end
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of the 21 day period unless other steps are timely taken [8-321(2) ]. Security interests in securities are expressly excluded from the perfection provisions of Article 9 [9-302(1)(f), 9-304(1) & (4) and 9-305]. Termination of Security Interests The security interest of a pledgee of a certicated security is normally released by redelivery of the security to the debtor. Similarly, the security interest in an uncerticated security created by registration of transfer to the secured party is released by registration of transfer back to the debtor. A security interest in an uncerticated security created by registration of pledge is released by registration of release [8-108]. Registration of release is eected by submission of an instruction [8-308(4) ] to the issuer, originated by the registered pledgee or his representative [8-308(7)(b) & (8) ]. The procedure for registration follows that established for registration of transfer or pledge. The issuer is obligated to send conrmatory statements to the pledgee and the owner immediately following registration [8-408(3) ] and the owner may choose to make arrangements to withhold his repayment until he has received an appropriate statement. A security interest in securities controlled by a third party would normally be terminated by a transfer back to the debtor under the same method employed for its creation [8-313(1)(d), (e), (f), (g) or (h) ]. Unless the parties otherwise agree, any such transfer will terminate the security interest. Provision is made for temporary continuation of perfection in the case where a certicated security is redelivered to the debtor for limited purposes [8-321(4) ], analogous to similar provisions in Article 9 [present 9-304(5) ]. The Initial Transaction Statement When a security is certicated, the security itself, if genuine, is prima facie evidence of the holder's rights [8-105(3)(c) ]. When a security is uncerticated, a similar, but distinctly more limited, function is served by the initial transaction statement (hereinafter ITS). The ITS is a signed statement sent by the issuer of an uncerticated security upon registration of transfer, pledge or release to the transferee, pledgee or owner, respectively [8-408(4) ]. Like certicated securities, an ITS acts as an estoppel statement against the issuer. But unlike certicated securities, an ITS runs in favor of only the addressee and speaks only as of the time of its issuance [8-105(3)(d) ]. Consequently, parties other than the addressee, particularly subsequent purchasers, cannot justiably rely on what an ITS does or does not contain. The statute requires a warning legend to that effect [8-408(9) ]. The purchaser of an uncerticated security is charged with notice of the issuer's right to a lien [8-103(b) ], terms of a security [8-202(1) ], restrictions on transfer [8-204(b) ] and adverse claims [8-304(2) ] which appear or are referred to in the ITS sent to him. Conversely, the purchaser for value without notice who receives an ITS which does not refer to defects or defenses is normally entitled to assume that none exists. Furthermore, the purchaser for value without notice who receives an ITS is generally entitled to assume that the uncerticated security referred to therein is valid [8-202(2)(a) ], that, in many cases, it has been properly signed, even when
1343

Appendix C

it has not [8-205], that it has been properly completed, even when it has not [8-206(3)(b) ] and receives the benet of certain warranties of third party signatories [8-208(1) ]. Finally, the purchaser for value without notice who receives an ITS enjoys a limitation in the warranties he has made in connection with the presentation of a certicated security to the issuer [8-306(1) ] and is shielded from liability to a former owner or pledgee [8-311(a) ]. In these respects, the ITS serves substantially the same function for the addressee as does a certicated security. Under the shelter principle, the purchaser of a security acquires the rights of his transferor [8-301(1) ]. If A had purchased an uncerticated security without knowledge of a restriction to which it was subject and had received an ITS which failed to note the restriction, he would take free of the restriction [8-204(b) ]. Any purchaser from A would acquire the security free of the restriction and could, relying on As rights, demand a clean ITS from the issuer. If, however, A had knowledge of the restriction when he purchased, A would be subject to the restriction even if, by error, the ITS sent to him had failed to note its existence. In that event, notwithstanding As clean ITS, the rights of a purchaser from A would rise no higher than As, and the purchaser would take subject to the restriction. The purchaser would take free of the restriction only if he purchased without knowledge and if the ITS sent to him failed to note the restriction. In contrast, if A had purchased a certicated security with knowledge of a restriction not noted thereon, a purchaser from A without knowledge would take free of the restriction [8-204(a) ] even though A could not have. There is a much more signicant dierence. A purchaser may normally assume that the holder (registered owner, indorsee or bearer) of a certicated security is the owner and entitled to transfer it. An ITS, however, merely evidences the facts at the time of its issuance [8-105(3)(d) ]. The fact that A exhibits an ITS showing that A had become the owner of an uncerticated security at some prior date gives a potential purchaser absolutely no assurance that A has any rights in that security now. Since the time of the ITS's issuance, A might have pledged, otherwise encumbered or transferred the security. While, in some cases, the purchaser may be willing to rely on As representations or on those of a third-party guarantor, he cannot justiably rely on any rights against the issuer until he receives his own ITS. Rights and Obligations of Buyers and Sellers All securities of the same issue, both certicated and uncerticated, are treated as fungible. Thus, when an issue of securities is comprised of both certicated and uncerticated securities, a person obligated to transfer securities of that issue may perform either by delivering duly registered or indorsed certicated securities to his obligee or by causing the registration of transfer of equivalent uncerticated securities to his obligee [8-107(1) ]. Similarly, the buyer of securities becomes obligated to pay the price whether the securities transferred to him are certicated or uncerticated [8-107(2) ]. In an exchange or brokerage transaction, the selling customer may complete his obligation by delivering certicated securities to his broker
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1977 Amendments

[8-314(1)(a)(i) ], by causing the registration of transfer of uncerticated securities to his broker [8-314(1)(a)(ii) ] or, if requested, by causing a third party to acknowledge that he holds a security for the broker [8-314(1)(a)(iii) ]. In addition, the selling customer can conditionally fulll his obligation by delivering to his broker a transfer instruction for an uncerticated security, but his obligation is not completed if the instruction is presented to the issuer within thirty days and the issuer refuses to register the requested transfer [8-314(1)(a)(iv) ]. This nal alternative is also available to the selling broker in fullling his obligation to the buying broker, with the same condition attaching [8-314(1)(b)(iii) ]. In a transaction not on an exchange or through brokers, the transferor's duty is not fullled, even conditionally, by the delivery of an instruction [8-314(2) ]. If the issuer of an uncerticated security demands proof of authority or other evidence which is necessary to obtain registration of transfer, pledge or release of the security, the transferor, pledgor or pledgee, as the case may be, is obligated to provide such evidence, but, if the transfer, pledge or release is not for value, only if he is reimbursed for any expense involved [8-316]. The performance exception to the statute of frauds includes, in addition to the acceptance of delivery of a certicated security, the acceptance of a transfer instruction and the situation where the transfer of an uncerticated security has been registered to the alleged buyer and the alleged buyer does not object in writing to the issuer within ten days after receiving the statement conrming the registration of transfer [8-319(b) ]. Warranties The person who requests an issuer to register the transfer of a certicated security, by presenting a duly indorsed certicated security, warrants to the issuer that he has the power to do so, or, in eect, that the chain of indorsements is genuine and complete [8-306(1) ]. In making that warranty, the presenter, who, in the typical case, is, or acts for, the transferee, has before him, as evidence, the security, the indorsements and signature guarantees. On the other hand, the person who requests an issuer to register the transfer (or pledge or release) of an uncerticated security does so by presenting an instruction, which is not even presumptive evidence that the originator is the registered owner or pledgee of the security involved. Hence, the presenter, as such, warrants nothing to the issuer. Rather, the originator of the instruction, who is responsible for its creation, warrants to the issuer that he will be, at the time of presentation, an appropriate person to originate the instruction and entitled to the requested registrationfacts which he, and perhaps no one else, knows [8-306(5) ]. The transferor of a certicated security warrants to a purchaser for value the eectiveness and rightfulness of the transfer and the genuineness of the security [8-306(2) ]. In eect, he undertakes that the issuer will recognize the purchaser as the owner of the intangible interest represented by the security free from any defects not noted thereon. The warranties made by the originator of an instruction to a purchaser for value are intended to produce substantially the same obligation and include,
1345

Appendix C

therefore, a warranty of absence of defectsa fact which the purchaser of a certicated security can himself ascertain from the security itself [8-306(7) ] but of which the purchaser of an uncerticated security cannot have knowledge until he receives his initial transaction statement from the issuer. The warranties made by secured parties who originate instructions with respect to uncerticated securities are limited [8-306(8) ] consistent with similar limitations of the warranties of secured parties who deliver certicated securities they hold in pledge [8-306(4) ]. Guarantees The signature guarantee, which is an essential element of the transfer process for widely-held securities, presents a special problem. The signature guarantor of the indorsement of a certicated security warrants that the indorser is an appropriate person, i.e., that he is, or acts for, the owner [8-312(1)(b) ]. To make a similar undertaking with respect to the originator of an instruction to transfer (or pledge or release) an uncerticated security, the signature guarantor, without a certicated security, prior indorsements and signature guarantees before him, would have to warrant a fact of which he has no evidencethat the originator is, or acts for, the registered owner or pledgee. That fact, however, will be known to the issuer and since the issuer is the only person who must act on the instruction, there is no need to require the signature guarantor's warranty. Hence, the warranties of the signature guarantor of an instruction are limited to genuineness, capacity and the fact that the signer is, or acts for, the purported owner or pledgee [8-312(2) ]. The originator himself warrants to the issuer that he is an appropriate person [8-306(5) ]. A special guarantee of signature is also provided by which the guarantor warrants, in eect, that the instruction will result in the requested transfer, free from defects [8-312(3) ]. Although the issuer cannot require a special guarantee [8-312(7) ], it is anticipated that it will be used in brokerage transactions in which the broker will specially guarantee the signature of his own customer. When a special guarantee of signature is made, the originator makes equivalent warranties to the guarantor [8-306(6) ]. Finally, there is a guarantee of instruction which entails a warranty of rightfulness in all respects [8-312(6) ], analogous to the guarantee of indorsement of a certicated security [8-312(5) ]. This guarantee cannot be required by the issuer [8-312(7) ], but when it is made, the originator makes equivalent warranties to the guarantor [8-306(7) ]. Bona Fide Purchase The concept of bona de purchase applies to both certicated and uncerticated securities [8-302(1) ]. The dierence is that the purchaser of a certicated security is charged with notice only of what appears when he or a person acting in his behalf takes delivery of the security while the purchaser of an uncerticated security is charged with notice of what appears in the initial transaction statement sent to him. Thus, the purchaser of a certicated security without notice takes free of liens [8-103(a) ], terms of a security which may be defenses [8-202(1) ] and restrictions [8-204(a) ] not noted on the security. He may also take free of any adverse claim
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[8-302(3) ] unless the nature of the claim is such that it would be disclosed by the security itself [8-304(1) ]. The purchaser of an uncerticated security without notice, however, is charged with notice of liens [8-103(b) ], defenses [8-202(1) ] and restrictions [8-204(b) ] noted in the initial transaction statement sent to him. He is also charged with notice of adverse claims shown in the initial transaction statement [8-304(2) ]. Only when he has received a clean initial transaction statement can he be sure that he enjoys bona de purchaser status [8-302(1)(b) ]. The above-described dierence is of limited practical signicance. As has already been noted, the purchaser of an uncerticated security cannot be sure that he has received anything (whether or not defective) until he receives his initial transaction statement. Therefore, unless he chooses to rely on the warranties of his seller or a third party guarantor, he will not release his consideration unless and until he receives a clean initial transaction statement to give him the assurance that he has, indeed, received what he bargained for. The wide-spread use of wholly certicateless systems will necessarily involve the development of escrow arrangements or other mechanisms by means of which the parties will obtain satisfactory assurances. Adverse Claims The treatment of adverse claims presented a very special kind of problem. With certicated securities they are communicated by mere written notication to the issuer [8-403(1) ]. They do not normally constitute a serious problem because they can be so easily defeated by transfer of the security to a purchaser without knowledge [8-302(3) ]. The rules for certicated securities have, therefore, been preserved [8-403(1), (2) & (3) ]. With uncerticated securities, however, the rules become unworkable because transfer is accomplished only by communication with the issuer [8-313(1)(b) ] and the purchaser is charged with notice of whatever appears in the initial transaction statement sent to him [8-304(2) ]. Consequently, new rules have been developed for uncerticated securities. They require that a third party claim be embodied in legal process in order to make it cognizable by the issuer [8-403(4)(a) ]. They also permit, under certain circumstances, the registration of transfer or pledge subject to an adverse claim [8-403(5) ]. Finally, they provide protection to a registered pledgee who attained bona de purchaser status prior to the time that notice of a cognizable adverse claim reached the issuer [8-403(6) ]. Creditors' Rights The general rule of present Article 8, that no judicial lien on a debtor's interest in a security is valid until the security is actually seized [present 8-317(1) ] is wholly inapplicable to uncerticated securities and, in the light of wide-spread nominee registration, depository systems and the like, has become inadequate even with respect to certicated securities. That rule is retained only for certicated securities in the debtor's control [8-317(1) ]. Uncerticated securities registered in the debtor's name may be reached only by service upon the issuer [8-317(2) ]. The interest of a debtor in either certicated or uncerticated securities under the control of secured parties or nancial intermediaries is reached by service upon the
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controlling party [8-317(3) & (4) ]. When a debtor's interest in securities controlled by a third party is subject to a judicial lien, provisions are made for the transfer of such securities, free of the lien, and the shifting of the lien to the proceeds in the hands of the third party [8-317(5) ]. Nominee Registration The increasing incidence of nominee registration in brokerage accounts, bank custody accounts, security depositories and otherwise has led to new and expanded provisions regarding the rights of creditors [8-317]. The same phenomenon has also led to a revision of the general transfer rules by substituting the broader category of nancial intermediary [8-313(4) ] where only broker formerly appeared [8-313(1)(c) & (d), (2) & (3) ].

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ARTICLE 8 INVESTMENT SECURITIES

PART 1 SHORT TITLE AND GENERAL MATTERS 8-101. Short Title. This Article shall be known and may be cited as Uniform Commercial CodeInvestment Securities. Reasons for 1977 Change
Although the title of the Article has not been changed, its coverage has been broadened, by amendment to Section 8-102, to include both securities which are reied, i.e., represented by certicates or other instruments, and those which are not. The former are dened as certicated securities and constitute the entire subject matter of present Article 8. The latter are dened as uncerticated securities and are not now expressly covered by the Uniform Commercial Code. The revised Article is intended to govern the relationships, rights and duties of the issuers of and the parties that deal with both certicated and uncerticated securities to the same extent that present Article 8 governs such relationships, rights and duties with respect to certicated securities alone. This Article does not purport to determine whether a particular issue of securities should be represented by certicates, in whole or in part. It is contemplated that such determination will be made by the issuer under appropriate state or federal law. It is further contemplated that a particular issue of securities may be partly certicated and partly uncerticated, in which event the determination will be at the option of the owner to the extent that the issuer permits. The form of the Article has been disturbed as little as possible and each numbered section deals with the subject matter of the similarly numbered section of the present Article. Only four new sections, 8-108, 8-321, 8-407 and 8-408, have been added.

8-102. Denitions and Index of Denitions. (1) In this Article, unless the context otherwise requires: [ (a) A security is an instrument which (i) is issued in bearer or registered form; and (ii) is of a type commonly dealt in upon securities exchanges or markets or commonly recognized in any area in which it is issued or dealt in as a medium for investment; and (iii) is either one of a class or series or by its terms is divisible into a class or series of instruments; and (iv) evidences a share, participation or other interest in property or in an enterprise or evidences an obligation of the issuer.] (a) A certicated security is a share, participation, or other interest in property of or an enterprise of the issuer or an obligation of the issuer which is (i) represented by an instrument issued in bearer or registered form; (ii) of a type commonly dealt in on securities exchanges or markets or commonly recognized in any area in which it is issued or dealt in as a medium for investment; and
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Appendix C

(iii) either one of a class or series or by its terms divisible into a class or series of shares, participations, interests, or obligations. (b) An uncerticated security is a share, participation, or other interest in property or an enterprise of the issuer or an obligation of the issuer which is (i) not represented by an instrument and the transfer of which is registered upon books maintained for that purpose by or on behalf of the issuer; (ii) of a type commonly dealt in on securities exchanges or markets; and (iii) either one of a class or series or by its terms divisible into a class or series of shares, participations, interests, or obligations. (c) [ (b) ] A security is either a certicated or an uncerticated security. If a security is certicated, the terms security and certicated security may mean either the intangible interest, the instrument representing that interest, or both, as the context requires. A writing [which] that is a certicated security is governed by this Article and not by [Uniform Commercial CodeCommercial Paper] Article 3, even though it also meets the requirements of that Article. This Article does not apply to money. If a certicated security has been retained by or surrendered to the issuer or its transfer agent for reasons other than registration of transfer, other temporary purpose, payment, exchange, or acquisition by the issuer, that security shall be treated as an uncerticated security for purposes of this Article. (d) [ (c) ] A certicated security is in registered form [when] if (i) it species a person entitled to the security or the rights it [evidences] represents, and [when] (ii) its transfer may be registered upon books maintained for that purpose by or on behalf of [an] the issuer, or the security so states. (e) [ (d) ] A certicated security is in bearer form [when] if it runs to bearer according to its terms and not by reason of any indorsement. (2) A subsequent purchaser is a person who takes other than by original issue. (3) A clearing corporation is a corporation registered as a clearing agency under the federal securities laws or a corporation: (a) at least [ninety] 90 percent of [the] whose capital stock [of which] is held by or for one or more [persons (other than individuals) ] organizations, none of which, other than a national securities exchange or association, holds in excess of 20 percent of the capital stock of the corporation, and each of [whom] which is (i) [is] subject to supervision or regulation pursuant to the provisions of federal or state banking laws or state insurance laws, [or] (ii) [is] a broker or dealer or investment company registered under the [Securities Exchange Act of 1934 or the Investment Company Act of 1940] federal securities laws, or (iii) [is] a national securities exchange or association registered under [a statute of the United States such as the Securities Exchange Act of 1934,] the federal securities laws; and [none of whom, other than
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8-102

a national securities exchange or association, holds in excess of twenty per cent of the capital stock of such corporation; and] (b) any remaining capital stock of which is held by individuals who have purchased [such capital stock] it at or prior to the time of their taking oce as directors of [such] the corporation and who have purchased only so much of the capital stock as [may be] is necessary to permit them to qualify as [such] directors. (4) A custodian bank is [any] a bank or trust company [which] that is supervised and examined by state or federal authority having supervision over banks and [which] is acting as custodian for a clearing corporation. (5) Other denitions applying to this Article or to specied Parts thereof and the sections in which they appear are: Adverse claim. Bona de purchaser. Broker. Debtor. Financial intermediary. Guarantee of the signature. Initial transaction statement. Instruction. Intermediary Bank. Issuer. Overissue. Secured Party. Security Agreement. Section Section Section Section Section Section Section Section Section Section Section Section Section [8-301] 8-302. 8-302. 8-303. 9-105. 8-313. 8-402. 8-408. 8-308. 4-105. 8-201. 8-104. 9-105. 9-105.

(6) In addition Article 1 contains general denitions and principles of construction and interpretation applicable throughout this Article. Reasons for 1977 Change
New paragraph (1)(a) denes certicated security in essentially the same terms as present paragraph (1)(a) denes security. The denition is rearranged in order to permit a parallel denition of uncerticated security in new paragraph (1)(b). Two minor changes have been made. The phrase of the issuer has been repeated in order to make clear that it modies property and enterprise as well as obligation. It is understood that this was intended in the present statute. The word represented has been substituted for evidenced as more accurately conveying the notion that a certicated security is, in many ways, treated as if it were the property itself, e.g., ownership is transferred by delivery. Compare the denition of instrument in Section 9-105(1)(i). This terminology, which is used throughout the revised Article, conforms to that of Section 23 of the Model Business Corporation Act and avoids confusion since there will be pieces of paper, statements and the like that will evidence uncerticated securities. The denition of uncerticated security in paragraph (1)(b) diers from the denition of certicated security in two respects. The rst change is in subparagraph (i) which provides that it is not represented by an instrument and is always registered. The second change is the omission from subparagraph (ii) of the phrase or commonly recognized in any area in which it is issued or dealt in as a medium for investment. It was thought that where there was no requirement of representation by an instrument a great many interests which might be regarded as media for